Bonds, especially government bonds, are typically seen as a "safer" investment than stocks. After all, a bond is a promise made by a borrower to pay the creditor a certain amount of money, whereas a shareholder has no such assurances.
However, it’s not that simple. At the 2018 annual Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) investor meeting, Warren Buffett have his views on the U.S. Treasury market.
Buffett will be the first to admit that he has no idea what the bond market is going to do in the future, but he will also be the first to tell you that he thinks nobody else knows either, including central bankers.
He does think that long term bonds are a very unattractive investment for anyone. Although Berkshire does have a sizable U.S. Treasury position, that is simply because Buffett and Charlie Munger (Trades, Portfolio) haven’t been able to make the large acquisitions they have wanted to in recent years.
It is the stated goal of the U.S. Federal Reserve to keep inflation at a 2% rate. Why, then, would an investor want to buy a bond that, even at the best of times, gives them only slightly more than that? As of the writing of this article, the 30 year U.S. Treasury bond has an effective yield of 1.4%, so investors who want to compound their wealth by investing in them are fighting a losing battle, especially when you factor in income taxes.
This is not a new phenomenon. Buffett recalls a time from his childhood when the U.S. government appealed to the patriotism of its citizens during World War 2 by encouraging them to purchase "U.S. Savings Stamps," previously known as "War Bonds." Investors could buy them at $18.75 and get $25 in ten years, representing a 2.9% compounded return - not a great deal for the times.
One of the main reasons the government felt uncomfortable making this promise was because it knew that the enormous deficit spending program being undertaken would lead to a corresponding rise in inflation, further decreasing the value of that $25 payout. As Buffett said:
“We actually were on a massive Keynesian-type behaviour, not because we elected to follow Keynes, but because war forced us to have this huge deficit in our finances that took our debt up to 125% of GDP. It was the great Keynesian experiment of all time and we backed into it and it sent us into a wave of prosperity like we’ve never seen.”
Of course, there are other reasons why investors might want to buy government bonds. They may anticipate that the price of the bond itself might increase due to increased demand. However, this kind of speculative trading is probably not something that a risk-averse bond investor wants to engage in. Thus, there is little reason to rely on Treasury income if your goal is to increase your wealth.
Disclosure: The author owns no stocks mentioned.
Read more here:
- Seth Klarman: The Proper Way to Think About Investment Risk
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- Seth Klarman: Absolute vs. Relative Performance
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