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Warren Buffett writes an annual letter to the shareholders of his company, Berkshire Hathaway. The letter is written in a simple and easy to digest format.

This year, 2019, Mr. Buffett reflected on:

  • The “American tailwind” that drives the global economy forward
  • The long term growth of diversified portfolios through indexing
  • The true cost of investment advisers, or “helpers,” as he calls them. (This is where you could double your returns.)
  • Why international stocks should be in your portfolio

He also spends some time on why he doesn't own gold, which fits with my own thoughts on gold. You can read the entire letter here for free.

The American Tailwind

Mr. Buffett often writes in his letters about the amazing ability of the American economic system to consistently deliver tremendous economic growth, prosperity, and wealth over the generations. Here are his reflections on the last 231 years of American history:

On March 11th, it will be 77 years since I first invested in an American business. The year was 1942, I was 11, and I went all in, investing $114.75 I had begun accumulating at age six. What I bought was three shares of Cities Service preferred stock. I had become a capitalist, and it felt good.

Let’s now travel back through the two 77-year periods that preceded my purchase. That leaves us starting in 1788, a year prior to George Washington’s installation as our first president. Could anyone then have imagined what their new country would accomplish in only three 77-year lifetimes?

During the two 77-year periods prior to 1942, the United States had grown from four million people – about 1⁄2 of 1% of the world’s population – into the most powerful country on earth. In that spring of 1942, though, it faced a crisis: The U.S. and its allies were suffering heavy losses in a war that we had entered only three months earlier. Bad news arrived daily.

Despite the alarming headlines, almost all Americans believed on that March 11th that the war would be won. Nor was their optimism limited to that victory. Leaving aside congenital pessimists, Americans believed that their children and generations beyond would live far better lives than they themselves had led.

The nation’s citizens understood, of course, that the road ahead would not be a smooth ride. It never had been. Early in its history our country was tested by a Civil War that killed 4% of all American males and led President Lincoln to openly ponder whether “a nation so conceived and so dedicated could long endure.” In the 1930s, America suffered through the Great Depression, a punishing period of massive unemployment.

Nevertheless, in 1942, when I made my purchase, the nation expected post-war growth, a belief that proved to be well-founded. In fact, the nation’s achievements can best be described as breathtaking.

His small investment of $114.75 at age 11 reminds me of my own small investments I made in high school and college as I worked summer and college jobs.

My savings through high school and college in my Roth IRA allowed my wife and I to access $10,000 to put towards the down payment on a condo at my first duty station.

Long Term Growth of S&P 500

Mr. Buffett goes on to demonstrate the power of compounding returns on small investments:

Let's put numbers to that claim: If my $114.75 had been invested in a no-fee S&P 500 index fund, and all dividends had been reinvested, my stake would have grown to be worth (pre-taxes) $606,811 on Jan. 31, 2019 (the latest data available before the printing of this letter). That is a gain of 5,288 for 1.

Meanwhile, a $1 million investment by a tax-free institution of that time — say, a pension fund or college endowment — would have grown to about $5.3 billion.

The numbers are crazy when shown that way! If Mr. Buffett had invested his $114.75 in an ETF like SPY (S&P 500 index fund), VOO (Vanguard S&P 500 Index Fund), or a mutual fund like VTSAX (Vanguard Total US Stock Market Index Fund), it would have returned $5288 for every $1 invested.

Granted, this is an extremely long time horizon. Most of us will be lucky to live to 77! But think of all the social upheaval and massive technological changes that have happened in the last 77 years.

It gives me confidence that if we have made it through the last 77 years with such amazing returns, we just might make it through the next 77 years with good returns, even if they are not as great.

The True Cost of Investment Advisers

I wrote before about my investing principles. Two of them are low cost and simple. Passive index investing, where you buy and hold the entire market through mutual funds or ETFs, provide the best returns over the long run.

Very few investment advisers or traders are able to beat the index given a long enough time horizon. More importantly, it is extremely unlikely that YOU can beat the index, even over the short term. Or, that you can pick the investment adviser who will beat the index over the long run.

Even more importantly, while investment performance is often out of your control, investment costs are not. By focusing on what you can control and ignoring what you can't, you can win the investing game in the long run.

Jack Bogle used to say that performance comes and goes, but costs are forever. Here's Mr. Buffett's real world example:

Let me add one additional calculation that I believe will shock you: If that hypothetical institution had paid only 1% of assets annually to various “helpers,” such as investment managers and consultants, its gain would have been cut in half, to $2.65 billion. That's what happens over 77 years when the 11.8% annual return actually achieved by the S&P 500 is recalculated at a 10.8% rate.

This total cost is almost as astounding as the S&P 500 returns over the last 77 years! Let's shrink down the numbers to something we can relate to more. If you had started with $500 in 1942, it would have grown to $2.6 million by 2019. That's enough to retire on $104,000 per year.

