It’s common practice for the president or CEO of a company to include a letter to shareholders in the annual report. Berkshire Hathaway’s chairman and CEO, Warren Buffett, doesn’t buck the trend.
His annual letter (http://www.berkshirehathaway.com/letters/2018ltr.pdf) captures plenty of attention, and this year was no exception. The focus is on the investments and operating performance of Berkshire Hathaway, but the Oracle of Omaha also includes many sound principles for wealth creation as well as his general thoughts about the U.S. economy.
From 1965-2018, the market value of Berkshire Hathaway has posted a compounded annual gain of 20.5%, more than double the S&P 500’s advance, which averaged 9.5%, including reinvested dividends.
There are two things that pop out here. First, Buffett's enviable record and his ability to create long-term wealth using time-tested principles. Second, the S&P 500’s record illustrates that a well-diversified stock portfolio has been a critical component of a long-term financial plan.
In case you’re wondering, Berkshire Hathaway’s overall gain has been 2,472,627% versus the S&P 500’s still-impressive 15,019%.
One more data point – Buffet continues to perform well, topping the S&P 500 Index in eight of the last 11 years.
Focus on the forest–not the trees
Your financial plan is comprised of many parts. This would equate to what Buffett calls the “economic trees.” In other words, let’s not get to caught up on any one investment.
“A few of our trees are diseased and unlikely to be around a decade from now. Many others, though, are destined to grow in size and beauty,” Buffett writes.
He won’t get every investment right. Neither will we. Berkshire holds a substantial position in Kraft Heinz (KHC), whose shares recently tumbled after the company delivered poor results and slashed its dividend.
But, if we review the portfolio as we’d view the forest, we find a diversity of trees, wildlife, and plants. It’s a work of beauty. Your portfolio is built from the bottom up. Like the forest it’s very diversified, and it is created with your financial goals in mind.
As Buffett opines (and we agree), “I have no idea as to how stocks will behave next week or next year. Predictions of that sort have never been a part of our activities.”
That said, how did the 19.8% drop in the S&P 500 Index (September peak to Dec 24th trough) sit with you? With your input, we do our best to gauge your tolerance for risk. If you found yourself fretting over the volatility, let’s talk.
On the other hand, if you slept soundly, it would suggest your investment mix in relation to risk is on target.
“At Berkshire, the whole is greater–considerably greater–than the sum of the parts.” We feel the same way about your financial plan.
The American tailwind
Warren Buffett is bullish on America.
In 1942, he invested $114.75 in three shares of Cities Service preferred stock. At the time, the country was mobilizing for what would be a massive war effort.
If Buffett had invested his $114.75 into a no-fee S&P 500 index fund, and all dividends had been reinvested, his stake would have grown to $606,811 (pre-taxes) on January 31, 2019 (the latest data available before the printing of his letter).
The U.S. was victorious in WWII, but challenges never cease.
We’ve endured the cold war, the divisiveness of the 1960s, OPEC’s oil embargo, double-digit inflation, soaring interest rates, a rising federal deficit, the tragedy of 9-11, the war on terrorism, the financial panic of 2008, the ensuing Great Recession, falling home prices, and more.
Let’s say that you had had the foresight to see the oncoming explosion in the federal deficit, one that is up 40,000% over the last 77 years.
“To ‘protect’ yourself,” Buffett said, “You might have eschewed stocks and opted instead to buy three 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.” Compare that to the performance of the S&P 500!
What is this nation’s secret sauce? The answer is complex and difficult; yet, the overarching theme lies in front of us.
The experiment called the United States has birthed and attracted the best and the brightest. Freedom and opportunity are its calling cards. Today, we are the wealthiest nation on Earth, and we continue to ride the wave of innovation and enjoy the benefits.
But, is that wave about to crash on the shore?
A recent piece by Morgan Stanley entitled, Millennials, Gen Z and the Coming ‘Youth Boom’ Economy, complements Buffett’s optimistic viewpoint. The population of the Millennials will overtake the Baby Boomers this year, and “Gen Z, born between 1997 and 2012, will overtake the Millennials as the country's largest cohort by 2034,” it said. For the U.S. economy, “The demographic tailwinds created by these high-population cohorts could be significant, delivering the kind of ‘youth jolt’ that the Baby Boomers were famous for.”
Sure, we can’t know when the next recession will ensue or some of the challenges we’ll face as a nation in the coming years. Yet, as Buffett sums up his annual letter, “Over the next 77 years, 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.”
Shorter-term risks never completely abate. But Warren Buffett’s message has been consistent. Don’t bet against America.