This question arises quite a few times when investors ponder over the investment strategy of Warren Buffett who made millions by investing into other companies stock. The answer to this question is surprisingly YES. The investor of all times does invest in bonds to a certain extent although as he regards them as a riskier investment as compared to equity. Bonds are stated as an investment that is denominated in terms of currency and although many investors consider this as a safe investment, Warren Buffett regards them as one of the riskiest investments. He states that although their systematic beta is zero, the danger that they offer is quite high.
Although Warren Buffett does not prefer investment in bonds, his company Berkshire holds a variety of bonds based on short term. This is not due to the need to generate returns but is done with the aim of maintaining liquidity of the company. Warren Buffett has invested in US treasury bills in order to maintain liquidity of a maximum of $20 billion and a minimum of $10 billion. Warren Buffet states that the investment is primarily for the purpose of ensuring sufficient cash equivalents within the firm and maintenance of liquidity that is required by the regulators. Although, Warren Buffet is keen to invest in bonds that offer unusual returns or are likely to rise in terms of price in the future thus offering high capital gains, he states that current conditions do not offer such possibilities and he remains as far away from investment in bonds as possible.
Investors question Buffettâ€˜s aversion to bonds and this is what he states: Warren Buffet believes that bonds are responsible for destroying the purchasing power despite the timely interest payments and initial capital repayments. This is because the interest rate is not in line with the rate of inflation. The inflation rate exceeds the interest rate causing the money to erode its value in real terms. Thus any investor that holds bonds is likely to face a loss in the real value of wealth. The interest payments cannot be termed as income but rather contribute partially towards maintenance of purchasing power of initial capital as per Money Forum.
The interest generated from bonds is applicable for taxation purposes and therefore the after tax return is not satisfactory to maintain the purchasing power of an individual. For example, a bond that offers an annual yield of 5.7% such as US treasury bills is likely to be subject to a tax rate of 25% indicating that most of the income is paid in form of taxes. The remaining 4.3% is well below the current rate of inflation and therefore inadequate to maintain the real wealth of the investor. Warren Buffett claims that bonds should be labeled as dangerous because of their ill effects and investors should stay away from bonds. Buffett states that although high interest rates, well above the rate of inflation could prove to be beneficial, the current rates are not sufficient to offset the wealth erosion risk faced by the bond investors and therefore he avoids investment in bonds except for those done for liquidity purposes.
Contact Name:Preston Pysh
Company Name: Buffett's Books
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