Every year, dating back to 1977, Warren Buffett has written Berkshire Hathaway’s annual shareholder letter. Warren Buffets annual letter, has attracted more than just Berkshire shareholders over the years. Its essentially become gospel for investors, businessmen, and women and anyone interesting in understanding the thought process of a genius businessman and investor. Our investment philosophy can be traced back to much of what Buffett preaches. Keep investment expenses low, take a long-term approach, be patient, find intrinsic value, and manage emotions. All cornerstones of what we and many other industry professionals use to manage money. The letter can be quite extensive and provides information specifically regarding Berkshire’s operations in addition to golden nuggets of wisdom and advice. This article highlights the golden nuggets from a personal finance and investing perspective.
In case you don’t quite understand the brilliance of Warren Buffett’s track record, we’ll start by looking at the growth he’s led his company, Berkshire Hathaway to over the years. Since 1965, Berkshire has averaged an annual compounded gain of 20.9%, compared with the S&P 500’s 9.9%. The cumulative gain is a whopping 2,404,748%. Over the years he’s preached investing in people just as much as investing in a business. His willingness to purchase businesses with great management, allow them to operate independently of Berkshire while utilizing Berkshire’s extensive resources and capital, aids in their success. Now, let’s take a look at the golden nuggets throughout this year’s annual letter.
“Our aversion to leverage has dampened our returns over the years. But Charlie and I sleep well. Both of us believe it is insane to risk what you have and need in order to obtain what you don’t need”
Warren has always been against borrowing money to invest. Using borrowed money, or margin in investing terms, to “chase” returns in the short-term is unpredictable and can lead to disastrous results. On a relative basis, what we can predict is markets will grow over extended periods of time. Having a long-term approach to investing, while being able to enjoy life in the present, is a much better formula for success than amplifying risk by borrowing money in hopes of hitting it big with a short-term investment. Especially when it’s not necessary!
“Charlie and I view the marketable common stocks that Berkshire owns as interests in businesses, not as ticker symbols to be bought or sold based on their “chart” patterns, the “target” prices of analysts or the opinions of media pundits”
When you turn on CNBC or read investing articles, it’s common to get lost in the fact that when you purchase a stock, stock ETF, or index fund tracking the S&P 500, you’re buying a stake in an ACTUAL business. You’re an owner of a public business. Looking at it from that perspective, why do people try to buy and sell businesses based on the movement of the business’s price on any given day? Technical analysis, what Buffett is alluding to in this statement, has ZERO impact on the intrinsic value of a business. It’s simply trying to guess what the movement of a stock price will do next based on the movement it’s had in the past. It makes no sense in our view.
What matters is fundamental analysis. What’s are the numbers telling us? Does management take a long-term view as well? Occasionally, technical analysis and its followers will allow fundamental investors to buy stocks cheaper than what their intrinsic value might be. That’s when investors should pounce. During market corrections or recessions, long-term investors have great opportunities to invest at a discount.
“Performance comes, performance goes. Fees never falter.”
10 years ago, Buffett made a 1 million dollar bet for a charity that an S&P 500 index fund would outperform a hedge fund of funds (a hedge fund investing in other hedge funds). The chart below shows the average annual gain and the cumulative gain with the index fund vastly outperforming any other fund.
This highlights the simple fact that no matter how great an investment manager may be, overcoming high fees is an insurmountable task in most cases. When it comes to investment management, we use low-cost index funds and ETF’s to manage our client portfolios. We’re not afraid to recognize the simple fact that investment management fees are compressed because it’s become relatively commoditized. Our TRUE value to clients is through financial planning and helping manage behavior when it comes to investing. Vanguard estimates that behavioral coaching adds roughly 1.5% in net returns for the average investor. An unbiased third party, who’s with you to plan for your life goals and the financial necessities to achieve them, can be priceless.
“It is a terrible mistake for investors with long-term horizons – among them, pension funds, college endowments and savings-minded individuals – to measure their investment “risk” by their portfolio’s ratio of bonds to stocks.”
Given you have a long-term time horizon, typically referred to as 10+ years, common belief that a diversified portfolio needs to contain bonds holds less truth. Especially in particular times of rising interest rates. The fed continues to increase interest rates, and longer-term bonds react most negatively. If an investor knows they can get a higher interest on a bond today, why would they buy a longer-term bond that pays less interest? This results in the long-term bond losing value.
As history suggests, long-term investors are best served by investing in equities. Portfolios have time to weather the unpredictable, yet certain, corrections and recessions of the market in the short-term. However, they will greatly benefit from using the principle of compound interest over the long term. This is further pronounced if investors continually invest, and put extra cash to work during market corrections or recessions.
To read Warren Buffett’s annual letter in full for further business and investing insights visit the website here.
Want help implementing the principles and lessons discussed here? Get started on your financial plan today using our free tool.
Levi is the Co-Founder, Financial Planner of Millennial Wealth, a fee-only financial planning firm for young professionals and tech industry employees. He is an avid sports fan, personal finance and investing geek, and enjoys a great TV show or movie. His mission is to help educate his generation about better money habits and provide financial planning services to those who want to start planning for their future today!