By Gautam Baid
Berkshire Hathaway’s annual “Woodstock for Capitalists” was held on 30 April. After two years of virtual annual meetings, the energy and enthusiasm among attendees was high for this year’s meeting. This was the first in-person meeting that I attended since 2019. Tens of thousands of shareholders came to hear what the iconic duo had to say about business, the economy and investing. Warren Buffett and Charlie Munger answered questions from shareholders for over five hours. Here are my five biggest takeaways and learnings from the 2022 meeting:
The importance of cash in one’s asset allocation
“We will always have a lot of cash on hand,” Buffett said. “There have been a few times in history, and there will be more times in history, where if you don’t have it, you don’t get to play the next day.” “It’s like oxygen,” he added. “It’s there all the time, but if it disappears for a few minutes, it’s all over.”
Cash is a call option on the opportunity. Having ample liquid cash puts valuable optionality in the hands of investors, to make bargain purchases when opportunities arise, and it also makes them antifragile. Cash is a much-underappreciated asset. It’s one of the only price-stable assets that is simultaneously highly value-elastic: cash increases in value as other asset prices drop. The more they drop, the more valuable cash becomes. Conversely, if you are forced to sell assets in a market with a small number of buyers, you may end up taking large haircuts. This is especially true in markets for illiquid stocks, luxury items, and other esoteric assets (such as art, wine, and so on). So, how do you prevent this from happening to you? Have ample liquidity (cash reserves) so that you aren’t forced to sell assets during periods of market turbulence and sharp drawdowns. Create an emergency fund equal to two years of living expenses and gradually increase it to five years as you increase your exposure to equities over time. If you need to spend money and you can’t, that is risk. Nothing is worse for an investor than selling an asset at rock-bottom prices to get cash for essential purchases.
Focus on buying value, not market timing
“We have not been good at timing,” Buffett said. “We’ve been reasonably good at figuring out when we were getting enough for our money.”
Liquidity and sentiment drive the market index in the short term, whereas individual company earnings drive stock prices in the long term. Great businesses create enormous wealth over long holding periods across market cycles, even in the midst of negative macro headlines about high inflation, rising interest rates, geopolitical tensions, weak macroeconomic data points, and political uncertainty. Gruesome businesses eventually destroy wealth, irrespective of whether the news is positive or negative.
Sample this. The Dow Jones Industrial Average was 874.12 on December 31, 1964, and 875.00 on December 31, 1981. Nearly zero change in seventeen long years. Yet Buffett compounded his capital at more than 20 percent compound annual growth rate during this period. Successful investing is all about identifying businesses with growing earnings and good capital allocation at sensible valuations, and firmly holding on to them as long as they exhibit these characteristics. The stock markets do not really matter over the long run when you invest in such businesses and, most important, stay the course. This is the philosophy we follow for our investors at Stellar Wealth Partners.
Emotions and expenses are two of the biggest enemies of an investor
Buffett said the past couple of years have witnessed a burst of speculative mania among new investors. There has been an explosion of options used for gambling activities.
“It’s a gambling parlor,” Buffett told shareholders, adding that Wall Street had contributed to the casino mentality. “They don’t make money unless people do things…and they make a lot more money when people are gambling than when they’re investing.”
“It’s almost a mania of speculation that we now have,” Munger said. “We’ve got people that know nothing about stocks being advised by stockbrokers who know even less.”
Dopamine rushes can prove to be very expensive for investors. Brokers make their money off our activity. We should embrace inactivity and avoid disturbing the process of compounding.
In a paper titled “Why Do Investors Trade Too Much?” finance professors Brad Barber and Terrance Odean looked at nearly 100,000 stock trades made by retail investors at a major discount brokerage firm from 1987 through 1993. They found, on average, that the stocks these investors bought underperformed the market by 2.7 percentage points over the subsequent year, whereas the stocks they sold outperformed the market by 0.5 points in the subsequent year. Similarly, in a paper published by the Brookings Institution, economists Josef Lakonishok, Andrei Shleifer, and Robert Vishny showed that the stock trades made by pension fund managers subtracted 0.78 percent from the returns they would have earned by keeping their portfolios constant. When we trade excessively, the only people who become rich are the intermediaries and brokers.
The best hedge against inflation – your talent
With inflation at its highest level in 40 years, a key concern among shareholders was how to protect themselves from losing purchasing power amid rising costs.
“The best thing you can do is to be exceptionally good at something,” Buffett said. “Whatever abilities you have can’t be taken away from you – they can’t actually be inflated away from you.”
“The best investment – by far – is anything that develops yourself,” he said.
The way to wealth is to be exceptionally good at something. If you are the best at whatever it may be, people are going to pay you well and that value can’t be destroyed by inflation. Nobody can take away your talent.
Rather than adopting a scarcity mindset of penny pinching to avoid spending on the little pleasures of life, a more positive approach is to embrace an abundance mindset and to focus on increasing your earning power. It is true that reducing your expenses shortens the time it takes to reach financial freedom. However, there are limits on how low your expenses can go, but there are no limits on how much you can earn. The best investment you can make is an investment in yourself.
Find your calling in life
When answering a question about how to find one’s calling, Buffett and Munger shared a few key steps:
- Work for whomever you admire the most
- Figure out what you are bad at and avoid all of it
- Choose work that interest you
Buffett has always held the opinion that the people who discover their passion in life are lucky. His early passion for money management resulted in his studying, by age eleven, every book the Omaha Public Library had on investing, some of them twice. In an interview with Fortune magazine in 2012, Buffett was asked how other people can “tap dance to work” the way he does. He provided the following answer: “Follow your passion…I always tell college students to take the job that you would take if you were independently wealthy.” By doing that, the logic goes, you’ll bring more energy to your work than anybody else does. There is power in passion.
As the well-known saying goes, “Choose a job you love, and you will never have to work a day in your life.” You know that you are doing things right in life when you go to bed at night and cannot wait to wake up and live the next day. Instead of merely trying to live a long life, we should endeavor to infuse life into our lives. Too often, life appears short to us because we all seem to have so much to do. But the reality is that life is long if you know how to use it well.
(Gautam Baid is a smallcase manager and Founder, Stellar Wealth Partners Private Limited. Views expressed are the author’s own. Please consult your financial advisor before investing.)