Why Warren Buffett's Prescription Will Not Work for Retirees

In a Fortune article titled “Why Stocks Beat Gold and Bonds,” Warren Buffett provides a glimpse of his upcoming shareholder letter.

While Buffett’s advice is perfect for investors who have a long-term perspective, anyone near or in retirement may want to think twice about acting on the prescription.

The core of Buffett’s advice is as follows:

  • Investing is fundamentally about the transfer of purchasing power with the “reasoned expectation” of that current transfer resulting in greater purchasing power in the future.
  • Given this focus on the preservation and ideally growth of purchasing power, investors should care less about any price volatility that may occur over time since the end goal (greater future purchasing power) is all that matters.
  • The perceived safety and stability of “currency-based” investments such as bonds, money market funds and bank deposits is a mirage.  The reason is that while these currency-based investments produce regular cash flows with very little price volatility, inflation will likely erode the value of these cash flows over time.
  • Investment in productive assets—equities, entire businesses, real estate, etc—is the strategy that is most likely to result in the preservation of purchasing power over time.

The issue that retirees need to consider boils-down to the fact that financing retirement is fundamentally different than investing, and Buffett’s advice is appropriate for investors such as himself.

Retirement finance is about funding consumption on a current and ongoing basis with assets that have been accumulated over a lifetime.  This exercise is very different than transferring purchasing power and related consumption considerations to a future date.

The reality is that price volatility or “beta” does matter very much to retirees.

Financing current consumption (or any constant spending plan) with volatile assets such as equities is a problematic strategy for several reasons:

  • The strategy exposes people to sequence of returns risk.
  • The strategy is inefficient since it produces shortfalls when markets are down and wasteful surpluses when markets have risen.
  • The strategy has to be stressful for people who need to live off their savings for several decades.

The vast majority of retirees must fund current spending and consumption with the bonds and other currency-based investments that Buffett cautions against in his shareholder letter.

This unfortunate reality does not eliminate the very real inflation-related risks discussed by Buffett.

What retirees can take away from Warren Buffett’s letter is the importance seeking currency-based investments that adjust with inflation over time.  Treasury Inflation-Protected Securities (TIPS) and inflation protected annuities fall into this category.

Source: Fortune