In a 2014 interview, Warren Buffett said the following:
“Cash is always a bad investment. When people said ‘cash is king’ a year ago, I mean, that’s crazy. Cash wasn’t producing anything and it was sure to go down in value over time … It’s like oxygen – you want to be sure it’s around, but you don’t need to have excessive amounts of it around.”
Berkshire Hathaway (NYSE:BRK.B) might have been increasing its cash pile recently. But I think Buffett’s view is as true now as it has ever been.
Inflation
Buffett talking about the value of cash going down is a point about inflation. And in 2014, US prices were increasing at 1% while interest rates were below 0.5%.
That meant anyone holding on to cash was probably losing money. But things are different now – inflation in the UK is around 3% and interest rates are 4.75%.
Despite this, Buffett’s warning about cash is as relevant now as it ever was. Admittedly, there are times when it’s a good asset. Cash savings are ‘safer’ than shares and have guaranteed interest rates. But I don’t think cash is a good asset over the long term.
Central banks on both sides of the Atlantic are aiming for 2% inflation. So if they succeed, savers will need to earn at least this on their cash to avoid going backwards.
Whether or not they can do this depends on where interest rates are headed. But whatever happens, rising prices are likely to be a drag on the returns generated by cash.
There is, however, a better option. Buying shares in companies that are somewhat protected from the effects of inflation can help offset the effect of higher costs.
Businesses
Buffett has long held that stocks are a better choice for the long term. And Berkshire Hathaway is a good illustration of different ways investors can protect themselves from inflation.
This comes in a few different forms. Some of Berkshire’s subsidiaries – such as the utilities business and the railroad – are able to increase prices to offset the effect of higher costs.
That’s not to say these are without risk. Both industries are regulated and the company’s ability to earn a return depends on it getting the approval of the regulators, which isn’t guaranteed.
Other businesses are protected from the effects of rising prices because they don’t have to spend much to maintain their assets. This is most obvious in the companies Berkshire owns shares in.
With Coca-Cola, for example, its brand is its key asset. The company outsources the parts of its business that need heavy investment to local franchisees, meaning its costs are relatively low.
When a business doesn’t have much in the way of costs, rising prices don’t affect it much. And Buffett has said before that this is the best form of protection against inflation.
What is Buffett doing?
I’ve heard a few theories around as to why Buffett has been building a cash pile recently – some more plausible than others. Whatever the reason, I doubt very much it’s a long-term strategy.
As a result, I’m not looking to build a cash pile right now. Once I’ve done that, my plan is to keep investing in businesses that I think can handle inflationary pressures. Berkshire Hathaway will be one of them.
