Warren Buffet: Bonds are Riskier than Stocks

Warren Buffet Advice Stocks-Bonds

Warren Buffet, also known as “The Oracle of Omaha”, is perhaps one of the greatest investors and currently one of the top billionaires on earth. Buffet, the chairman and CEO of Berkshire Hathaway has been referred to as the “Oracle” because of his successful stocks picks and his own special view on the markets.  Each year, Warren Buffett shares his thoughts in his annual letter to Berkshire Hathaway shareholders. In his letter for 2017, he wrote something that gave us some other perspective about risk, stocks and our portfolio.

It is widely thought that bonds are much safer than stocks. So, whenever you want to lower the risk on your investment’s portfolio, simply exchange your high-risk stocks with bonds. But, is it really true?

According to Warren Buffet, who wrote in his letter to the shareholders: “It is a terrible mistake for investors with long-term horizons- among them, pension funds, college endowments and savings-minded individuals- to measure their investment ‘risk’ by their portfolio’s ratio of bonds to stocks”. What Buffet means is that in the long run, bonds – or any other fixed-income investments -are actually riskier than stocks. How is that possible you ask? Here is why:

Buffet and Protégé Partners made a bet. Buffet believed that no hedge fund can outperform the return on stock indexes in the long-run. His counter-party to the bet, who has invested in more than 200 hedge funds, believed differently. In the end, after 10 years, the S&P500, which Buffet invested in, earned 125.8%, while his bet partner gained only 36.3%.

The agreement was that $1,000,000 will be paid to a charity picked by the winner. To pay that $1,000,000, each of them bought US government’s zero-coupon bonds, which will sum to a $500,000 in a decade. The bonds delivered 4.56% to maturity from the price they were purchased at.

By 2012, the yield of these bonds was just 0.88%. If you wait with the bond until maturity and don’t sell it before, then it shouldn’t affect you. They did get $1,000,000 at the end of these 10 years as promised, but they realized something important. At that time, even a 1% annual rate of inflation between 2012 and 2017 would have decreased the purchasing-power of the government bond that they sold.

Buffett adds:

“I want to quickly acknowledge that in any upcoming day, week or even year, stocks will be riskier – far riskier – than short-term U.S. bonds. As an investor’s investment horizon lengthens, however, a diversified portfolio of U.S. equities becomes progressively less risky than bonds, assuming that the stocks are purchased at a sensible multiple of earnings relative to then-prevailing interest rates.”

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