Warren Buffett has been thinking about inflation for a long time. The legendary 90-year-old investor had the dangers of inflation drilled into him by his Republican Congressman father, according to biographers, and has repeatedly commented on the subject throughout his investing career.
“We’re seeing very substantial inflation,” Buffett said at last month’s Berkshire Hathaway annual meeting. “We’re raising prices, people are raising prices to us. And it’s being accepted.”
Consumer prices jumped 4.2 percent in April 2021 compared to the prior year, the largest increase since September of 2008. The increase has unnerved investors, with some wondering if we could be headed for a return to the 1970s when inflation reached double digits.
So why is inflation such a concern for investors? Inflation, or a general increase in prices, causes you to lose your purchasing power over time. For investors, this can turn what appears like a positive return into a negative one if inflation gets high enough. Owning a bond paying 5 percent interest annually may sound like a solid investment, but if inflation reaches 6 percent, your “real” return goes negative.
With prices sharply on the rise again as the economy recovers from the COVID-19 pandemic, it’s worth revisiting some of Buffett’s best suggestions for combating what he once referred to as a “gigantic corporate tapeworm.”
Buffett has long advocated for owning businesses that earn high returns on the capital invested in the business. During inflationary times, businesses with low capital needs that are able to maintain their earnings should fare better than ones that are required to invest more money at ever higher prices just to maintain their position.
Buffett once equated the challenge posed by inflation to “running up a down escalator.”
“The single most important decision in evaluating a business is pricing power,” Buffett told the Financial Crisis Inquiry Commission in 2010. “You’ve got the power to raise prices without losing business to a competitor, and you’ve got a very good business.”
If a business can increase its prices, it has a big advantage during periods of high inflation because it’s able to offset its own increasing costs.
Buffett once said that an unregulated toll bridge would be the ideal asset to own in an inflationary world because you would have already built the bridge and could raise prices to offset inflation. “You build the bridge in old dollars and you don’t have to keep replacing it,” he said.
Treasury Inflation-Protected Securities, or TIPS, are another investment endorsed by Buffett for investors who are concerned about rising inflation. TIPS pay investors a fixed interest rate twice a year, but the principal amount is adjusted for inflation, as measured by the Consumer Price Index.
Investing in your own talent is one of the best ways to maintain your purchasing power over time, Buffett told shareholders in 2004. The best surgeon or lawyer in a city or town benefits from an education paid for in “old dollars” but is able to price their services in current dollars without having to re-educate themselves.
Consider bulking up your resume by learning a new skill through online resources or a local college. Pursuing advanced degrees can be expensive, but they can also help grow your knowledge base and make you an indispensable employee in the future. Increasing your value to your employer and its customers will help you command your fair share of earnings over time.
“Bonds are not the place to be these days,” Buffett wrote in his 2020 letter to Berkshire’s shareholders. With interest rates still hovering near record lows, bond investors could be hurt significantly in an inflationary environment.
Buffett has pointed out that purchasing a 10-year bond yielding 2 percent is similar to paying 50 times earnings for a business, a key difference being that the bond’s earnings can’t grow.
“Fixed-income investors worldwide—whether pension funds, insurance companies or retirees—face a bleak future,” he said.
Buffett’s business partner and vice chairman of Berkshire Hathaway, Charlie Munger, has his own take for how best to cope with periods of high inflation: “One of the great defenses to being worried about inflation is not having a lot of silly needs in your life,” Munger told Berkshire shareholders back in 2004. “In other words, if you haven’t created a lot of artificial demand to drown in consumer goods, why, you have a considerable defense against the vicissitudes of life.”
To help with this, consider tracking your expenses through a budgeting app. This will help you understand how you’re currently spending your money and may help identify problematic spending bursts before they become a habit.
Notably, Buffett has shunned gold, an asset often thought of as being a great inflation hedge. Fans of gold are especially fearful of inflation’s impact on paper money, a concern Buffett shares. But as he noted in 2011: “If you own one ounce of gold for an eternity, you will still own one ounce at its end.” Instead, he prefers to own productive assets such as stocks, real estate or farmland that generate dividends, income and food for their owners.
Recently, cryptocurrencies have occasionally been referred to as the digital version of gold, but Buffett is highly skeptical of these as well.
“Bitcoin has no unique value at all,” he told CNBC in 2019. “It doesn’t produce anything. You can stare at it all day, and no little Bitcoins come out or anything like that. It’s a delusion, basically.”
It’s still too early to tell if the current spike in inflation is likely to last or if it will prove to be temporary.
If you’re concerned about rising inflation, consider taking Buffett’s advice and own productive assets such as high-quality businesses with low capital needs and stay away from low-yielding bonds that don’t increase payments along with inflation rates.
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