Berkshire Hathaway 2018 Annual Meeting Audience Question # 21

Long term bonds are terrible investments at current rates

Warren Buffett:

OK. Station 7.

Audience Member:

Good morning. And I have a question related to the bond market… U.S. Treasury bond market.

And my name is Ola Larsson. I live in the San Francisco bay area.

And I never worked in the financial industry. I started out buying penny mining stocks on the Vancouver Stock Exchange. And then decades later, I got married. And my wife convinced me to buy Berkshire shares. That was probably a good decision.

So my question is, I read the newspapers about the Federal Reserve and the inflation numbers.

And there must be an increase supply of Treasury bonds that must go to auction. And my question is how would… what do you expect that to impact yield or interest rate?

Warren Buffett:

Yeah. The answer is, I don’t know. And the good news is, nobody else knows, including members of the Federal Reserve and everyone…

There are a lot of variables in the picture. And the one thing we know is we think that long-term bonds are a terrible investment, and we… at current rates or anything close to current rates.

So basically all of our money that is waiting to be placed is in Treasury bills that, I think, have an average maturity of four months, or something like that, at most.

The rates on those have gone up lately, so that in 2018, my guess is we’ll have at least $500 million more of pretax income than we would’ve had in the bills last year.

But they still… it’s not because we want to hold them. We’re waiting to do something else.

But long-term bonds… they’re basically, at these rates… it’s almost ridiculous when you think about it. Because here the Federal Reserve Board is telling you we want 2 percent a year inflation. And the very long bond is not much more than 3 percent. And of course, if you’re an individual, then you pay tax on it. You’re going to have some income taxes to pay.

And let’s say it brings your after-tax return down to 2 1/2 percent. So the Federal Reserve is telling you that they’re going to do whatever is in their power to make sure that you don’t get more than a half a percent a year of inflation-adjusted income.

And that seems to me, a very… I wouldn’t go back to penny stocks… but I think I would stick with productive businesses, or productive… certain other productive assets… by far.

But what the bond market does in the next year, you know… you’ve got trillions of dollars in the hands of people that are trying to guess which maturity would be the best to own and all that sort of thing. And we do not bring anything to that game that would allow us to think that we’ve got an edge.

Charlie?

Charlie Munger:

Well, it really wasn’t fair for our monetary authorities to reduce the savings rates, paid mostly to our old people with savings accounts, as much as they did. But they probably had to do it to fight the Great Recession, appropriately.

But it clearly wasn’t fair. And the conditions were weird. In my whole lifetime, it’s only happened once that interest rates went down so low and stayed low for a long time.

And it was quite unfair to a lot of people. And it benefited the people in this room enormously because it drove asset prices up, including the price of Berkshire Hathaway stock. So we’re all a bunch of undeserving people… and I hope that we continue to be so.

Warren Buffett:

At the time this newspaper came out in 1942, it was… the government was appealing to the patriotism of everybody. As kids, we went to school and we bought Savings Stamps to put in… well, they first called them U.S. War Bonds, then they called them U.S. Defense Bonds, then they called them U.S. Savings Bonds. But they were called war bonds then.

And you put up $18.75 and you got back $25 in ten years. And that’s when I learned that that $4 for three… in ten years… was 2.9 percent compounded. They had to put it in small print then.

And even an 11-year-old could understand that 2.9 percent compounded for ten years was not a good investment. But we all bought them. It was… you know, it was part of the war effort, basically.

And the government knew… I mean, you knew that significant inflation was coming from what was taking place in finance, in World War II.

We actually were on a massive Keynesian-type behavior, not because we elected to follow Keynes, but because war forced us to have this huge deficit in our finances, which took our debt up to 120 percent of GDP. And it was the great Keynesian experiment of all time, and we
backed into it, and it sent us on a wave of prosperity like we’ve never seen. So you get some accidental benefits sometimes.

But the United States government (the sound in this part of the video is inaudible) every citizen to put their money into a fixed- dollar investment at 2.9 percent compounded for ten years. And I think Treasury bonds have been unattractive ever since… with the exception of the early ’80s.

That was something at that time.

I mean, you really had a chance to buy… you had a chance to invest your money by buying zero- coupon Treasury bonds, and in effect, guarantee yourself that for 30 years you would get a compounded return, you know, something like 14 percent for 30 years of your lifetime.

So every now and then, something really strange happens in markets and the trick is to not only be prepared but to take action when it happens.

Charlie, did you ever buy any war bonds?

Charlie Munger:

No. No. I never bought war bonds.

Warren Buffett:

No. Used to be like take me…

Charlie Munger:

I didn’t have any money when I was in the war.

Warren Buffett:

That’s a good reason not to buy.

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