Why Warren Buffett Wouldn’t Choose A Cash ISA

Warren Buffett’s fans aren’t big risk takers; they’re ordinary investors who have seen their savings steadily grow under his conservative management. Over the past 50 years that he has been running Berkshire Hathaway, shareholders have seen the book value per share rise from $19 to over $146,000, a compound annual growth rate of 19.4%.

Homespun wisdom

Each year he writes to shareholders, imparting the kind of homespun wisdom that has given him the moniker The Sage of Omaha.

What is sound advice for the moms and pops of Oklahoma is worth listening to in the hard-pressed households of middle England. And Mr Buffett’s most recent letter has some specific advice that might come as a surprise to many who put savings into cash ISAs in the belief that it’s a safe way to invest for the future. In this year’s 50th anniversary letter he says:

“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…. 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.”

(The italics are Mr Buffett’s, not mine).

The UK equivalent of “securities”, “cash-equivalent holdings” and “currency-denominated instruments” are gilts, bonds, bank deposits and the like. Mr Buffett’s argument is that, over time, these kinds on savings are riskier than stocks. That’s because stocks grow in value, on average, whilst inflation makes the value of money shrink. He cites how, with reinvested dividends, the S&P 500 generated a return of 11,196% over the past 50 years, compared to an 87% decline in the purchasing power of the dollar.

Volatility isn’t the same as risk

Of course, stocks are more volatile, so owning stocks for just a day or week or year is riskier. Money that investors might need in this timescale should be stored in cash-like investments. Many financial advisors recommend keeping 6-months’ worth of earnings as cash. But if you have money to tuck away for several years, then stocks aren’t just likely to grow more, according to Mr Buffett they are less risky than cash. And if you can put that money in a stocks and shares ISA, you protect those big long-term gains from tax.

A low cost FTSE 100 tracker is one easy way for inexperienced investors to get started. The index has returned 9.6% p.a. over last three years and 9.1% p.a. over the last five.

One of the ways that long-term investments grow is through the reinvestment of dividends, which acts just like compound interest. Albert Einstein called that the eighth wonder of the world, saying "He who understands it, earns it... he who doesn't... pays it".

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Tony Reading has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.