If you had paid a 1% expense ratio, you would have $1.3 million and only $52,000 per year. That's a very different life style! Flying business class vs. economy. Buying a new Tesla vs. keeping the Honda Civic a few more years. You get the idea.

Do not discount the power of compounding interest working against you. That's what expense ratios represent. You can take a look at your expense ratios on your investments with Personal Capital. I have used it for 4 years now and use it to update my net worth every month.

Why Warren Buffett Does Not Own Gold (And Neither Do I)

Those who regularly preach doom because of government budget deficits (as I regularly did myself for many years) might note that our country's national debt has increased roughly 400-fold during the last of my 77-year periods. That's 40,000%!

Suppose you had foreseen this increase and panicked at the prospect of runaway deficits and a worthless currency. To “protect” yourself, you might have eschewed stocks and opted instead to buy [a few ounces of] gold with your $114.75.

And what would that supposed protection have delivered? You would now have an asset worth about $4,200, less than 1% of what would have been realized from a simple unmanaged investment in American business. The magical metal was no match for the American mettle.

Do you think you can trust this guy? I don't.

Anytime anyone talks about buying gold or silver or Bitcoin, I come back to examples like this.

When you buy gold, you are buying a commodity. It has value based on the marketplace. When supply goes down and demand goes up, the price increases. When supply increases and demand goes down, the price decreases.

There is not inherent value of gold, silver, or Bitcoin. For that matter, there is not inherent value in stocks either. However, stocks represent ownership in companies.

Companies produce goods and services. People pay for those goods and services. That money is eventually returned to the owners of the company, which is you. If the company does well, they grow and make more money.

Why Mr. Buffett Recommends International Stocks

Mr. Buffett's famous advise to his wife's financial adviser should he die is 90% S&P 500 mutual fund and 10% short term US Treasury bonds. However, he seems to make the case for some international stock exposure in your portfolio.

Charlie and I happily acknowledge that much of Berkshire's success has simply been a product of what I think should be called “The American Tailwind.” It is beyond arrogance for American businesses or individuals to boast that they have “done it alone.” The tidy rows of simple white crosses at Normandy should shame those who make such claims.

There are also many other countries around the world that have bright futures. About that, we should rejoice: Americans will be both more prosperous and safer if all nations thrive. At Berkshire, we hope to invest significant sums across borders.

Over the next 77 years, however, the major source of our gains will almost certainly be provided by The American Tailwind. We are lucky — gloriously lucky — to have that force at our back.

I personally use VTIAX (Vanguard Total Stock Market Ex-US) to buy stocks outside the US. It makes up about 20% of my total portfolio. If I was purely weighting my stock portfolio by market capitalization, international should be 50% of my stocks.

I am guilty of some home country bias, but I am not fully convinced of international companies capacity for growth going forward. GoCurryCracker discusses this topic more here.

Mr. Buffett's letter to the Berkshire Hathaway shareholders is only 15 pages long. I recommend reading through the whole thing.

Warren Buffett's 2019 Letter to Shareholders Could Double Your Returns

One thought on “Warren Buffett’s 2019 Letter to Shareholders Could Double Your Returns

  • April 27, 2019 at 05:55
    Permalink

    Good take on things.

    It’s interesting that Buffett/ Charlie will say 1 thing and do another. They are proponents for index funds, but do not invest in them. They trade options and invest in individual companies. They are classic value investors and look at valuation metrics (P/E, P/B, etc) to determine if the company is a good deal vs the asking price (margin of safety). They also look at management, and make sure that the business is something they understand (side note: do you think they “understand” Apple?). What they are not is index investors. In fact, you can youtube videos of them speaking poorly of diversification (Charlie specifically).

    This is not to say that indexing isn’t a good way to go. Most of my money is in index funds. I believe for most people, this is absolutely the best way to go. But let me ask a question: If every valuation metric is pointing to things being “overpriced” at the moment (27 Apr 19), would it be a bad idea to wait for some mean reversion to happen and to start systematically buying into things? Nobody can time the market, but if you had some valuation metrics for “fair value” based off historic valuations, would it be wise to wait for valuations to drop below that and then start buying index funds/ ETFs? I do not know the answer.

    Over the long term it is probably best for investors to buy the index if their time horizon is decades. But remember, the US stock market has literally gone nowhere over periods of 30 years! If you are a buy and hold investor, you need to make sure your risk tolerance can support periods (decades) where the market goes sideways with all the volitility that comes with it.

    Curious to know your thoughts on using valuations to determine how much you invest into indexes/ other securities. I’ve been thinking of having some cash saved up for when valuations drop below the mean (P/E around 15, for example).

    Great write-up!

    Reply

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