Warren Buffett: How to Make Money During Inflation

Are you seeing signs that

inflation

is starting to rise? We are seeing very substantial

inflation

. It's very interesting. I mean, we're raising prices. People are raising our prices. It is being accepted. I mean it's not inflation. It's a big concern for everyone right now. Political Investors Inflation has been a big concern and topic of conversation for the last year or 18 months or so. In this video, we will analyze a hierarchy of different investment categories and how they are classified into periods of inflation, all according to Warren Buffett, who at 91 years old knows a thing or two about inflation because he has lived it.

I spent hours interviewing Warren Buffett while he researched this video. All I ask in return is that you seriously hit the like button, that's all. okay, and maybe subscribing to the channel if you're not already, let's get into the video. The worst investment you can have during a period of inflation is cash. Warren Buffett isn't the only investor who doesn't like holding cash during a period of inflation. Fellow billionaire. Ray Dalio has also expressed his distaste for cash with a very memorable and catchy quote: Cash is garbage, this is because during times of inflation, the cash you have in a savings account or on your dresser at home is worth less. let alone every day, every week, every month and every year, one of the most important takeaways I want you to know from this video is that you, as an investor, need to think about the return on your investment and what is known as real terms, the math behind calculating your The real return on an investment is simple, let's say your investments earned you 10 per year, that's great, right, not so fast, it really depends on what the rate of return is. inflation.

To calculate the real return on your investments, you need to subtract the impact of inflation. So if inflation is seven percent and your investments return 10 that year, your real return is only 3 percent, not that exciting, that's why cash is at the bottom of this hierarchy, because its return on holding cash is essentially zero if you hold cash for a long period. a period of time allows the impacts of inflation to work against you above cash in the hierarchy are fixed interest rate bonds, these investments are generally considered very safe according to conventional investing wisdom, but Buffett would argue that these investments They are not really that safe when you take into account the impact of inflation, let me explain what I mean: the current yield on a 10-year US government bond is around 1.8 at the time of making this video, This means that if you bought a 10-year government bond today, you would effectively lock in an annual return of 1.8 every year for the next decade, let's say inflation averages four percent for the next decade, which is not necessarily a stretch.

Given that the most recent inflation report had inflation at seven percent, with inflation at four percent, this means you would have a real annual return of negative 2.2 after taking into account the impact of inflation on your return. Now this is still better than just holding cash, but it's still a long way from the best you know if we go down if we go down. With $1 million in cash in every home in the United States today, everyone is feeling pretty good except the people who invested in dollar-denominated things. It is important to note that people who own fixed rate debt, such as government bonds, lose in times of inflation in the The other side of the coin is that people who borrow

money

in a long-term structure at a fixed rate They are winners during inflation.

An example of this would be people using a mortgage to buy a property in December 2020. I bought a house which I was able to insure on a 30.2.8 year fixed rate mortgage, this means my interest rate will stay the same for the next 30 years. My mortgage payment will also be exactly the same for 30 years. This is a great place to be in times of inflation this is because inflation eats away at the value of mortgage debt month after month and year after year as inflation

make

s each dollar worth less and less. I can pay off my mortgage debt with devalued dollars if I own a home, albeit at a huge price tag. mortgage and you have incredible inflation, erase the mortgage, then you still have the house, I'm serious, in Wymart, Germany, they gave you your mortgage back at the end, that was very interesting, that's the only thing they did next in this.

The hierarchy is what Buffett calls unproductive assets. They are things like gold, silver and other precious metals. It's not terrible to own them during a period of inflation because, all things being equal, as the price of everything else increases, these things should at least hold up. In theory, we are keeping pace with inflation, however these unproductive assets will probably not increase their purchasing power either. Let's listen to Warren Buffett explain this. I will say this about gold, if you took all the gold in the world, it would form roughly a cube. 67 feet on a side, so if we took all the gold in the world, we could have a cube that went down there 67 feet 67 feet high and that would be it now, for that same cube of gold it would be worth in today's market. trades around seven trillion dollars, which is probably about a third of the value of all stocks in the United States, so you may have the option of owning a third of all stocks in the United States or you may have the option to own a small block. of gold that can do nothing but shine there and

make

you feel like you have less or wrinkles or something now for seven trillion dollars there are about a billion acres of farmland in the United States that are valued at about two billion and a half dollars, that's about half of the continental United States is farmland.

