Good Financial Advice

October 17, 2008
Op-Ed Contributor
Buy American. I Am.
By WARREN E. BUFFETT
Omaha

THE financial world is a mess, both in the United States and abroad. Its problems, moreover, have been leaking into the general economy, and the leaks are now turning into a gusher. In the near term, unemployment will rise, business activity will falter and headlines will continue to be scary.

So ... I’ve been buying American stocks. This is my personal account I’m talking about, in which I previously owned nothing but United States government bonds. (This description leaves aside my Berkshire Hathaway holdings, which are all committed to philanthropy.) If prices keep looking attractive, my non-Berkshire net worth will soon be 100 percent in United States equities.

Why?

A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.

Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over.

A little history here: During the Depression, the Dow hit its low, 41, on July 8, 1932. Economic conditions, though, kept deteriorating until Franklin D. Roosevelt took office in March 1933. By that time, the market had already advanced 30 percent. Or think back to the early days of World War II, when things were going badly for the United States in Europe and the Pacific. The market hit bottom in April 1942, well before Allied fortunes turned. Again, in the early 1980s, the time to buy stocks was when inflation raged and the economy was in the tank. In short, bad news is an investor’s best friend. It lets you buy a slice of America’s future at a marked-down price.

Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.

You might think it would have been impossible for an investor to lose money during a century marked by such an extraordinary gain. But some investors did. The hapless ones bought stocks only when they felt comfort in doing so and then proceeded to sell when the headlines made them queasy.

Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts.

Equities will almost certainly outperform cash over the next decade, probably by a substantial degree. Those investors who cling now to cash are betting they can efficiently time their move away from it later. In waiting for the comfort of good news, they are ignoring Wayne Gretzky’s advice: “I skate to where the puck is going to be, not to where it has been.”

I don’t like to opine on the stock market, and again I emphasize that I have no idea what the market will do in the short term. Nevertheless, I’ll follow the lead of a restaurant that opened in an empty bank building and then advertised: “Put your mouth where your money was.” Today my money and my mouth both say equities.

Warren E. Buffett is the chief executive of Berkshire Hathaway, a diversified holding company.

Get Rich Slowly

Get Rich Slowly
“Get rich slowly” is a book title that expresses my advice on personal finance. For most of us, get rich quick schemes are a bad idea. Market insiders have a way of discovering and grabbing ‘free money’ before the average person is aware of the opportunity. By the time you hear of a scheme on TV or in a book the ‘low hanging fruit’ has long since been picked. But if you will give up the ‘get rich quick’ idea there is a way for the average person to accumulate significant wealth.

First you must decide to save and invest rather than borrow and spend. Most Americans, especially young adults, choose the latter. The average credit card balance in America (ca. 2003) is $8000. According to the government, the average personal savings rate in the U.S. is zero. If you cannot resist buying unnecessary stuff on credit you can forget getting rich and focus on paying interest. Even a good income can easily be consumed this way. In trying to resist the ‘siren song’ of consumerism think about the happy times in your life. You will realize that good memories revolve around experiences…as in personal accomplishment, nature, sports, etc. or memories of relationships… as in family, friends and lovers. On the other hand, the thrill of buying stuff wears off quickly. The exception is buying a home. A home is usually a good investment even if you have a mortgage.

People with good incomes can most easily invest…unless they are too far in debt from self-indulgent spending habits. Low wage earners can still squeeze out a few dollars each month if the discipline is there. After all, in America, people who claim they can’t buy food for their kids still find money for beer, cigarettes and cable TV. Not everyone will accumulate a million (2006) dollars but a nest egg of $50,000 or $100,000 is possible.
Some ordinary people have succeeded. Two blue collar employees at a GE plant were featured on TV because they became millionaires by age 55 by taking maximum advantage of the company 401K stock sharing plan. There are many millionaires being created by 401K plans where people take full advantage and make wise investments. Here is how it is done:

1. To prevent taxes from reducing return take maximum advantage of tax deferred savings. Try to find an employer who has a 401K plan with matching contributions. The best would be one that matches with cash rather than company stock. The 401K rules allow up to 10% of pay to be invested by the employee and another 5% added by the employer for a total of 15% of pay. These deposits and any profit they generate are not taxable until funds are withdrawn. Forget those get-rich-quick schemes and the lottery because this is the best deal the average person will ever find. If you don’t have a 401k then anyone can start a tax deferred IRA account, though you do not get help from an employer.

2. What is the best investment for your account? The long term (75 year) average for the stock market is about 11%. This is double or more what you can get in an interest bearing account. Picking stocks is too risky. Instead, use the solid long term average return of the market. The best vehicle for this is an S&P 500 index fund. This is a fund that buys the stocks of a group of 500 reputable companies carefully selected to represent the entire market. Thus you are extremely well diversified and the fund will track the overall market. Since no genius (and highly paid) stock pickers are needed to manage the fund the fees on this fund will be minimal. The caveat is that the 11% average includes annual swings of 30% or more up and down and periods of slow growth. However, since you are investing for the long term you should not get nervous about these temporary and unpredictable gyrations. After all, temporary gains and losses are only hypothetical until you cash out. Incidentally, I do not like 401Ks when the only investment is your company’s stock. You could do well like those GE guys or it could turn out to be another Enron.

3. Do not try to “time the market”. No one, not even the experts, knows when the market will reach a bottom or a peak. Instead you should use the technique called “dollar cost averaging”. This simply means that if you invest the same amount each payday into stocks your dollars will buy more shares when prices are down and fewer shares when prices are up. Thus you have a built in efficiency over the long haul and it fits nicely with a 401k payroll plan.

4. You will make use of the miracle of compounding. Compounding means your profits are automatically re-invested and begin to earn profits. If you make regular deposits and get a good return your account will eventually be earning more than you are depositing. This is like free money. If you continue, the day might come as you near retirement that your account will be earning more money even than your total pay. How is this possible? Example…if you accumulate $500,000 and get a return of 11% you will net $55,000 a year in tax deferred income. The sooner you start investing, the better. The math shows that investment growth is very sensitive to time. It is like an accelerating locomotive…it is slow off the starting line but in time an enormous momentum can be achieved.

In conclusion, we have shown a way whereby ordinary workers can accumulate large sums over time. The IRS’s deferred taxation of 401K and IRA accounts is a gift to the average person. The caveats are that you have to give up the “instant wealth” idea and apply some fiscal discipline. I do not suggest saving is easy. I can remember my younger days when ‘fiscal discipline’ took a back seat to ‘lust for stuff’ and retirement was not even on my radar. However, as I look back now from my position as a senior citizen the benefits of ‘save and invest’ are obvious and achievable.