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BACK IN 2010, at the Berkshire Hathaway annual meeting, a shareholder challenged Warren Buffett. Noting that shares of motorcycle maker Harley-Davidson had nearly tripled over the prior year, he asked Buffett why he had chosen to buy the company’s bonds rather than its stock. Buffett’s reply was a two-minute masterclass in how to think about investments. It’s worth walking through it point by point.
To start, Buffett acknowledged that hindsight can be cruel. “I might have asked the same question,” he said. But then he reminded the investor that we should never judge an investment decision solely based on its result. Instead, he emphasized the importance of a sound decision-making process. He then detailed how he thought about the Harley decision at the time.
Buffett started at a high level, with a discussion of asset allocation, and here he made a counterintuitive argument. Many of Berkshire Hathaway’s liabilities extended out more than 50 years, he said, and with such a long time horizon, it might seem like the company could afford to take an almost unlimited amount of risk in the stock market. Buffett acknowledged that was indeed the case. But, he said, “we would never have all our money in stocks,” even if, on paper, it seemed like the best choice.
Buffett and his partner, Charlie Munger, still chose to hold substantial amounts in bonds, even if that meant giving up potential gains. Why? Buffett went on to explain why holding bonds made sense even in the absence of any clear need. For starters, bonds provide flexibility during stock market downturns. And since bear markets always arrive without notice, and can last multiple years, it makes sense to hold bonds, more or less, at all times.
Perhaps not surprisingly, Buffett once mentioned that a trust he’d established for his family was similarly structured, with 10% in bonds, even though it had a long time horizon and could theoretically afford to be entirely in stocks.
Coming back to the Harley-Davidson decision, Buffett referenced his mentor, Benjamin Graham. In his book Security Analysis, he had explained the relative benefits of “junior” and “senior” securities. “Junior securities,” Buffett said, “usually do better, but you’re going to sleep better with the senior securities.”
What did he mean by junior and senior? In a typical corporate structure, where a company has issued both bonds and stocks, bondholders would have first claim on the company’s assets if it went into distress. Stockholders, on the other hand, would be further back in line. For that reason, bonds are said to be senior, while stocks are junior.
It’s an important distinction. Because of this structure, bonds are inherently more secure than stocks. They are essentially IOUs. But also because of that structure, bonds will normally have lower returns than stocks. Companies know they don’t have to offer as much in the way of interest to bondholders because of their more senior position. This is the technical reason why, all things being equal, bonds offer both lower risk and lower returns than stocks.
Buffett acknowledged that Harley-Davidson was a beloved company. “I kind of like a company where your customers tattoo your name on their chest.” Still, Buffett said, there were no guarantees. Even great companies can run into trouble. It was for this reason, Buffett said, that buying Harley-Davidson’s bonds was a relatively easy decision. “I knew enough to lend them money. I didn’t know enough to buy [the stock].” That’s because buying the stock would have required a much more detailed analysis of the motorcycle market, including an understanding of consumer trends and the effects of competition on Harley’s profit margins. Buying the company’s bonds, on the other hand, “was a very simple decision. It was just a question of, are they going to go broke or not?”
When we choose to buy bonds, in other words, we’re intentionally choosing the slow lane, but it’s for a reason: because bonds offer a level of certainty that stocks can never provide. And because of that certainty, we shouldn’t feel badly when bonds deliver meager returns. It’s by design.
Buffett wrapped up the discussion acknowledging that if he’d opted for Harley’s stock, he would have made far more money for Berkshire shareholders. But that wasn’t the right yardstick, he argued. “We are running this place so that it can stand anything.” That, I think, is the most important thing we can take away from this story. The investment industry spends a lot of time talking about performance—and specifically, about outperformance. Of course, we all want to see our investments grow, but what’s most important, in my view, is that your portfolio be resilient enough to “stand anything.”
One of the benefits of stock market downturns is that they give us an opportunity to stress test our emotional response to the market. After a roughly 10% downturn earlier this year, stocks are back at all-time highs, so this is a good time to take the temperature of your portfolio. If you lost some sleep during the downturn this spring, or the one we experienced last spring, this might be a good time to shift some of your portfolio to more senior, more secure, securities. If, on the other hand, you barely even noticed these downturns, that’s important information as well. Investing, in other words, isn’t just about numbers.
Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam’s Daily Ideas email, follow him on X @AdamMGrossman and check out his earlier articles.
Holding mainly SPY or VOO makes sense—you’re essentially betting on the strongest capitalism in the world and riding momentum investing. SPY naturally allocates more to the best-performing stocks.
Bonds, however, are a different story. Over the last 5, 10, and 15 years, BND returned roughly 0%, 1.5%, and 2.2% annually—trailing inflation. Many high-rated bond indexes are like planes without pilots, since managers can’t adjust the portfolio for changing market conditions. That’s why I’ve never held high-rated bond funds directly.
Hint 1: Stocks are easy—stick to indexes. Bonds are where you can truly add value. Look for funds with strong Sharpe ratios and solid absolute performance—that’s how you find well-managed bond funds.
Hint 2: Always consider unique local and global factors. Anyone who didn’t sell in early 2022 didn’t understand basic investing. After the highest inflation in over four decades, the Fed was loud and clear: rates were going up fast.
