{"id":91201,"date":"2023-02-05T06:50:00","date_gmt":"2023-02-05T10:50:00","guid":{"rendered":"https:\/\/www.shortform.com\/blog\/?p=91201"},"modified":"2023-02-09T11:40:40","modified_gmt":"2023-02-09T15:40:40","slug":"bad-investments","status":"publish","type":"post","link":"https:\/\/www.shortform.com\/blog\/bad-investments\/","title":{"rendered":"Bad Investments, According to Warren Buffett"},"content":{"rendered":"\n

What assets should you never invest your money in, according to Warren Buffett? Why are these investments dangerous? <\/p>\n\n\n\n

Warren Buffett prefers equities over other forms of investment. He cautions against bad investments such as unproductive assets, junk bonds<\/a>, and financial derivatives.<\/p>\n\n\n\n

Keep reading to learn why you should steer clear of these investments, according to Buffett. <\/p>\n\n\n\n\n\n\n\n

Investments to Avoid<\/strong><\/h2>\n\n\n\n

Some bad investments are made out of fear\u2014people want to keep their money safe in case of a financial crisis. Money market funds and bonds appear safe, but Buffett points out that their interest doesn\u2019t keep pace with inflation. Money in those investments loses value, even as the total dollar figure slowly rises.<\/p>\n\n\n\n

(Shortform note: Money market funds are not the same as money market accounts<\/a>, a type of savings account. A money market fund<\/a> is a mutual fund that invests in short-term, low-risk financial instruments. Bonds, on the other hand, are fixed-interest loans<\/a> made by you, the investor, to a company or the government. The most famous of these may be the US War Bonds<\/a> used to finance the United States\u2019 participation in the second World War.)<\/p>\n\n\n\n

More foolish, though, is to invest in assets that are completely unproductive, such as jewelry, collectibles, or gold. Unlike a business, these investments create nothing. These items only have value at all as long as people believe that they do. People who invest in unproductive assets hope that someone else will pay a higher price for them in the future, a hope based more in fantasy than fact. (Shortform note: The most popular current types of unproductive assets are gold and other precious metals<\/a>, but the classic example of unproductive investment speculation is the Dutch tulip craze of 1636<\/a> when, for a short while, tulips became a hot investment commodity in the Netherlands before prices fell back to rational levels.)<\/p>\n\n\n\n

Fantasy also drives the market for <\/strong>junk bonds<\/em><\/strong>.<\/strong> These are bonds issued by companies that are already saddled with more debt than they can bear. Junk bonds are a way to refinance that debt, but the issuing companies are in such poor financial straits that they still pose a very high risk of default. Nevertheless, there are investment firms that funnel lots of money into the junk bond market, believing once again that diversification minimizes risk. In the case of junk bonds, this is much the same as buying a lot of lottery tickets in order to increase your chance of winning. Buffett writes that junk bonds exacerbate financial crises on a regular basis.<\/p>\n\n\n\n

(Shortform note: Junk bonds are often marketed more enticingly as \u201chigh-yield bonds<\/a>\u201d because of their promised high rate of return. The market for junk bonds was particularly active in the 1980s until a series of defaults in 1989<\/a> sent the stock market into a downturn that led to the bankruptcy of the investment firm Drexel Burnham<\/a>, one of the chief underwriters of junk bonds. There were fears of a similar crisis in 2015<\/a>, but the junk bond market stabilized itself. Despite the risk involved with high-yield bonds, in A Random Walk Down Wall Street<\/em><\/a>, Burton G. Malkiel doesn\u2019t discount them as an option for young investors with diversified portfolios<\/a>.)<\/p>\n\n\n\n

Financial Derivatives<\/strong><\/h3>\n\n\n\n

The most troublesome of all complex financial products are derivatives<\/em>, such as those that drove the subprime mortgage<\/a> crisis. Buffett explains that derivatives are contracts between two parties in which one pays the other if some other financial instrument (for example, a stock or a bond) reaches a certain price, up or down. In the simplest terms, derivatives are bets <\/em>that a portion of the market will behave a certain way.<\/strong> They are instruments of pure speculation, and unless there\u2019s some form of collateral involved, a derivative\u2019s value rests entirely on the financial strength of the parties involved in the gamble.<\/p>\n\n\n\n

Buffett argues that derivatives are also instruments of fraud. Until the derivative actually comes due, both parties to the bet can use fictitious projections to claim that their derivatives produce actual earnings, and then get paid by their investors based on those supposed earnings (like receiving a cut from a race horse\u2019s winnings before the race is even run). It\u2019s only when one of the parties tries to cash in on their derivative contract that any fictitious claims about its value are revealed, and if the \u201closer\u201d of the derivative bet defaults, then both sides’ projected earnings disappear. Before that time comes, however, derivative contracts are designed to be so complex that their true risks and false earnings claims are hard for portfolio auditors to spot.<\/p>\n\n\n\n

Even more than avoiding such toxic financial products, Buffett wants to impress upon his readers that you should never borrow money to invest.<\/strong> This has always been the curse of Wall Street, and it’s led many individuals, companies, and banks straight down the road to financial ruin. Brokers, advisers, and money managers sugar-coat debt by calling it \u201cleverage,\u201d which fueled the corporate takeover craze of the 1980s. Easy access to debt can be like a drug, especially when tied to the thrill of investing. Eventually, though, all debts come due, and if your investments have dropped in value, you won\u2019t be able to pay your debts off. However, if you only invest with cash, you\u2019ll be well-prepared for any hiccups in the market.<\/p>\n","protected":false},"excerpt":{"rendered":"

What assets should you never invest your money in, according to Warren Buffett? Why are these investments dangerous? Warren Buffett prefers equities over other forms of investment. He cautions against bad investments such as unproductive assets, junk bonds, and financial derivatives. Keep reading to learn why you should steer clear of these investments, according to Buffett.<\/p>\n","protected":false},"author":7,"featured_media":30678,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_jetpack_memberships_contains_paid_content":false,"footnotes":""},"categories":[81,31],"tags":[889],"class_list":["post-91201","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-economics","category-money","tag-the-essays-of-warren-buffett","","tg-column-two"],"yoast_head":"\nBad Investments, According to Warren Buffett - Shortform Books<\/title>\n<meta name=\"description\" content=\"What assets should you never invest your money in? 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