Warren Buffett's 8 Investing Commandments

NEW YORK ( TheStreet) -- Warren Buffett, chairman of Berkshire Hathaway ( BRK.B) and unofficial CEO of America, is giving investors one more chance to stop being led into speculative bubbles and reckless investments and build a portfolio the smart way: meaning to invest like him.

In an excerpt from his upcoming annual letter to Berkshire shareholders published on Fortune's Web site Thursday, Buffett put it plainly to investors: Ditch gold, beware of bonds and hold equities for the long term. Anything else, and an investor is confusing fear-based speculation and the herd mentality for investing, Buffett says.

Writing on bonds and commodities as two of the three investing pillars, Buffett remarks: "Our first two categories enjoy maximum popularity at peaks of fear: Terror over economic collapse drives individuals to currency-based assets, most particularly U.S. obligations, and fear of currency collapse fosters movement to sterile assets such as gold. We heard 'cash is king' in late 2008, just when cash should have been deployed rather than held. Similarly, we heard 'cash is trash' in the early 1980s just when fixed-dollar investments were at their most attractive level in memory. On those occasions, investors who required a supportive crowd paid dearly for that comfort."

It's a philosophy that Buffett has long espoused: Equities are the only way to go. At last year's Berkshire Hathaway annual meeting, Buffett joked about the uselessness of a bar of gold.

To break down the don of American capitalism's antipathy for fixed-income and commodities and his ceaseless love of stocks and businesses, here are eight principles Buffett laid out in his latest ode to equities:
  • 1. The riskiness of an investment is not measured by Wall Street's preferred lingo of beta, but rather by the probability -- the reasoned probability -- of that investment causing its owner a loss of purchasing power over his contemplated holding period.
  • In other words, the "safe" assets of fixed income and commodities aren't so safe, after all. In truth, Buffett argues, currency-based assets are "the most dangerous."
  • 2. What makes currency-based investments like bonds and money market funds so unsafe is the inevitable lack of control investors have compared to the government.
  • "Over the past century these instruments have destroyed the purchasing power of investors in many countries, even as these holders continued to receive timely payments of interest and principal. This ugly result, moreover, will forever recur. Governments determine the ultimate value of money, and systemic forces will sometimes cause them to gravitate to policies that produce inflation. From time to time, such policies spin out of control."

  • 3. Taxes only make the inefficiency of fixed-income even more pronounced.
  • Using a 47-year time horizon, Buffett shows that U.S. Treasury bills returned 5.7% annually. For an individual investor paying personal income taxes at a rate averaging 25%, this 5.7% return would have yielded nothing in the way of real income. This investor's visible income tax would have stripped him of 1.4 points of the stated yield, and the invisible inflation tax would have devoured the remaining 4.3 points.

    Or, as Buffett quipped, "In God We Trust" may be imprinted on our currency, but the hand that activates our government's printing press has been all too human. ... Right now bonds should come with a warning label."
    Warren Buffett says equities aren't just a better investment than bonds or commodities, but safer.
  • 4. U.S. Treasury bills, which Berkshire does own for liquidity reasons, are the only non-equity investment that can be counted on under the most chaotic of economic conditions.
  • 5. An investment in gold is an investment in fear, and the follows in the foolish footsteps of famous bubbles from capitalism's past: tulips, the Internet and U.S. housing.
  • Or, in Buffett's typically snarky way, when it comes to investing fads that he hates, "True, gold has some industrial and decorative utility, but the demand for these purposes is both limited and incapable of soaking up new production. Meanwhile, if you own 1 ounce of gold for an eternity, you will still own one ounce at its end."
  • 6. Fear only works for so long as an investment philosophy.
  • "What motivates most gold purchasers is their belief that the ranks of the fearful will grow. During the past decade, that belief has proved correct. ... As 'bandwagon' investors join any party, they create their own truth -- for a while."
  • 7. The compound value of gold will always lag the compound value of a business
  • Buffett compares gold to a farm in this point (to understand the "16 Exxons" and literally betting on the farm references, it's important to note that Buffett compares today's value for the gold market -- $9.6 trillion - to what it could buy in other assets: all U.S. cropland and 16 Exxon Mobils.:

    "A century from now the 400 million acres of farmland will have produced staggering amounts of corn, wheat, cotton and other crops -- and will continue to produce that valuable bounty, whatever the currency may be. Exxon Mobil ( XOM) will probably have delivered trillions of dollars in dividends to its owners and will also hold assets worth many more trillions (and, remember, you get 16 Exxons). The 170,000 tons of gold will be unchanged in size and still incapable of producing anything. You can fondle the cube, but it will not respond."
  • 8. Equities aren't just the runaway winner against bonds and commodities, but they're the safest investment.
  • Or, in words typical of Buffett's bread-and-butter American heartland image: "Metaphorically, these commercial 'cows' will live for centuries and give ever greater quantities of 'milk' to boot. Their value will be determined not by the medium of exchange but rather by their capacity to deliver milk. Proceeds from the sale of the milk will compound for the owners of the cows, just as they did during the 20th century when the Dow increased from 66 to 11,497 (and paid loads of dividends as well)."

    TheStreet asked private wealth manager Wedgewood Partners' CIO David Rolfe, a Berkshire investor, if he thought Buffett would add anything else to this 8 point breakdown of the right way to invest. Rolfe said Buffett might add one thing: "Class dismissed."

    -- Written by Eric Rosenbaum from New York.

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    -- Written by Eric Rosenbaum from New York.

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