Uh, you could have all the farmland in the United States, you could have about seven Exxon Mobils and you could have a trillion dollars of walking

money

and if you offered me the option to look at a 67 foot cube of gold and look at it all the day, you know, I'm not touching him, petting him from time to time, you know, and then saying you know, do something for me and he says I don't do anything. I stay here and look pretty and the alternative to that was having all the farmland in the country, all cotton, corn, soybeans, seven Exxon Mobils, just think about that, add a trillion dollars of walking money.

You know, maybe you call me crazy, but I. We'll take Exxon Mobils' farmland, let's move on to the next category of investments in our inflation hierarchy. Now these investors don't just want to keep up with inflation, we want investments that can outperform inflation and produce a real return for This is where what Warren Buffett calls productive assets comes into the picture. Now we all know that Warren Buffett made his fortune by buying stocks and entire businesses, but according to Buffett, not all businesses are created equal. Next in the inflation hierarchy are productive assets. Average business. Average businesses have a couple of characteristics, one of which is that these types of businesses require a ton of additional capital, which is just a fancy word for cash to keep operating;

Unfortunately, most companies will not do well in real terms during inflation, their profits may increase quite a bit over time, but they are forced to invest more and more dollars into the business just to stay in the same place and you know that The worst type of business is the one that makes you put more money on the table all the time. time and doesn't give you greater profits, so here's a simplified example using a real company that will hopefully prove the point. united rentals ticker symbol uri is the world's largest equipment rental company. They have a pretty simple business model.

United Rentals purchases equipment that is typically used in construction projects, so things like bulldozers, portable toilets, and heavy duty trucks, United Rentals then turns around and rents that equipment for short-term construction projects, usually the duration of the project. Obviously, this equipment that the United Rentals company rents to its customers does not last forever and needs to be replaced approximately every few years, let's say for simplicity that each excavator the company buys costs a million dollars and let's say that during the useful life of That excavator can be rented to customers and generate $1.2 million. in sales for the company, that's a nice profit of two hundred thousand dollars, but let's say, for the sake of this example, that inflation is twenty percent, which means that the next time the company goes to buy another bulldozer to replace the existing one, the company will have to spend. 1.2 million dollars, see what is happening here, the company cannot take money from the business in the form of profits.

All the money United Rentals makes in profits must be reinvested directly into the business to purchase new equipment. to replace old equipment now I don't expect inflation to be anywhere near 20 percent, hopefully, and United Rentals is a great company, but this example demonstrates the challenge capital-intensive businesses face during periods of inflation, a short story before moving on to the next. Business characteristic you want to avoid during inflation. Warren Buffett's partner and friend, Charlie Munger, had this quote that pretty much sums up what I explained: There are two categories of good businesses, one is the business where all reported profits just sit there and the surplus cash. at the end of the year and you can put it out of business and the business will run as well without the cash as it would have if you stayed in business.

The second business is one that brings profits but there is never cash. It reminds me of my old friend's used construction equipment business and he used to say that in my business every year you make a profit and there it is in the yard and there are a lot of businesses like that where you just keep going. to stay in place there is never any cash the next trade average companies you want to avoid are companies that do not have what is known as pricing power the best way to explain what I mean by companies that do not have pricing power pricing It's talking a little bit about a company having pricing power when I think about pricing power.

