I always make time to read Warren Buffett’s annual letter to his Berkshire Hathaway shareholders.
In contrast to the usual dry company reports, his letters read like a warm Buffett family Christmas newsletter, with a cast of familiar characters, recurring japes – and, okay, a fairly detailed description of how an insurance free float works.
And digesting the latest 2010 Berkshire letter with a nice glass of Australian Shiraz, I discovered a fabulous gem tucked amongst all the usual investing wisdom that surprised even a Buffett fanboy like me.
It was a modest letter within the main letter that Warren Buffett has republished, which was originally written by his grandfather, Ernest Buffett.
The Buffett family money gene
Anyone who has read The Snowball will know how Buffett’s early experiences and family life shaped his financial character.
But what this new Buffett letter reveals is that being careful with money – and feeling the urge to teach others how to shepherd it, too – runs deep in the Buffett family.
The letter was written in 1939 by Buffett’s grandfather Ernest, to his youngest son (and Buffett’s uncle) Fred, and his wife.
It reads (with idiosyncratic grammar) as follows:
Dear Fred & Catherine,
Over a period of a good many years I have known a great many people who at some time or another have suffered in various ways simply because they did not have ready cash. I have known people who have had to sacrifice some of their holdings in order to have money that was necessary to have at that time.
For a good many years your grandfather kept a certain amount of money where he could put his hands on it in very short notice.
For a number of years I have made it a point to keep a reserve, should some occasion come where I would need money quickly, without disturbing the money that I have in my business. There have been a couple of occasions when I found it very convenient to go to this fund.
Thus, I feel that everyone should have a reserve. I hope it never happens to you, but the chances are that some day you will need money, and need it badly, and with this thought in view, I started a fund by placing $200 in an envelope, with your name on it, when you were married. Each year I added something to it, until there is now $1000 in the fund.
Ten years have elapsed since you were married, and this fund is now completed.
It is my wish that you place this envelope in your safety deposit box, and keep it for the purpose that it was created for. Should the time come when you need part, I would suggest you use that you use as little as possible, and replace it as soon as possible.
You might feel that this should be invested and bring you an income. Forget it – the mental satisfaction of having $1000 laid away where you can put your hands on it it, is worth more than what interest it might bring, especially if you have the investment in something that you could not realize on quickly.
If in after years you feel this has been a good idea, you might repeat it with your own children.
For your information, I might mention that there has never been a Buffett who ever left a very large estate, but there has never been one that did not leave something. They never spent all they made, but always saved part of what they made, and it has all worked out pretty well.
This letter is being written at the expiration of ten years after you were married.
Isn’t it great? I absolutely love this letter: I love the formality of it, the humility, I love the thought and the care of it.
Most of all I love the hard won wisdom in it.
This is a letter by a man who lived through the Wall Street Crash and the Great Depression. When Ernest Buffett says keep the money in cash in a deposit box where it’s easily accessible, he’s partly thinking about bank runs!
And when Grandpa Buffett says he knows people who have suffered from a lack of ready cash, he doesn’t mean that they couldn’t pop to IKEA to buy a sofa bed before the guests arrived. He means destitution in a world with no credit cards and few safety nets, save family.
In praise of cash
Buffett says that it’s this sort of Buffett family thinking that explains why Berkshire Hathaway customarily has at least $20 billion on hand.
That’s a lot of cash, and it’s held despite having the world’s greatest investor at the helm, who could be expected to make far higher returns on it than the measly percentage gains Berkshire will get on short-term deposit.
For you and I (who are still in the process of proving whether we’ll be the world’s latest greatest investors) there’s no debate – we should run hefty emergency funds and also keep a chunk of our portfolio in cash.
I love cash as an asset class. When people trash cash, warning me about inflation or telling me I should put more money into government bonds instead – or worst of all borrow to invest – my eyes genuinely glaze over.
Over the long-term the returns from gilts and cash aren’t so different, especially if you’re a private investor with a relatively modest nest egg who can chase the best savings deals. Yet the flexibility1 of cash is impossible to compare with bonds, let alone equities, REITS, or whatever else might take your fancy.
Having cash on hand means you don’t have to go into debt if the boiler blows up. Having cash in reserve means you can swoop to buy cheap securities in bear markets. It means some portion of your portfolio is as unblinking as a hungry Buffett sat before an out-sized hamburger.
In fact, I think new investors could do a lot worse than simply split their investing between a main market tracker and cash, and then forget about the other asset classes for a few years. The security of the cash is very helpful while you learn to stomach the volatility of shares.
Don’t get me wrong – I’m over 90% invested in equities. Cash has its place, but it’s little use in fighting inflation, and that’s the bane of long term investment.
But whatever you do, don’t bung cash overboard in your quest for future riches or even just a nice retirement. Cash cannot be beaten for liquidity and versatility.
Investing doesn’t end with a cash savings account, but that’s certainly where it starts – whether you’re in the Buffett family or not.
Oh yeah, and let’s not forget this bit in the letter from Ernest:
I might mention that there has never been a Buffett who ever left a very large estate, but there has never been one that did not leave something. They never spent all they made, but always saved part of what they made, and it has all worked out pretty well.
That made me smile, too. It’s a Buffett family joke we can all share!