2004: How should investors prepare for an inflationary environment?

AUDIENCE MEMBER: Mr. Buffett, Mr. Munger, good morning. My name is Zachys Sarris (PH) and I am from Athens, Greece.

There is a widespread perception that we’re heading towards an inflationary environment. What advice would you give to investors who need to preserve their capital and their purchasing power in such an environment?

WARREN BUFFETT: The best thing is to have a lot of earning power of your own. If you’re the best brain surgeon in town, or even the best lawyer in town, you will retain purchasing power, in terms of your income, no matter what happens, you know, whether people are using seashells for money, or whatever as time goes by.

In the investment world, it’s tougher. But Charlie and I think the best answer is to own fine businesses that will be able to price in inflationary terms and will not have huge capital investment that is required to handle the larger dollar volume of sales.

Some years ago, I used See’s Candy in our — in the annual report — as an example of the kind of business that, more or less, can handle an inflationary world and maintain investment and value, no matter what happens to the currency.

Unfortunately, most businesses will not come out well in real terms during inflation. Their earnings may go up a fair amount over time, but they’re compelled to put more and more dollars into the business just to stay in the same place.

You know, the worst kind of a business is one that’s — makes you put more money on the table all the time and doesn’t give you greater earnings. So you really want a business that can have pricing that reflects inflation and does not have very much capital investment that reflects inflation. But inflation is the enemy of the investor, in terms of real returns.

As you know, there are, in this country as well as a half a dozen other countries, there are what they call “inflation protected bonds” — we call them TIPS in the United States — where the income is adjusted — or, the principle amount is adjusted — to inflation. And that’s not a bad investment for people that have worries about inflation heating up. And I think, incidentally, we’re starting to see it heat up in this country.

Charlie?

CHARLIE MUNGER: Yeah, most people are going to get a very small real return from investment after considering inflation and taxes. I think that’s an iron law of the world and if, for a brief period, some of us do better than that, we ought to be very thankful.

One of the great defenses to being worried about inflation is not having a lot of silly needs in your life. In other words, if you haven’t created a lot of artificial demand to drown in consumer goods, why, you have a considerable defense against the vicissitudes of life.

WARREN BUFFETT: Charlie, we’re selling consumer goods in the other room. (Laughter)

It’s OK to talk that way at home, but — (Laughter)

CHARLIE MUNGER: It doesn’t do any good there. (Laughter)

WARREN BUFFETT: I know the feeling. (Laughter)