Warren Buffett 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 5% in May 2021 compared with the prior year, the largest increase since summer 2008. The increase has unnerved investors.
So why is inflation such a concern? 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% interest annually may sound like a solid investment, but if inflation reaches 6% 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."
- Invest in good businesses with low capital needs.
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.
- Look for companies that can raise prices during periods of higher inflation.
"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's able to offset its own increasing costs.
- Take a look at TIPS.
Treasury Inflation-Protected Securities, or 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.
- Invest in yourself and be the best at what you do.
Consider bulking up your resume by learning a new skill through online resources or a local college. Increasing your value to your employer and its customers will help you command your fair share of earnings over time.
- Steer clear of traditional bonds.
"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.
- Limit your wants.
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.
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."
Bottom line: It's still too early to tell if the current price spike is likely to last, but if you're concerned about rising inflation, consider owning productive assets such as high-quality businesses with low capital needs, and stay away from low-yielding bonds.
