The unconventional, but inescapable, conclusion to be drawn from the past fifty years is that it has been far safer to invest in a diversified collection of American businesses than to invest in securities – Treasuries, for example – whose values have been tied to American currency. That was also true in the preceding half-century, a period including the Great Depression and two world wars. Investors should heed this history. To one degree or another it is almost certain to be repeated during the next century.
Stock prices will always be far more volatile than cash-equivalent holdings. Over the long term, however, currency-denominated instruments are riskier investments – far riskier investments – than widely-diversified stock portfolios that are bought over time and that are owned in a manner invoking only token fees and commissions. That lesson has not customarily been taught in business schools, where volatility is almost universally used as a proxy for risk. Though this pedagogic assumption makes for easy teaching, it is dead wrong: Volatility is far from synonymous with risk. Popular formulas that equate the two terms lead students, investors and CEOs astray.
It is true, of course, that owning equities for a day or a week or a year is far riskier (in both nominal and purchasing-power terms) than leaving funds in cash-equivalents. That is relevant to certain investors – say, investment banks – whose viability can be threatened by declines in asset prices and which might be forced to sell securities during depressed markets. Additionally, any party that might have meaningful near-term needs for funds should keep appropriate sums in Treasuries or insured bank deposits.
For the great majority of investors, however, who can – and should – invest with a multi-decade horizon, quotational declines are unimportant. Their focus should remain fixed on attaining significant gains in purchasing power over their investing lifetime. For them, a diversified equity portfolio, bought over time, will prove far less risky than dollar-based securities.
The Berkshire Hathaway annual letter to shareholders 2015 (page 18).
What this tells me
- Equities are good things to hold in retirement as long as I don’t need to sell them
- Dividend income beats inflation (but can go down as well as up)
- If I can afford to draw down income and not capital, I should be alright
- I am scared of doing this on my own.
1. Equities can be good things to hold in retirement but better if you have an experienced investor to advise when to hold for income and when to sell and reinvest in better income.
2. Agreed, as far as it goes (which isn’t far), but it may help inform decisions on which equities to hold on to and which to sell to reinvest.
3. “could” rather than “should”.
4. You’re not alone, but you will be in a minority.
But trustees are often discouraged from holding equities – hence many cast aside logic for short term insulation aided and abetted by regulators and consultants.
Remember Berkshire Hathaway doesn’t pay a dividend on the basis that it is more tax efficient for Berkshire to retain and reinvest all their earnings and shareholders to sell down some stock if they require cash as “income”. Cash is a fungible asset but so few shareholders understand this which is strange given how much institutional investors get paid to manage money.
US taxation favours capital gains over dividend income.
And UK tax will change yet again next year to make dividends less attractive compared with interest on government gilts.
The tax distortions don’t end there – companies are encouraged to issue debt and not to grow dividends because of the different tax reliefs for corporate bonds versus equity.
The problem with selling down equities (as Berkshire Hathaway) suggest , is not with companies like Berkshire Hathaway which provide a relatively stable share price.
They are the exception proving the rule- don’t you think Martin?
George- I too dislike the distortions being introduced into the Uk tax system. I hope that the dividends payable to pension funds will not be any further injured.
It’s all well and good talking about what’s best in retirement if you are still fiscally focused on making money but is that retirement? Most people just want to hang up their tools and enjoy retirement without the stress of the risk element. I personally will use my DB pensions to provide a regular income with my DC schemes as a drawdown.
Must be missing something here, Chris.
It’s usually DC which gives members the stress of the risk element.
DB (with a good, but by no means perfect, sponsoring employer) used to immunise the members from stresses and strains, at least before certain actuaries, legislators and regulators stuck in their respective oars.
George, that’s not what I meant. I’m lucky to have DB scheme membership. What I was pointing at was that for those reliant on DC schemes need a stable choice in retirement and not to playing around in equities. I repeat, that’s not retirement for Joe Public it’s heart attack material!