Lessons from Warren Buffett, 2019

Warren Buffett’s Berkshire Hathaway Inc.’s 2018 Annual Shareholders Letter was released last Saturday morning. This letter has been required reading for me for as long as I can remember. There are always lessons to be gleaned from his letter which can help all of us to be better investors and smarter financially.

Below are my comments, followed by selected portions of Buffett’s writings (in italics) from the 2018 Berkshire Hathaway Annual Letter.

WWM: It is clear that Buffett realizes that not all of his investments will succeed. He knows that many of the companies, or trees as he refers to them below, will not be able to adapt and be successful in the future.

  • Buffett: Investors who evaluate Berkshire sometimes obsess on the details of our many and diverse businesses   – our economic “trees,” so to speak. Analysis of that type can be mind-numbing, given that we own a vast array of specimens, ranging from twigs to redwoods. 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 knows that having ample cash on hand is critical for Berkshire, but is important to our clients as well. We often stress to clients that having many years of their annual withdrawal needs in fixed income should enable them to be able to sleep better at night.

  • Berkshire held $112 billion at year-end in U.S. Treasury bills and other cash equivalents, and another $20 billion in miscellaneous fixed-income instruments. We consider a portion of that stash to be untouchable, having pledged to always hold at least $20 billion in cash equivalents to guard against external calamities. We have also promised to avoid any activities that could threaten our maintaining that buffer.
  • Berkshire will forever remain a financial fortress. In managing, I will make expensive mistakes of commission and will also miss many opportunities, some of which should have been obvious to me. At times, our stock will tumble as investors flee from equities. But I will never risk getting caught short of cash.

Berkshire Hathaway grew in value during the 1970s through the early part of this century based on Buffett’s stock investments in many large US companies, as well as the success of its vast insurance companies. During most of this century, he has focused more on buying large companies outright, as well as making many opportunistic investments during times of crisis, such as during the financial meltdown of 2008-09. Now he has had to focus more on stock purchases again, due to the higher prices of buying companies outright.

  • In the years ahead, we hope to move much of our excess liquidity into businesses that Berkshire will permanently own. The immediate prospects for that, however, are not good: Prices are sky-high for businesses possessing decent long-term prospects.
  • That disappointing reality means that 2019 will likely see us again expanding our holdings of marketable equities. We continue, nevertheless, to hope for an elephant-sized acquisition.

Buffet does not try to make predictions or forecasts on the short term direction of stock prices, and does not pay attention to other short term issues, such as the Federal Reserve and economists. We agree with this approach!

  • My expectation of more stock purchases is not a market call. Charlie (Munger) and 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. Our thinking, rather, is focused on calculating whether a portion of an attractive business is worth more than its market price…
  • Charlie and I do not view the $172.8 billion…. (their 15+ top stock investments) as a collection of ticker symbols – a financial dalliance to be terminated because of downgrades by “the Street,” expected Federal Reserve actions, possible political developments, forecasts by economists or whatever else might be the subject du jour.

Due to their large insurance business, Berkshire has built up huge cash and investment reserves, called float, which is the excess of premiums paid to them greater than the claims they have paid out. Berkshire is well prepared with funds for a major insurance loss, as we want you to be prepared for stock market declines. Both will occur. You just don’t know when a huge insurance loss or market decline will occur or the cause, in advance.

  • As I have often done before, I will emphasize that this happy outcome (the build up of insurance float) is far from a sure thing: Mistakes in assessing insurance risks can be huge and can take many years to surface. (Think asbestos.) A major catastrophe that will dwarf hurricanes Katrina and Michael will occur – perhaps tomorrow, perhaps many decades from now. “The Big One” may come from a traditional source, such as a hurricane or earthquake, or it may be a total surprise involving, say, a cyber attack having disastrous consequences beyond anything insurers now contemplate. When such a mega- catastrophe strikes, we will get our share of the losses and they will be big – very big. Unlike many other insurers, however, we will be looking to add business the next day.

In his letter, Buffett tells how he started with his first stock investment in 1942. He emphasizes the importance of savings and the compound effect of the long term growth of US companies, despite political and other challenges over the decades. He attributes some of his success to “The American Tailwind,” but hopes there are bright futures worldwide and stresses that we all benefit if countries around the globe “thrive.”

  • If my $114.75 (in 1942) 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 January 31, 2019 (the latest data available before the printing of this letter). That is a gain of 5,288 for 1.
  •  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 3.25 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.
  •  Our country’s almost unbelievable prosperity has been gained in a bipartisan manner. Since 1942, we have had seven Republican presidents and seven Democrats. In the years they served, the country contended at various times with a long period of viral inflation, a 21% prime rate, several controversial and costly wars, the resignation of a president, a pervasive collapse in home values, a paralyzing financial panic and a host of other problems. All engendered scary headlines; all are now history….
  •  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.

