Warren Buffett’s Insight Never Gets Old

On Saturday, Berkshire Hathaway released its annual shareholder letter. For investment professionals and BRK aficionados, it’s something to look forward to every year as a must-read. The beauty of the letter, penned by Warren Buffett, is how well his comments about Berkshire, one of the world’s most valuable companies, apply to individual investors. Here’s what we learned this year from the 54th annual letter:

Be a compounding machine

Like a giant flywheel, Berkshire Hathaway’s momentum just keeps on going. The immense wealth and opportunity created at Berkshire is due to a relentless commitment to retained earnings (savings), risk management, reinvesting and compounding. Buffett repeats this message every year to drive home the point that it simply works. This year he puts it this way:

“If our forefathers had instead consumed all they produced, there would have been no investment, no productivity gains and no leap in living standards.”

We see compounding at work year after year with our most successful clients who continue to keep expenditures at reasonable levels despite having more and more to spend.

Go easy on debt

“Rational people don’t risk what they have and need for what they don’t have and don’t need.” That, in a wonderful nutshell, is Buffett’s take on leverage. Liberal borrowing may expand your opportunities to invest, but can also drive a company or individual into the ground. It’s true when Berkshire considers an investment in a railroad or bank, and just as true when a family goes hunting for real estate.

He continues:

“We use debt sparingly. Many managers, it should be noted, will disagree with this policy, arguing that significant debt juices the returns for equity owners. And these more venturesome CEOs will be right most of the time. At rare and unpredictable intervals, however, credit vanishes and debt becomes financially fatal. A Russian-roulette equation – usually win, occasionally die – may make financial sense for someone who gets a piece of a company’s upside but does not share in its downside. But that strategy would be madness for Berkshire.”

Maintain a ready cash and TBill supply

“Berkshire held $112 billion at yearend in U.S. Treasury bills and other cash equivalents, and another $20 billion in miscellaneous fixed-income instruments. We consider a portion of that stash to be untouchable, having pledged to always hold at least $20 billion in cash equivalents to guard against external calamities… I will never risk getting caught short of cash.”

A similar dollar reserve pledge is just as smart for wealthy families. We suggest a cash and cash equivalent balance large enough to provide three essentials: a cushion against a sudden loss of income or unexpected expense, a pot for the unique spending and investing opportunities that tend to pop up, and most importantly, an emotional buffer so that financial anxiety doesn’t follow you everywhere you go. The resulting number is different for everyone and we can help calculate it for you.

Clients and regular readers know that with rising rates last year we became fans of the use of TBills. Buffett’s mention of using TBills within BRK is a positive affirmation.

Some BIG losses

Buffett readily accepts occasional setbacks as an inevitable element of long-term investing. For instance, he didn’t hide the fact that his stock picks resulted in a $25 billion unrealized loss in Q4. He warned last year that new accounting rules that require reporting unrealized stock gains and losses would skew his numbers – and he was right. The $25B loss is on a stock portfolio that was worth $170B by the end of 2018. So long as the assets aren’t earmarked for use elsewhere, the short term volatility is part of the plan and par for the course. Individual investors would do well to apply this same perspective when markets decline.

Age ain’t nothing but a number

Warren Buffett is 88. Think of all the wealth he has created since the “normal” retirement age of 65 – for his family and for shareholders. He’s an admirable champion for those who are completely comfortable staying engaged in business and working forever. That’s even more true for his right-hand man Charlie Munger, now 95 years young.