In a recent CNBC interview, Warren Buffett said, “in terms of bonds, some day they will sell (at a) yield a whole lot more than they’re yielding now. I think it is silly – to have some ratio like 30 or 40 or 50 percent in bonds. They’re terrible investments right now.”
When the “Oracle of Omaha” speaks, investors listen as he is widely considered to be the most successful investor of the 20th century and has amassed a personal net worth of over $50 billion dollars.
So is it time to sell your bonds?
Let’s be clear on one thing: if your personal portfolio and risk capacity is the same as Warren Buffet’s, then perhaps bonds, which are at historically low yields, may not make sense. But not everyone is Warren Buffet and this topic warrants deeper analysis.
Understanding your own risk capacity
Risk capacity is basically the amount of risk an investor “must” take in order to reach their long-term financial goals like charitable giving or retirement lifestyle needs.
For Warren Buffet, his risk capacity is off the charts. In fact, a 100% allocation to stocks is completely reasonable as 99% of his net worth is earmarked for charity. So he is investing the vast majority of his wealth for the long-term benefits of others.
Imagine you were a financial planner sitting down to do a financial plan with him.
- He is 82 years old.
- He is still working.
- He has a net worth of over $50 billion.
- And he has publically stated he will be giving about 99% of his net worth to charity, which will still leave him with $500 million dollars.
You can imagine the conversation …
“Things look pretty good Mr. Buffett, … you are easily on track to give away $49.5 billion dollars to charity. Based on what is left over and the life expectancy of a well-educated, 82 year old man like yourself, I think your portfolio could support yearly lifestyle needs of $50 million dollars per year, but let’s be safe and scale that back to $25 million per year. How does that sound?”
Do Mr. Buffett’s comments on bonds marry to your own personal risk capacity?
Understanding risk tolerance
We refer to personal risk tolerance, as the “sleep at night” factor. But here are two very important points you should consider before you take Buffet’s comments to heart and bail on bonds:
1. Buffett states, “Investors should have “enough cash on hand so they feel comfortable, and then put the rest in equities”
Comfort is subjective, as every individual will have a different comfort level. Someone with a very secure job, high income and no debts might be comfortable with everything in stocks and nothing in cash.
A retiree with no pensions might only feel comfortable with 5 years’ worth of lifestyle expenses in cash or short-term bonds. 5 years’ worth of lifestyle expenses might translate into some sort of ratio like 30%, 40% or 50% of their investment portfolio.
There is no one size fits all for level of comfort.
2. Buffett states, “Investors should have the proper attitude if “stocks go down 20% next month, they’re not going to be bothered.”
Think about what happens when stocks do actually go down 20%. There is one screaming doomsday headline after another. Here are a couple of examples from September 2008: “Citing Grave Financial Treats, Officials Ready Massive Rescue”, followed a few days later by “Bailout Plan Rejected, Markets Plunge, Forcing New Scramble to Solve Financial Crisis”.
It is one thing to say you can withstand the stock market going down 20%, 30% or 40%; it is much more difficult to endure that when faced with the end of the financial narrative surrounding this type of stock market move. Remember, it isn’t just the financial media, when this happens everyone is talking about it.
Bottom line is that it is always best to properly address your own personal risk tolerance issue ahead of time. If that includes having an allocation to bonds investments so you can sleep at night, then so be it.
I disagree with the Oracle of Omaha. Bonds are an important part of each individual’s risk capacity and risk tolerance investment strategy.
If you ever wake up in the morning and see Warren Buffett’s reflection in the mirror, then by all means only own stocks. If you don’t, then you should make your own individual investment and asset allocations based on your own personal risk capacity and risk tolerance. In fact you should always make financial decisions based on your own personal factors, not the outlook or actions of others.