 

Source: 2018 Berkshire Hathaway Annual Shareholder Letter, released Saturday, February 23, 2019. See Berkshirehathaway.com.

Disclosure: Brad Wasserman, author of this blog post, owns a small number of Berkshire Hathaway shares, which were purchased to enable me to attend Berkshire’s annual meeting. All my other stock investments are in DFA mutual funds, which is one of the primary mutual funds companies that we recommend to our clients.

The Real News About Charitable Deductions

There seems to be some mis-understandings about the tax deductibility of charitable contributions due to the Federal tax changes that were enacted in late 2017, which are now effective for 2018 and going forward. Let’s try to clarify this matter.

There were no changes in the new tax law that specifically affected charitable contributions. 

What changed is whether you can itemize or not.

We know that the financial world is continually changing. We know that the tax laws changed, and we hope this information provides you with clear and useful information. We want to help you overcome complexity and enable you to make better financial decisions.

If you can itemize, which means that your various deductions total more than the increased standard deduction amount, then you would continue to get a direct tax benefit from your charitable contributions.

The Tax Cut and Jobs Act (TCJA) vastly increased the standard deduction amounts. The 2018 and 2019 standard deductions amounts are as follows, respectively:

  • Filing Single….$12,000 and $12,200
  • Married Filing Joint couples….$24,000 and $24,400
  • Head of Households….$18,000 and $18,350

What is deductible to determine if you can itemize has changed, but how or what charitable contributions can be deductible has not changed.

  • State and local taxes, such as property taxes and state income taxes are now limited to $10,000 per year (previously, there was no limit).
  • In general, mortgage interest is still deductible.
  • Most miscellaneous itemized deductions have been eliminated.

If the total of your deductions exceeds the standard deduction amount for the filing category that is applicable to you, then you would benefit from itemizing. And if you have charitable contributions as some of your deductions, then you would get a tax benefit from those contributions.

If the total of your deductions is below the standard deduction amount that is applicable to you, then you would not be getting an incremental tax benefit from your charitable contributions.

If you are married, your standard deduction amount is $24,000 for 2018. If a couple paid $10,000 of state and local taxes and had mortgage interest expense of $10,000, any charitable contributions above $4,000 would enable this couple to itemize. If they made $10,000 in charitable contributions, which includes cash and property contributions, like used clothes donated, they would benefit as their total deductions would be $30,000.

If the same deductions were made by a single person, the $30,000 of deductions would far exceed the standard deduction amount of $12,000, and clearly this person would itemize and benefit from their charitable contributions.

This is really a case specific issue. Each person or couple will need to review the impact of the new tax law to their own specific situation and determine the impact on their deductions.

What we want to clarify is that many people will continue to be able to itemize and will continue to get real tax benefits from their charitable giving.

If your deductions are going to be far above the standard deduction amount each year, then you should continue with your annual charitable giving, as the tax law change really will not impact the deductibility of your charitable contributions.

Bunching strategy…

If you do not think you will exceed the standard deduction amount each year, but could be close, then more planning may be beneficial. In this situation, we recommend that you consider bunching your contributions every other year, if that will help you exceed the standard deduction amount every other year.

For example, let’s say a couple will have $15,000 of deductions in 2019, not including their charitable contributions of around $8,000 per year. If they make the charitable contributions each year, they would have $23,000 of deductions, and thus utilize the standard deduction amount of $24,400 in 2019.

However, if they bunch the contributions into an every other year cycle, they would get a significant benefit. If they gave most of the prior annual contributions of $8,000 into one year of $16,000 of contributions and then skip making most of the contributions in the following year, they would get a significant tax savings.

In the above example, they would have $15,000 of deductions in 2019, not including charitable contributions….and would still get the $24,400 standard deduction amount. In the next year, they would have deductions of $31,000 (the $15,000 + $16,000 of bunched charitable contributions), which would far exceed the 2020 standard deduction amount. You probably cannot or would not want to skip some contributions in a year, but you could let the charity know your plans, if they are counting on your annual gift.

If you have questions about this topic, you should consult with your tax advisor and review the figures.

For more advanced or significant charitable tax planning and giving concepts, please contact us. We have advised many clients on charitable giving and the interaction with their investments, estate planning and retirement accounts. This is a high value service we provide.

Obviously, charitable giving is a very personal matter.

We hope that you give to charities which are important to you and will continue to support their worthy causes and efforts, regardless of whether you get a tax benefit under the new tax law.