Regarding Hint 2, Buffett didn’t sell bonds in 2022 and I’m pretty sure he understands basic investing.
Buffet mentioned Berkshire liabilities, extending out 50 years or so. What would be an example of such liabilities?
Berkshire owns insurance, utilities and railroads. All of these entities have very long term debt structures (I don’t know about 50 but definitely 30 year issuances) due to their underlying highly leveragable assets and need for very long term consistent cash flows.
Not too long ago, I read some articles suggesting that moving away from bonds and cash and into stocks made sense because of the historically low interest rates at the time. This suggestion was shortsighted because there are other reasons for holding these assets besides their earnings potential. Buffett’s lucid explanation is a useful reminder for me, and how I might consider random questions or suggestions I read or hear from time to time. Thank you Adam for another fine article.
Excellent article, Adam. Just the other day, I was talking with friends and family about being resilient in life overall. In my view, there are three key components: financial resilience, physical resilience, and mental resilience.
The best time to build each of these is when life is relatively calm, because we know challenges can arise at any time. Your perspective on resilient investing is a huge part of building financial resilience. Thank you for sharing your insights.
Grossman’s article resonates, and the Buffett anecdote is a useful one — especially the reminder that bonds aren’t a drag on a portfolio so much as a feature of it. The “senior vs. junior” framing is exactly right.
I’d add one wrinkle from the perspective of a retiree living on portfolio income rather than drawing it down. The conventional bond allocation Grossman describes is mostly about ballast — something to lean on when equities sell off. That’s valuable. But a well-diversified, actively managed sleeve of debt securities can do more than that. It can throw off a meaningful, durable cash flow that funds the lifestyle without forcing equity sales at inopportune moments.
In practice, that means looking past plain-vanilla Treasuries and investment-grade funds to include managed credit across the capital structure — senior loans, high-yield, structured credit, and the like — sized appropriately and held in vehicles run by managers who understand the underwriting.
The result, in my own experience, is a portfolio that’s both resilient in Buffett’s sense and productive. The bonds aren’t just letting me sleep. They’re paying the bills.
Thank you for sharing this wisdom Adam. Your insightful articles are most helpful and i look forward to them every week!
Today’s article is another example of why I enjoy and appreciate HD. I follow the k.i.s.s (keep it simple stupid) method of investing using only broad market index funds.
That being said, this topic is deep and over my head but it leads me to think and seek to understand
Another great article. You can say what you want about bonds, and how they balance your portfolio. Buffett also said for his wife, if he died her money should go to 90% S&P500 and 10% Treasuries. I am no Buffett, but at 80 years old, I like the goal of 85% S&P500 and 15% Cash. My personal ballast is Cash. I slept very well during the downturns recently, because over 57 years of investing, you watch when the market goes down, sell nothing and buy stocks if you have some cash in your equity accounts. That other 15% cash gets you through any long term down cycles. It is just what I did, and bought some S&P 500 at levels of 6800, and now are at 7500. This works well for me.
This was great, Adam, thank you. And the Warren Buffett video clip was wonderful. I liked how, once he turned the question over to Charlie Munger, he (Buffett) began casually digging into a plastic bag for snacks. Do you suppose he brought them from home? It would fit his profile!
This was great. I have not looked but corporate bonds don’t seem to be much higher than high yield savings account rates at least in times of moderately propped up interest rates.
While that may be a faulty observation by me the extra yield vs. risk is the debate between those two investment choices. Putting a choice on a corporate bond in the context of whether the company will go broke or not was very helpful. Gave clarity to my thought process simplifying things.
One question is what bond duration is he invested in? If one looks at Berkshire Hathaway which is mainly in short term T bills, duration is probably quite short- one year or less?- and definitely not 10 or 20 yrs.
This is Exhibit A of why although I’m not a stock picker and almost all of my nest egg is in stock and bond funds, the one stock I own a significant amount of is… Berkshire Hathaway.
lol the rest of us are mere mortals in investing compared to Buffett. I look at a lot of his holdings and think they’re not particularly impressive but you can’t argue with what he’s achieved. Some of them don’t seem to have very deep moats.
But in the spirit of not leaving all the chips on the table and with the market being high I did cash out of VGT to help our daughter buy her first house debt free at 30.
Tom, good for your daughter! Securing your housing I think is the start of financial freedom. Think, if one paid for home is good, isn’t two better? How about three or four?
I know a couple from church who lament that there’s 4 months left in their retirement account. She will be looking for a job to make at least $1400 a month…to pay rent! He says he has a bachelors degree. “That and $4.75 will get a coffee at Starbucks”
They are in their middle 70’s.
I say, “Do the correct things when you are young, so you can do the correct things when you are old”
Excellent article.
Thank you for this important reminder, and a more detailed lesson in why we hold bonds. I didn’t realize if a company goes under, bond holders get first dibs! I’m shifting money now from real estate to my portfolio and need to up my bond allocation, so thanks fo rthe confidence to do just that.
Nice article and reminder why I have bonds and in fact tweaked up my holdings in this market up turn. I do appreciate that senior position.
I soured on bond investments after my professionally managed bond ladder held a defaulting bond and my subsequent bond fund lost value when interest rates climbed. I’m satsfied holding cash reserves in the money market