Following Buffett, Jhunjhunwala isn't the best way to make money

Following Warren Buffett, the world’s most celebrated investor, can be a problem for lesser folk. His views are often cast in stone, and when they are not, they can be contradictory. Since too many people listen to him for clues on where to put their money, it can be dangerous to their financial health. The same holds for those who swear by Rakesh Jhunjhunwala in India. Till recently, he too was losing a packet.

In a recent article in Fortune, Buffett said he was against investing in assets like gold and treasury bonds because they are either unproductive or do not deliver returns post-inflation, post-tax.

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This is what Buffett said about fixed-income and other assets denominated in currency. “Investments that are denominated in a given currency include money-market funds, bonds, mortgages, bank deposits, and other instruments. Most of these currency-based investments are thought of as “safe.” In truth they are among the most dangerous of assets. Their beta may be zero, but their risk is huge.”

He said: “Under today’s conditions, therefore, I do not like currency-based investments. Even so, Berkshire holds significant amounts of them, primarily of the short-term variety.”

Buffett invests in things he does not believe in for reasons of liquidity. It’s the same reason why an Infosys sits on Rs 20,000 crore in cash earning 7-8 percent returns when its main business yields 30-and-odd percent margins. It’s why a Reliance sits on Rs 95,000 crore in cash even today when investment opportunities theoretically beckon. The money is waiting for the right cues.

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Buffett’s doubts on currency-related assets are sound because he does not expect governments to act wisely to maintain a currency’s value. He said: “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.”

And yet, when the US government lost its Triple A status last August for doing precisely this - printing more money and debasing the dollar - he debunked the downgrade. “I don’t get it. In Omaha, the US is still triple A. In fact, if there were a quadruple-A rating, I’d give the U.S. that.”

So Buffett will give the government that debases the dollar a Quadruple A. And even though he does not believe in holding currency assets, he will still hold a lot of it for liquidity reasons.

Now figure out what he really stands for.

Next, let’s see what he said about gold, or “assets that will never produce anything.” According to Buffett, assets like gold are “purchased in the buyer’s hope that someone else - who also knows that the assets will be forever unproductive - will pay more for them in the future. Tulips, of all things, briefly became a favourite of such buyers in the 17th century.”

In short, these assets are bought in the hope that a bigger fool will turn up.

In the case of gold, investors are tanking up on the metal in the expectation that when other assets fall in value (like paper money), gold will hold its own.

And yet, Buffett played silver bull from 1997 to 2006. At one point, he owned more than a third of the world’s known silver supplies. When he had started buying, silver was under $6 an ounce. When he sold out nine years later, he sold it for all of $7.5 an ounce. Not a heavenly profit, when adjusted for inflation. He also missed the boom in silver.

And guess today’s price of silver: nearly $34 an ounce. The world’s best investor goofed up on silver.

Buffett’s own preference is for productive assets, “businesses, farms, or real estate**.** Ideally, these assets should have the ability in inflationary times to deliver output that will retain its purchasing-power value while requiring a minimum of new capital investment.”

No one can quarrel with this formulation. When pitting risk-free investments in an inflationary environment, and unproductive assets against productive ones, only a fool would believe that the former are better.

However, the real catch is not in this motherhood statement, but that whether what works for Warren Buffett can work for everyone else.

In fact, what works for Warren Buffett does not always work even for him in the short to medium term. Reason: despite all his acumen, he can make bad investments (like Bank of America, to which he lent $5 billion, which is currently under water; or the investment in silver.)

The point, of course, is not to show that Buffett is a blunderbuss, but that a strategy that is fine for him may not be fine for you.

On the contrary, many of the things that work for you cannot work for him. For example, Berkshire Hathaway is such a huge investor that when Buffett moves in on any scrip or asset, prices are impacted. A T-Rex cannot move quietly in the bushes waiting for his kill. The chances are he will be heard long before he nears his prey. Little wonder, they are extinct.

For the ordinary investor, thus, it is not a great idea to follow the all-time greats in investing - whether it is a Warren Buffett or a Peter Lynch or even our own home-grown Rakesh Jhunjhunwala. It is always good to read what they have to say about the markets or various asset classes, but ultimately you have to think for yourselves.

Here are my rules for investing:

One, the first and basic rule is asset allocation. When choosing between debt, equity, gold or any other asset, remember the following: money you cannot afford to lose has to be in fixed investments (fixed deposits, tax-free bonds, debt funds, etc), never mind if the real return may turn out to be negative. You are trying to protect capital here, and earn a bit of interest. A caveat: even debt funds can drop in value when interest rates rise. So the best thing is a fixed deposit that does not lose value. Or a bond where there is a buyback option. Tax-free bonds, of the kind issued recently by NHAI and IRFC are great, for they give you higher post-tax returns, well above inflation.

Two, stocks ought to be part of everyone’s portfolio. Here we have to debunk two myths first: that mutual funds are the only way for ordinary folks to invest in equity. And two, that timing is not important. The truth is mutual funds very often do not beat the indices because when they buy or sell, the market rises or falls in the process. The market is simply not liquid enough to absorb such large purchases or sales, and hence equity funds (especially large ones) end up buying or selling at adverse rates.

It is individual investors - those who cannot move the market - who can get the best prices, not mutual funds. For this, you need to read up a bit on stocks, but believe me, it is largely commonsense. You don’t need Buffett’s knowledge to make money in stocks. The second myth is timing: that you must not time the market. You should. While no one can predict the right time to buy or sell, you still must figure out whether the broad market or sector trend is up or down. You must try to buy when more people are selling, and sell when more people are buying.

Three, one should invest in gold for two reasons. First, preservation of value over the long-term, and not returns. And second, for use in jewellery or other forms. Seen this way, gold is that ultimate asset which one hoards for that terrible day when all other things lose value. When the government of India was going bankrupt, gold came in handy in 1991. All Indians value gold for this reason - and this is a good enough reason, no matter what Buffett says. However, gold should not exceed 10-15 percent of one’s investments at any time.

Four, real estate is not an investment for most people. You should buy real estate only for living in your own house, and not for investment. The rich can speculate in land and property, but most middle class people should not do so. And especially not by borrowing. In India, real estate does not earn adequate rental yields to even take care of half your EMIs. So the only value comes from your ability to sell it at some point. And remember, the real estate market is simply not liquid enough to help you when you need money. It is rigged in favour of builders.

Five, the belief that in the long-term stocks will beat all other asset classes is not always true. For this to be true, two conditions are essential. First, the overall economy (and the sector your stock is in) must be growing predictably. Second, more and more money must be moving into stocks - systemically. Americans stocks had a long bull run till recently because pension fund money was steadily moving into stocks. If the flows dwindle, stocks cannot rise as much. In India, pension funds are just starting to move into stocks through the New Pension Scheme (NPS). The flow will grow as efforts are on to popularise the NPS. If a reform-oriented government allows a portion of the Employees’ Provident Fund also to be invested in stocks, the markets will see sustained growth.

India fits condition five right now, but not Europe or Japan or even America. There is a good chance a canny investor can beat Warren Buffett and Rakesh Jhunjhunwala hands down if he invests wisely in India.