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Mr. Buffett's Investing Advice for Those Nearing Retirement

August 17, 2012 | About:

Being forced to articulate and defend one’s opinions before a group of hungry young minds is a fantastic thought experiment and can really help to refine one’s principles. It’s likely no small coincidence that two of the better investors of the 20th century both taught classes on investing at points in their lives. The first, nicknamed “The Dean of Wall Street,” is none other than Benjamin Graham.


Mr. Graham taught an investment class at Columbia’s business school and also ran a successful partnership, in spite of the economic turmoil of the Great Depression as a backdrop. His most-famous protege, Warren Buffett, once taught a class on investing at the University of Nebraska at Omaha before eventually taking over the helm of Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) and growing book value by 19.8% annualized over the last 46 years. As we’re big fans of both gentlemen (read: copycats), we decided to follow in their footsteps and teach classes on investing as a way to hone our craft. Little did we know that we’d find the process so enjoyable.

We come into contact with more than our share of bright and thoughtful students in the MBA program where we teach. One question that keeps coming up (enough that we thought we should formalize our response): “My parents are nearing retirement — what should they be invested in?”

There’s no doubt, knowing what to invest in as you approach retirement can be a daunting puzzle. Stocks, bonds, cash, commodities, options, gold, annuities... there’s such a wide range of opinions — how can so many experts have such contradictory recommendations?

At the 2012 Berkshire Shareholders’ Meeting, Warren Buffett delivered a great quote to the audience: “Never risk what you have and need, for what you don’t have and don’t need.” Basically, always be mindful of the risks each investment entails.

The conventional finance rule of thumb is to start with 100 and subtract your age to determine the percentage you should allocate between stocks vs bonds. Based on that “wisdom,” at 81 years old, Mr. Buffett should have 19% of his portfolio in stocks and 81% in bonds. Is he following that conventional wisdom and should we? The short answer is a less-than-surprising “no.”

On Feb. 9, 2012, Mr. Buffett released an article in Fortune magazine detailing how he thinks about current investment opportunities. A peek into the mind of one of the best investors of all time is rare treat, and we encourage anyone who cares about their finances to read it when they have time.

Cash and Bonds

The first class of investments Mr. Buffett examines are “currency-based,” meaning cash and bonds. Mr. Buffett doesn’t find either cash or bonds currently attractive for two reasons:

1. The low interest-rate environment (how much has your savings account been paying you lately? All LIBOR-manipulation aside.)

2. Potential inflation (have you been to the grocery store or gas pump lately? Ouch!)

According to the Senior Citizens’ League, “Since 2000, the Social Security Cost of Living Adjustment (COLA) has increased benefits just 36 percent while typical senior expenses have jumped 82 percent, more than twice as fast.”

As a recent MSN article highlighted, “The American Institute for Economic Research recently unveiled a new inflation gauge that better measures the actual day-to-day experiences of most people. We rarely buy a new house or a car, yet we are very sensitive to prices of ordinary purchases like food, fuel, phone services and personal care products. This new measure, dubbed the "Everyday Price Index," is running at 7.2%.” On a fixed income, a 7.2% inflation rate will cut your living standard in half in 10 years time! You don’t want to be in supposedly “conservative” investments like cash and bonds during inflationary times, lest you find yourself clipping Alpo coupons.

Unproductive Assets

The second class of investments Mr. Buffett covers are what could be termed “unproductive assets.” They’ve also been classified as “greater fool” investments — they are bought with the hope that a greater fool will come along and pay more for them than you just paid. Mr. Buffett singles out gold today, housing in the 2000s, Internet stocks in the 1990s, and tulips in the 17th century. Buffett’s concern with these type of investments are two-fold:

1. They produce no cash flow, in fact often incurring storage and insurance costs.

2. They are “sterile” — they don’t replicate themselves or compound themselves with time.

It can be very difficult to determine an intrinsic value for these type of assets, making it nearly impossible to find the all-important margin of safety.



That leaves us with the third class of investments; what Mr. Buffett recommends and also buys with the majority of his wealth. This third class is the equity of world-class businesses, especially when they’re bought at attractive prices. These businesses have the pricing strength to keep up with inflation and protect their owners’ purchasing power (never forget that stocks aren’t just pieces of paper-- they represent partial ownership of a business). Companies like Coca-Cola (NYSE:KO) and Walmart (NYSE:WMT) will be able to raise their prices in-step with inflation and protect the owners of the business. Great businesses provide real, useful goods and services to people. No matter what happens with currencies, that value will pass through to the owners (hyperinflationary disaster excluded). Granted, even the most remarkable company isn’t worth an infinite price though, so be mindful of over-paying.

Mr. Buffett concludes:

“Berkshire's goal will be to increase its ownership of first-class businesses. Our first choice will be to own them in their entirety -- but we will also be owners by way of holding sizable amounts of marketable stocks. I believe that over any extended period of time this category of investing will prove to be the runaway winner among the three we've examined. More important, it will be by far the safest.”

