- Warren Buffett said in his annual letter the practice of managing portfolio risk using a specified ratio of bonds-to-stocks is flawed.
- The Berkshire Hathaway chief argues a diversified portfolio of equities progressively becomes less risky than bonds over an extended period.
Warren Buffett wants to dispel a common investing myth.
In his most recent annual letter, the billionaire investor and Berkshire Hathaway chief says investors who measure the risk of their portfolios using a ratio of stocks to bonds are doing it all wrong.
It's a practice that's more common than you might think, and Buffett counts pension funds, college endowments, and savings-minded individuals among the parties most likely to make such a mistake.
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Buffett's skepticism around the strategy stems from his view a diversified portfolio of equities progressively becomes less risky than bonds over extended periods of time. He wonders why, if bonds aren't necessarily safer, investors force themselves to own a certain number of them.
"It is a terrible mistake for investors with long-term horizons ... to measure their investment 'risk' by their portfolio's ratio of bonds to stocks," Buffett wrote in the February 24 letter. "Often, high-grade bonds in an investment portfolio increase its risk."
"Purportedly 'risk-free' long-term bonds in 2012 were a far riskier investment than a long-term investment in common stocks," he continued. "At that time, even a 1% annual rate of inflation between 2012 and 2017 would have decreased the purchasing-power of the government bond" he sold.
Buffett's stocks-versus-bonds argument is perhaps even more relevant right now because the traditional inverse relationship between the two asset classes has deteriorated. Long-term Treasurys have been rising along with stocks, derailing traditional ideas of diversification.