I always look forward to the Annual Letter from ‘The Oracle of Omaha’ Warren Buffett. Often a lot of wisdom and common sense is found in these letters. It also provides insight in the thinking of one of the best investors of all time. Let’s find out what we can learn from Buffett’s 2018 letter for those striving for financial freedom!
“Never risk getting caught short of cash”
The mantra of ‘cash is trash’ does not diminish the value of cash at all. I personally prefer ‘cash is king’. Obviously, to achieve financial freedom you need to invest. But we should not underestimate the importance and value of cash.
Berkshire Hathaway has an enormous cash-pile of around $130 billion. That’s huge! This enormous war chest gives Berkshire Hathaway a lot of opportunities. With that kind of money they can easily buy almost any (private) company. Buffett is willing to forego a decent return on the $130 billion to seize the opportunity when it occurs.
During an interview with CNBC, Warren Buffett mentioned that Berkshire Hathaway was having negotiations with a company which Warren wanted to buy out-right. Unfortunately, things did not pan out, but who knows what could happen? If Berkshire Hathaway did not have the $130 billion cash-pile this opportunity and the following negotiations probably didn’t occur at all.
For any investor, and especially those that want to live off their investments, holding a percentage of your portfolio in cash is a wise thing to do. Being fully invested is very joyful in a bull market, but not so much in a bear market.
Especially if you need to repair your car, perform maintenance on your house, or maybe even lose your job. A bear market is often an early indicator of grim economic times. Your job may even be on the line.
Losing your job and seeing your investment portfolio decline with 30% is not something to look forward to! Especially if you do not have an emergency account and a part of your portfolio in cash. The takeaway here is to never risk getting caught short of cash on your journey to financial freedom.
Debt can be dangerous
In Buffett’s 2018’s annual letter he writes:
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. Rational people don’t risk what they have and need for what they don’t have and don’t need.
As an investor trying to achieve financial freedom as soon as possible, you are all-in. You share in both the upside as the downside. You need to invest your money wisely. Do not take unnecessary risks with things you have and need for what you don’t have and don’t need.
Paying off debt (i.e. mortgage) may not always be the best choice from a return perspective, but it sure is a good choice for your peace of mind! To retire early you need your own house to live in. Why don’t check this off the list as soon as possible?
Do you want to reach financial freedom quick (and with Buffett’s Russian roulette equation: occasionally die = go bankrupt) or want to reach financial freedom for sure (but take a bit longer with prudent investing)? I surely choose the latter.
Focus on the forest, forget the trees
Warren Buffett wrote this to provide insight to his shareholders on how to look at Berkshire Hathaway. He wants investors to focus on the forest, with Berkshire being a diversified bucket of businesses. Not focusing only at each individual business (the trees).
Obviously, Buffett and his managers pay close attention to the individual businesses and groups of businesses. But that’s not required for investors to come up with a rough estimate of Berkshire’s intrinsic value. Investors can come up with this estimation by looking at the ‘groves’ meaning the different businesses in different industries.
I see a connection of Buffett’s line of thinking for Berkshire, with investing in index funds such as the S&P 500. By investing in index funds you focus on the forest, the index. And not on every individual company.
Even though, Warren Buffett and Charlie Munger do not believe in diversification (as long as you know what you are doing), for the average investor Buffett is very much in favor of investing in an index fund tracking the S&P 500.
That’s exactly why the average investor striving for financial freedom should follow-up on Buffett’s advice and invest periodically in a diversified index fund such as the S&P 500.