Based on Mr. Buffett’s logical insights, our recommendations for those approaching retirement are:

1. Hold a certain amount of cash for liquidity, living expenses, and the ability to buy more businesses should the market present abnormally great prices.

2. Own the equity of first-class businesses, purchased at attractive, or at worst, reasonable prices in order to utilize the company’s pricing power to shield your own purchasing power. (If you’re not sure what’s a great business or an attractive price, it may be worthwhile to hire someone who does.)

3. Rebalance whenever relative equity or cash percentages get too far away from your comfort zone, eg. 70% equity and 30% cash or 90% equity and 10% cash.

Note: At some point, interest rate changes will make bonds attractive again, but we’re a long way from there right now.

About the author:

Jacob L. Taylor and Lonnie J. Rush are visiting assistant professors at the UC Davis Graduate School of Management where they teach Value Investing. They founded Farnam Street Investments, a boutique investment firm modeled after Warren Buffett’s successful 1950’s partnerships. FSI offers a hedge fund that gives sophisticated, high net worth investors the opportunity join an emerging Buffett-like partnership. They differentiate themselves by applying Mr. Buffett’s criteria to every stock in the known universe, with a special focus on smaller cap stocks. Like Mr. Buffett started with “A” in the Moody’s manual all those years ago, they spend their time scouring the globe for high-quality businesses that are selling for unreasonable prices. They welcome being contacted at [email protected]

Rating: 4.1/5 (29 votes)


Ry.zamora - 6 years ago    Report SPAM
Jacob and Lonnie,

I presume you two are maintaining this account so I'm hoping this comment reaches you.

I like your article, it's very straightforward and simple.

My question, however, is how these imminent seniors can actually appraise these "first class businesses" to determine whether the market price is, indeed, attractive or reasonable at worst.

Warby himself has stated that active management of equity portfolios destroy value and produce less than passive management due to the transaction costs, emotions and behavioral factors, closet indexing, as well as the short-term relative performance drag race many funds go into.

Obviously direct investment is necessary, but this requires a degree of sophistication, I believe, only experience and an entrepreneurial aptitude can provide. I've an uncle who invests successfully some his money in equities, using only newspaper articles as the basis of his decisions, (Most of his money flows into a business he owns.)

Learning how to wade through garbage and identify diamonds from coal isn't as simple as going through introductory material like Investopedia and the Motley Fool, especially when value-maximized analysis and valuation requires more than a background in economics, accounting, and finance (or a CFA candidacy for that matter) and is heavily tied to one's creativity, curiosity, aptitude for logical deduction, and the ability to read people.

I have faced the same question your student asked on an online forum, and although I recommended equities, options, and junior debt at reasonable if not attractive prices, I stressed their sophistication more than the investment classes themselves (by urging them to buy textbooks, learn how to "read between the lines", and put their brain power to work before it's too late), simply because information and data processing--the so-called mosaic theory--define success.

(Take note I am assuming the majority of GuruFocus readers aren't as sophisticated as we are in the Value Investing ideology and the discipline of financial analysis.) :)

~ Ry Zamora
Jacob L. Taylor
Jacob L. Taylor - 6 years ago    Report SPAM
Hi Ry,

Thank you for the thoughtful response.

I'm not sure I'd agree that you need to be highly sophisticated to be a successful investor. I'd point to someone like Walter Schloss as my prime example. In fact, being too "smart" can lead to dangerous blind spots and over-confidence bias (see LTCM). "Paradoxically when dumb money acknowledges it's limitations, it ceases to be dumb." --W.E.B.

And although I appreciate the implied compliment, I'm not sure I'd agree that the majority of gurufocus readers aren't as versed in value investing principles or financial analysis as we are. It's a pretty heady group.

As far as finding attractive ideas for the do-it-yourselfer, my suggestion would be to always have your radar tuned for "maximum pessimism," use research like gurufocus provides to figure out what managers you respect are investing in, or explore a more quantitative-based option like Joel Greenblatt's formulainvesting.com. As long as you're always "fishing in the cheap pond" and keep position sizing small (25-30 stock portfolio minimum), it's pretty tough to go wrong over a long period of time. My money's on the diligent, emotionally-detached, institutional-imperative-free small "unsophisticated" investor with a plan, over the typical finance expert.

Aside from those 3 idea avenues, we do recommend that investors not willing to do the above for themselves find a professional who's strategy makes sense to them (that may not be "value" per se-- there are lots of different paths to success). Value just happens to make sense to us so it's what we practice. Word of caution: it's likely that if the professional can't explain it clearly enough for you to understand in very simple terms, they likely don't understand it that well themselves or they are selling you on something questionable. Be skeptical and trust your gut. Your response should either be a "no" or a "hell yes!"

Happy investing! :)

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