Lessons From Warren
Although I’m not named after him, I feel a close connection with Warren Buffet, the famous Chairman of Berkshire-Hathaway. He regularly writes and comments about investments and life and I often quote him in conversations and my own writing. In fact, I wished him a Happy Birthday in an article in which I mentioned that he describes his investment strategy as: ‘I read and think’.
I too read a lot, trying to get a feel for what’s happening around the world by accessing news from multiple perspectives. I recently came across a website called The Financially Independent Millennial. It offered articles of interest to other age groups as well. One that caught my eye enumerated sixteen different investments that retirees should not make. The last half of the list identified specific investments but the first eight were broad enough categories that I felt them relevant to most investors; I requested and received permission to share (and comment on) them.
“#1: Cash
Cash is king” is a well-known phrase, but when it comes to retirement investing, cash is hardly king. Cash should be avoided by retirement investors because it earns no return. In stark contrast to bonds which pay interest or stocks that pay dividends, cash earns no interest. As a result, cash loses value over time due to the steady erosion of inflation.”
This is a very useful perspective, well supported by the math which underlies all our work. However, we often find that people’s feelings about their situation are more important than the actual numbers so we moderate their asset allocations accordingly. We keep one or more years of clients’ anticipated spending in cash so that market fluctuations don’t spur panic. Actually, we use a variety of different ‘cash-like’ investments in hopes of earning at least some return, even if not the rate of inflation.
“#2: High-Yield Bonds
Sometimes referred to as junk bonds, high yield bonds are fixed income securities issued by companies with sub-investment grade credit ratings.
With interest rates still near historic lows, fixed-income yields have plunged over the past several years. As an example, the 10-year Treasury yields just 1.3% right now. With inflation running significantly above this level, retirees will see their purchasing power erode with low-yielding bonds.”
Many amateur investors have turned to junk bonds in search of higher yields. These can make sense if investors are being suitably rewarded for assuming additional risk but that is not the case today. The issuers of these bonds are likely to find themselves in trouble should inflation continue and the economy weaken. We agree that high yield bonds should be avoided by most investors unless the difference between their yield and the yield of a similar maturity Treasury bond becomes compelling.
“#3: Cryptocurrencies
Cryptocurrencies like bitcoin are all the rage these days. The massive rise in the value of bitcoin and other cryptocurrencies over the past few years is enticing for any investor. And cryptocurrency gets a lot of coverage in the financial media.
But retirees need to remember that volatility is a two-way street. The price of bitcoin has declined by nearly 50% from its 52-week high, a reminder that any investment can lose value. Bitcoin also does not pay interest or dividends, meaning investors will not generate income from their investment. And another reason retirees should avoid Bitcoin is simply the higher level of risk involved in buying cryptocurrencies, not to mention the tax implications.”
Once again, I’m in agreement with the author. It might be possible to make a case for younger investors buying such privately issued currencies but we consider them highly speculative and, again, subject to potentially significant devaluation if markets correct. The inherent security of the underlying blockchain technology notwithstanding, news organization Reuters reported that over $12 Billion in various crypto currencies was stolen in 2021.
“#4: Oil & Gas Royalty Trusts
Oil and gas royalty trusts are niche securities within the stock market. These are companies that own oil and gas-producing properties. Investors receive distributions depending on how much income the trusts generate from these properties. Some well-known oil and gas royalty trusts include BP Prudhoe Bay Royalty Trust (BPH) and Permian Basin Royalty Trust (PBT).
If oil and gas prices fall, share prices of the royalty trusts collapse, and their distributions decline, often to zero as occurred in 2020 during the coronavirus pandemic.”
Transporters of fuels should be a rock solid investment choice since our world requires a lot of energy to operate. However, as the author points out less fuel is required during economic down cycles, so transport cash flow can fall to zero. With the world thinking more about ‘green energy’, perhaps investing in a system of powerlines would be a better approach but, per this article in the Wall Street Journal, the wind doesn’t always blow. Once again, there is no such thing as a risk-free high yielding investment.
