Warren Buffett is widely regarded as one of the greatest investors of all time. And for good reason.
As per the latest Berkshire Hathaway (NYSE: BRK.B) letter to shareholders, he has helped deliver an average annual return of 19.8% per annum since all the way back in 1965. This is double the market return over the same period.
So, when the Oracle of Omaha gives out advice, it can literally pay to listen.
On this occasion, we are going to look at why Buffett prefers stock and shares to term deposits.
Why pick ASX shares over term deposits?
Firstly, at their core, ASX shares and term deposits represent fundamentally different investment strategies. So, it is worth acknowledging that even uncle Warren's advice won't be suitable for everyone. But for the majority, I would say take his words and run with them.
Term deposits are essentially low-risk loans made to banks in exchange for a fixed interest rate over a specified period of time. And while they offer a degree of safety and stability, their returns are typically modest and subject to inflation risk.
Right now, you're looking at a return of approximately 4% per annum from a 12-month term deposit. This is notably lower than the current inflation rate, which means that your money is actually losing value in real terms.
Back in 2008, Buffett described this type of use of capital as being "comfortable." He opined:
Today people who hold cash equivalents feel comfortable. They shouldn't. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts.
In contrast, ASX shares represent partial ownership in a company and offer the potential for much higher returns over time. And although they are inherently more volatile than term deposits and subject to market fluctuations, they also provide the opportunity for capital appreciation and dividend income.
Historical outperformance
While we can't guarantee it will be the same in the future, historically, the difference in returns between shares and term deposits has been significant.
For example, the average annualised return for US shares from 1926 to 2022 was approximately 10%, while the average return for three-month U.S. Treasury bills (a commonly used proxy for term deposits) over the same period was just 3.3%.
To put that into context, a single $10,000 investment generating these returns for 50 years would turn into approximately $51,000 for term deposits and $1.2 million for shares. That's a staggering difference of more than $1.1 million!
But the positives don't stop there. In addition to the potential for higher returns, ASX shares also offer other advantages over term deposits. For example, shares are more liquid, meaning they can be bought and sold quickly and easily. They also provide the opportunity for diversification, which allows investors to spread their risk across multiple companies or industries.
All in all, while term deposits offer a degree of safety and stability, their returns are typically modest and subject to inflation risk. For investors seeking higher returns and long-term value, I believe the share market represents the superior option. By investing in high-quality companies with strong competitive advantages and long-term growth potential, just like Mr Buffett does, investors have the potential to generate enormous wealth over time.
