Jemal Countess/Getty Images for Time Inc.
Berkshire Hathaway CEO Warren Buffett attends the Fortune Most Powerful Women summit at Mandarin Oriental Hotel on October 5, 2010 in Washington, DC.
Thanks to Henry Blodget at Business Insider for directing to this Fortune except from Warren Buffett's annual letter to Berkshire Hathaway shareholders. In it, Warren Buffett lays out the commonsense case for avoiding investments in currency (for example, government debt like U.S. Treasuries) and gold (driven by fear) and sticking with stocks. Here's a taste:
My own preference -- and you knew this was coming -- is our third category: investment in productive assets, whether businesses, farms, or real estate. Ideally, these assets should have the ability in inflationary times to deliver output that will retain its purchasing-power value while requiring a minimum of new capital investment. Farms, real estate, and many businesses such as Coca-Cola (KO), IBM (IBM), and our own See's Candy meet that double-barreled test. Certain other companies -- think of our regulated utilities, for example -- fail it because inflation places heavy capital requirements on them. To earn more, their owners must invest more. Even so, these investments will remain superior to nonproductive or currency-based assets.
I love how he throws little See's Candy — a Los Angeles favorite — in with giants like Coke and IBM. But apart from that, he's right, although there are times when buying up government debt can be a good idea (when bond prices are very cheap and the yield is much higher than the historical average, for example).
Of course, you have to realize that getting rich like Warren on this strategy entails buying up as much of that productive asset as you possible can, so you can max out the value extraction for yourself and your investors. As you move down the investment food chain, this can be harder. Buffett is going to make lots of money his holdings because he...holds so much of companies.
The average investor has to think smaller. That said, he or she can still follow Buffett's guidelines, investing in companies that, in a nutshell, can consistently beat inflation over the long haul. In the end, that's really all you're trying to do. You shouldn't be aiming for a 30 percent return — you should be trying to stay ahead of inflation that runs at something like 4 percent historically.
And you definitely want to stay away from the giant cube of gold, which Buffett characterizes amusingly as a great idea for a sculpture, but no match whatsoever for a farm or an oil company as a lifetime investment.