For the last few years, I’ve been enjoying reading Warren Buffett’s annual letter to Berkshire Hathaway’s shareholders. These letters are full of interesting nuggets and insights of all kinds, not just on money management, but on life.
Last week, the most recent letter to shareholders was released, and I spent an afternoon reading it, marking with a pen the little bits that I found interesting.
I thought I’d share with you many of those bits that I highlighted, along with some of my own comments on them.
Money will always flow toward opportunity, and there is an abundance of that in America. Commentators today often talk of “great uncertainty.” But think back, for example, to December 6, 1941, October 18, 1987 and September 10, 2001. No matter how serene today may be, tomorrow is always uncertain.
Preparing for the future is always a good idea because the future is always uncertain. You don’t know what tomorrow will be like.
I’m very much in favor – much as Buffett is – of having a very large emergency fund so that you have the flexibility to handle whatever comes your way.
Don’t let that reality spook you. Throughout my lifetime, politicians and pundits have constantly moaned about terrifying problems facing America. Yet our citizens now live an astonishing six times better than when I was born. The prophets of doom have overlooked the all-important factor that is certain: Human potential is far from exhausted, and the American system for unleashing that potential – a system that has worked wonders for over two centuries despite frequent interruptions for recessions and even a Civil War – remains alive and effective.
We are not natively smarter than we were when our country was founded nor do we work harder. But look around you and see a world beyond the dreams of any colonial citizen. Now, as in 1776, 1861, 1932 and 1941, America’s best days lie ahead.
Of course, preparing for tomorrow does not necessarily mean just preparing for the negative. It also means preparing for the positive.
Tomorrow might hold something disastrous, but it might also hold some great opportunity. The more you can prepare for both, the better off you’re going to be.
Again, this is a great argument for having a lot of cash in the bank. The more cash you have, the more capable you are of handling the negative and taking advantage of the positive.
Today might be September 10, 2001, but it might also be the day before you meet the love of your life.
Other companies we hold are likely to increase their dividends as well. Coca-Cola paid us $88 million
in 1995, the year after we finished purchasing the stock. Every year since, Coke has increased its dividend. In
2011, we will almost certainly receive $376 million from Coke, up $24 million from last year. Within ten years, I
would expect that $376 million to double. By the end of that period, I wouldn’t be surprised to see our share of
Coke’s annual earnings exceed 100% of what we paid for the investment. Time is the friend of the wonderful
In other words, the stocks of Coca-Cola that Buffett bought in 1995 cost him somewhere on the order of $750 million. Got that?
He’s sat on those stocks for sixteen years now, collecting dividends each year. In 2011, Buffett anticipates collecting a dividend of $376 million, roughly half of what he paid for the stock.
In ten years, Buffett expects to collect a dividend of over $750 million. In other words, he’ll receive a dividend in one year that exceeds what he paid for the stock.
How is that possible? Patience. He sat on that stock regardless of whether the stock price went up or the stock price went down. He sat on that stock regardless of a booming economy or an economic apocalypse. He was patient, and now that patience is being rewarded.
With all the talk of stock trading and maximizing P/E and selling high and buying low, the simple act of buying a dividend-paying stock and just sitting on that stock is forgotten.
Unquestionably, some people have become very rich through the use of borrowed money. However,
that’s also been a way to get very poor. When leverage works, it magnifies your gains. Your spouse thinks you’re
clever, and your neighbors get envious. But leverage is addictive. Once having profited from its wonders, very
few people retreat to more conservative practices. And as we all learned in third grade – and some relearned in
2008 – any series of positive numbers, however impressive the numbers may be, evaporates when multiplied by a
single zero. History tells us that leverage all too often produces zeroes, even when it is employed by very smart
For individual people, the “leverage” that Buffett speaks of equates to consumer debt.
Sometimes, you can get into debt to swing a purchase that will amaze everyone around you. How did he afford that house?
The problem is that you have to pay the piper eventually, and the uncertainty of the future often causes people to fall short of the grandiose dreams they have when they first get into debt. They’re either stuck struggling to make ends meet every single month or, worse, they fall into foreclosure, losing the things they’ve dumped so much money and effort into.
The best solution is to avoid consumer debt if at all possible. The only types of debt that make any reasonable sense are student loan debts, mortgage debt on a reasonable small home, and car debt on your very first car. After that, you should do everything in your power to avoid further debt.
I didn’t meet Charlie [Munger, Buffett's partner in Berkshire Hathaway] until he was 35, though he grew up within 100 yards of where I have lived for 52 years and also attended the same inner-city public high school in Omaha from which my father, wife, children and two grandchildren graduated. Charlie and I did, however, both work as young boys at my grandfather’s grocery store, though our periods of employment were separated by about five years. My grandfather’s name was Ernest, and perhaps no man was more aptly named. No one worked for Ernest, even as a stock boy, without being shaped by the experience.
[...] Ernest never went to business school – he never in fact finished high school – but he understood the importance of liquidity as a condition for assured survival. At Berkshire, we have taken his $1,000 solution a bit further and have pledged that we will hold at least $10 billion of cash, excluding that held at our regulated utility and railroad businesses. Because of that commitment, we customarily keep at least $20 billion on hand so that we can both withstand unprecedented insurance losses (our largest to date having been about $3 billion from Katrina, the insurance industry’s most expensive catastrophe) and quickly seize acquisition or investment opportunities, even during times of financial turmoil.
Again, Buffett hammers the point home that being liquid – meaning having cash that’s easily accessible and available to handle whatever may come – is a great way to always be prepared for the future, whatever it may hold.
Berkshire Hathaway often holds far more in cash than comparable businesses. Of course, at the same time, Berkshire Hathaway is incredibly successful by any measure. They can handle any emergency and they can take advantage of any opportunity that comes along.
I tend to think there’s a big lesson to be learned from that with regards to how to manage your own finances.