The first company I think of is Apple. Apple has such a loyal customer base that many Apple customers will pay whatever the company wants to charge for their iPhone. product if someone wants a new iPhone they are not going to buy a competitor's product just because it is cheaper. Compare this to a company with little or no pricing power where pretty much the only thing the customer cares about is price, say a company manufactures plain and simple. white t-shirts that's all the company just makes white t-shirts with no design or branding this company has no pricing power because someone is just going to buy the cheapest white t-shirt they can find this t-shirt manufacturer also has no ability to increase prices prices more than its competitors because the second is that the prices are higher than its competitors people will simply choose to buy the white t-shirts of this company's competitors an inflationary environment it will be difficult for this company the cost of materials to make shirts is increasing the cost of paying workers to make the shirts is increasing and the cost of shipping the shirts to customers is also increasing the only thing that is not really increasing is the price the company can charge for the shirts now, TRUE?

See why inflation is so challenging for companies without pricing power. Now let's move on to the next investment category in the hierarchy. Let's call these investments productive assets. Big enterprises. I know a very clever name. Here is another example. Remember how in the previous example we had the company that spent a million dollars buying an excavator, let's say instead that our friend John uses that same million dollars to develop a software product that does something like make it easier for YouTube creators to create of videos like in the example above, let's say John makes $1.2 million in his first year with that product, a great $200,000 profit, but wait, it gets even better.

Let's say there is also 20 inflation in this example, which means that John can charge 20 more for his software this year than last year. This means that the $1.2 million John had in sales last year becomes $1.44 million due to inflation in 20, but the good news with this software business is that John doesn't have to reinvest. more money in the business you already have. the software and while he may have to spend some money updating and maintaining it, it would be aminimum amount. This is the opposite of a capital-intensive business. In the example above, this software business of John's would be what is called a capital-light business.

Because the amount of cash that John will have to continue to reinvest in the business just to maintain the operations and product of the business is minimal, this means that John can actually withdraw his profits from the business and not have to constantly reinvest them. maintain the business again like in the equipment rental company example above to find a business that performs well during inflation you want to find the exact opposite of the mediocre business we talked about earlier you want to find a business with low capital requirements, these They are companies that do not have to constantly reinvest large sums of money in the business to grow many times over.

These are companies with very strong brands, like Apple, Coca-Cola or Buffett's. Other examples of the type of companies that have low capital requirements are companies that are not dependent on owning a ton of physical assets like factories or physical inventory, so think about companies like Microsoft. Facebook or other technology-focused companies - virtually any company. Software falls into this category, since once the software is created and the money is spent building it, the reinvestment in the business is relatively minimal compared to most companies, the other key element of a company. What I want to possess in times of inflation is pricing power.

Now I'll be the first to admit that evaluating a company's pricing power is more art than science, but here are some useful things to think about in an exercise that I think is useful. To think about how a customer would react if the company raised their prices by 10, there are a few different reactions that customers would have that fall on a spectrum from I don't care about the price increase, take my money please, to no way. I'm not paying that in times of inflation, when prices rise, you want to own shares of companies that can easily increase the prices of their products, you want to avoid investing in companies in commoditized industries that struggle to raise prices even in normal times.

I want to end this video with some important advice from Warren Buffett and you know what the best investment is. I mean, if you're the town's leading neurosurgeon or the town's leading lawyer or whatever, you don't do it. You have to keep re-educating yourself so that in today's terms, you bought your experience when you went to medical school or law school with old dollars and you don't have to keep reinvesting and you keep your purchasing power and your current dollars. The best protection against inflation is to invest in yourself if you are the best at what you do whether you are the best mechanic lawyer dentist plumber or accountant you become immensely valuable to other people the benefit of being immensely valued in a market economy is that You Basically, you can charge whatever you want for your services and your clients will be happy to pay it, so there we have it.

I hope you enjoyed the video as always. Make sure you like this video and subscribe to the investor hub because my goal is to make you a better investor by studying the best investors in the world. We will talk to you soon.