Warren Buffett (Trades, Portfolio), the CEO of Berkshire Hathaway Inc. (BRK.A, Financial) (BRK.B, Financial), has often been asked for his opinion on gold as an investment vehicle, and, to many people’s surprise, he is not in favor. Far from it.
In a CNBC interview, he said, “If you buy an ounce of gold today and you hold it a hundred years, you can go to it every day and you can coo to it and you can caress it and you can fondle it, and 100 years from now you'll have one ounce of gold, and it won't have done anything for you in between. If you buy a hundred acres of farmland, it will produce for you every year you can use that money to buy more farmland (...) for a hundred years, it'll produce things for you, and you still have 100 acres of farmland at the end of the 100 years.”
The Oracle of Omaha has repeatedly expressed his preference for investments that are productive – that generate ongoing income and cash flow. So why does he prefer productive assets, and why does he think gold is a silly investment?
Understanding productive assets
Productive assets are investments that produce regular income or generate cash flow. Some examples include:
- Stocks: They provide dividends that can be reinvested to compound returns over time. Stocks also represent ownership in companies that can grow profits and cash flow.
- Bonds: They pay steady interest income throughout their lifetimes.
- Real estate: Rental properties generate rental income. Appreciation over time also builds wealth.
- Farmland: Crops can be harvested and sold year after year. The land itself tends to increase in value, too.
- Businesses: A profitable business generates earnings that can be reinvested in growth or paid to owners.
The key attribute of these assets is that they generate recurring cash flows, income or profits. In other words, they produce something of value on an ongoing basis.
The benefits of investing in productive assets
In Buffett's view, focusing your capital on productive assets is the path to building sustainable wealth. There are a number of reasons why they are superior to non-productive assets.
The first is income generation. The regular cash flow can be used to invest in more assets or fund living expenses. Non-productive assets do not provide this.
Second, they offer inflation protection. Rising income over time offsets inflation. Static assets do not have this advantage.
The third reason is compounding growth. Reinvesting cash flows back into productive assets amplifies returns over long time periods.
They also have tangible value. Farms, real estate and businesses have inherent worth beyond their financials. Gold and cash do not.
Finally, they offer diversification. Stocks and bonds provide diversification and income streams absent in concentrated assets.
Overall, the income, cash flow and growth generated by productive assets serve as an engine for compounding wealth. The intrinsic productivity of these investments works in the owner's favor.
Buffett's perspective on gold as an investment
Unlike stocks, bonds or real estate, gold does not generate any income or cash flow. It just sits there, hoping someone will pay more for it someday.
As Buffett notes, an investor who buys an ounce of gold today will simply have one ounce of gold in 100 years. The gold has produced nothing in between. Contrast that to farmland, which yields crops to sell year after year or a stock that provides dividends for a century.
This lack of productivity is why Buffett considers gold a non-productive asset – and a poor investment compared to owning productive ones. The essence of Buffett's argument is that gold is a sterile asset. It produces nothing. It just sits there, tries to look pretty and hopes to rise in price.
Gold's intrinsic value
There is also the matter of what gives gold its so-called intrinsic value in the first place. The truth is that gold's value is primarily derived from its scarcity and use as a historical store of value rather than any inherent productive capacity. For most of human history, gold has been prized for its rarity, luster and ability to be shaped into jewelry or currency.
However, in the modern economy, the intrinsic value of commodities like gold boils down to supply and demand dynamics more than any underlying utility. Gold prices fluctuate based on how much market participants are willing to pay. The supply of new gold mined each year is vastly outstripped by the demand from investors and speculators.
Gold bugs argue this scarcity and role as a perceived safe haven give it an intrinsic value floor. But the reality is gold’s value is driven by the irrational, speculative demands of investors rather than grounded in productivity like farmland, rental property or dividend stocks. The market could just as quickly change its sentiment and drive gold prices sharply lower when euphoria fades.
At the end of the day, gold’s limited real-world utility limits its intrinsic value. Outside of some industrial and jewelry applications, gold serves little productive purpose, meaning its value is largely determined by the whims of the market rather than tangible earnings power.
For long-term investors like Buffett focused on building wealth through compounding, gold’s lack of productive capacity makes it an inferior asset class compared to stocks, bonds and income-producing real assets.
The power of stocks as productive assets
Buffett sees stocks as powerful productive assets due to their dual abilities to pay dividends and grow value over time.
In his 2011 shareholder letter, he used the example of Coca-Cola Co. (KO, Financial) to illustrate the productive capacity of stocks. He explained that if you own a stock that does not pay dividends, the only "payout" you will ever get is when you eventually sell the shares. You will only make what the buyer is willing to pay at that point in time.
But if you own dividend-paying stocks, you receive income year after year that you can reinvest to buy more shares. As the dividends increase over time, your income stream grows exponentially thanks to compounding gains through reinvestment. So dividend stocks provide ever-rising income compared to non-dividend payers.
Buffett contrasts this with an asset like gold that will never provide any income or increase what it offers the owner. This example demonstrates why he favors stocks as productive assets.
Companies like Coca-Cola and Johnson & Johnson (JNJ, Financial) have paid – and grown – their dividends for over 50 consecutive years. This provides a rising income stream for shareholders that can be reinvested. In addition, the shares appreciate in price over decades.
For buy-and-hold investors focused on the long run, stocks are among the most attractive productive assets. Their ability to generate both cash flow and growth makes them ideally suited to compound wealth.
Investing in productive assets the Buffett way
When it comes to long-term investing, few philosophies have stood the test of time like Buffett's laser focus on productive assets.
By reinvesting the steady cash flows from stocks, bonds, real estate and businesses back into more income streams, investors can harness the snowball effect of compounding. Their money compounds exponentially over decades.
Meanwhile, unproductive assets like gold fail to generate the growing cash flow required to leverage compound interest. They offer no fuel to stoke the fire of compounding gains over the long haul.
Ultimately, Buffett's relentless focus on productive assets that pay their owners regularly has proven to be an unbeatable wealth-building strategy over the long run. By reinvesting the cash flows without end, investors can secure their financial futures through the power of compound interest.