“#5: Mortgage REITs
Real Estate Investment Trusts, also referred to as REITs, are a great way for retirees to earn higher levels of investment income. Many REITs have strong yields of 4% or more. Retirees might be tempted to buy mortgage REITs, a subset of the asset class that typically offers even higher yields.”
When we invest in REITs for our clients, it’s not to produce above average income streams but to broaden their market exposure: basically, we use them in an attempt to reduce portfolio volatility. We think of REITs as providing ‘total return’ with some dividend income and some potential for growth. Those who chase income through a REIT strategy run all the risks that any ‘high yield’ investor does: potential for falling yields as business conditions change along with the potential for capital losses should the specific real estate project sour. When we use this approach for our clients, we purchase well-diversified portfolios from highly experienced asset managers.
“#6: Gold
Every few years or so, gold gets a lot of attention in the media, usually because the price of gold has risen over a certain period of time. But for retirees interested in generating sustainable income from their investments, gold should be avoided.
Gold pays no dividends or interest, which is why it is not attractive for many retirees. To quote legendary investor Warren Buffett on gold: ‘The idea of digging something up out of the ground, in South Africa or someplace and then transporting it to the United States and putting it into the ground, in the Federal Reserve of New York, does not strike me as a terrific asset.’ ”
The writer goes on to point out that some gold stocks do pay dividends but they are often inconsistent. Even though gold gets a lot of TV exposure, we rarely consider it a good investment. In spite of the occasional high returns cited in the ads, gold underperforms the stock market over the long haul.
As a general rule, investors should be wary of speculating in gold or other precious metals.
“#7: Momentum Stocks
Momentum stocks are those that have captured investors’ attention, most often due to a rapid rise in their share price. This causes other investors to jump in, perhaps because of a fear of missing out, which can push share prices even higher. But in many cases, momentum stocks fall back down to Earth, as their underlying fundamentals may not justify the rallying share price.
Momentum stocks that have gotten a lot of attention in the financial media in recent months include GameStop (GME), AMC (AMC), and more. In all cases, their share prices skyrocketed in a relatively short period of time. Retirees should resist the urge to buy momentum stocks, as they can be highly volatile and almost never pay dividends.”
Stock investing is a proven way to accumulate wealth but it works best as a long-term strategy. Instead, many of today’s newer investors have gotten caught up in the excitement of buying stocks on a phone app that closely resembles a video game. Investors of all ages should heed the words of investment guru Peter Lynch: “Although it's easy to forget sometimes, a share is not a lottery ticket…it's part-ownership of a business.” Momentum has a way of reversing. It takes a very sharp eye to pick the ideal time to sell and no one gets it right every time. This is also a category we generally avoid.
“#8: Microcap Stocks
Stocks can be classified according to their market capitalizations, which is simply the current share price multiplied by the number of shares outstanding… The smallest group of stocks is known as microcaps. These are stocks with market caps below $100 million. Microcaps are very small businesses, their stocks generally have low liquidity, and many are in questionable financial condition. As a result, retirees should stick to midcaps and large caps.”
Before we purchase an investment for a client, our first questions is: ‘who will buy this from us when we’re ready to sell?’ For microcap stocks, that can be a difficult question to answer. These are the very smallest of publicly traded companies. Many fewer shares change hands every day than large company investors have come to expect. There are few investment experiences scarier than placing an order to sell and finding that there are no buyers so, once again, I’m in agreement with the author – microcap companies can provide portfolio balance but are best used as a ‘garnish’, not a main course.
After over thirty years in the investment business, I continue to be surprised at how many times the fundamentals need to be restated. At WWA, we believe that investing in the stocks and bonds of solid companies and making measured portfolio adjustments as market conditions change is the surest way to build wealth. Strategies intended to ‘get rich quick’ are more likely to have the opposite effect.