We welcome you to share this blog post with others, so they will have accurate information about charitable giving.

Let’s Talk

Will you even remember this occurred?

Late last year, most global stock markets dropped sharply. On Christmas Eve, the US markets had their worst Christmas Eve ever.*

Since Christmas, 2018, worldwide stock markets have risen dramatically and have recouped a large portion of the late 2018 decline.

In 66 trading days leading up to Christmas Eve, the S&P 500 declined 19.8%. However, in the 33 trading days December 26th to February 13, 2019, the S&P 500 has increased 16.6%.**

The chart below represents the above trading period, from 09/20/2018 to 02/13/2019.***
 

 While we believe that holding a broadly diversified global portfolio is in the best interest for most long term investors, I’m using the S&P 500 only for the illustrative purposes in this blog post, even though the S&P 500 consists of only US based large companies.

Global stock markets have increased significantly over the past 7 weeks despite many concerns about trade issues, the US government shutdown and worries about slowing economies in the US and globally.

This is a good reminder that even though you and others may be worried, and rightfully so, it does not mean that the stock market has to decline at that same time you have worries. The past few months are a terrific example of why we often remind you to focus on the long term, and not on the short term.

We believe it is nearly impossible to consistently and accurately time the stock market, to know when to get out and then when to get back in. You have to be right twice. To be a profitable market timer, you have to be able to do that over and over, and be correct to time the high and low points. This is not a game we advise you to play.

Though it can be difficult to handle markets when they decline quickly and sharply, we recommend that you adhere to your personal stock allocation plan, and not react to short term fluctuations and volatility.

Do you remember the decline in stocks which occurred in early 2016? Do you remember what caused this….3 short years ago? I assume that most of you do not remember that decline.

Just to refresh your memory, it was because of worries about China’s economy in January of that year. By early February, 2016, worldwide stocks began to climb again.

Three to five years from now, most investors will likely not clearly remember the late 2018 drop in stocks. It may have been worrisome for you to experience, as most major declines are scary to experience. But over time, the markets generally recover and go higher. And the memory of these declines fade.

But if your focus is on your long term future and long term financial plan, you will realize that declines like this are normal.

If you are in retirement, this is why we discuss with you the amount of fixed income savings that you have, and how long that can last you. We refer to this as your “Foundation.” For example, assume you are withdrawing around $80,000 annually from a $2 million portfolio. If you have $1 million of that portfolio in fixed income investments (50%), then you have over 12 years of annual withdrawals which are not subject to the volatility of the stock market….and that is without even including any interest on the fixed income investments. So you would really have 13 or more years of safe funds to rely on for your annual living.

If you think like this, you will hopefully be better able to tolerate the down periods in the financial markets, as you would know that you don’t actually need the stock portion of your savings for many, many years, for at least a decade in the example above. Thus, while the decline of 2018 was not pleasant for anyone, with this type of framework, you would realize that it is not directly impacting your current ability to live or your future standard of living.

It is this type of perspective and planning that we strive to develop with you, based on your age, income, expenses and savings.

We cannot predict when future major declines will occur, but we know there will be major declines in the future. On average, a major decline of around 20% or more occurs at least once every 5 years.

We want to work with you to develop a financial plan that begins to resolve your financial issues and concerns, such as how much money you may need to retire. And then we want to provide you with a plan and solution to live through your retirement years with the goal of reducing your stress that is related to financial issues.

We cannot eliminate down periods of the stock market. But we can work with you so you can strive to better handle down periods.

Let’s Talk.

*“The Stock Market just booked its ugliest Christmas Eve plunge-Ever”MarketWatch.com, by Mark Decambre, 12/24/2018

**“Stock Market Counterfactuals”awealthofcommonsense.com, by Ben Carlson, 2/08/2019

***S&P 500 ChartMorningstar.com

Realistic expectations

Helping you to develop realistic expectations can be one of the major benefits of working with a financial advisor.

We can help you to determine what you can realistically expect to live off of during your retirement or how much is a realistic amount that you need to save for a financial goal, such as college funding or your retirement.

We realistically expect that the future is uncertain. We know that finances can be confusing and difficult to understand. It is realistic for you to ask us in assisting with all the uncertainty and complexity and provide you with realistic solutions.

You are not being realistic if you plan to withdraw 7-10% annually of your investments during your retirement years. Academic research guides us to advise you to a more realistic annual withdrawal percentage, such as 4-5%. If you have a $2 million dollar portfolio, you should be able to comfortably withdraw $80,000 per year with a diversified and balanced portfolio and not run out of money.

Realistic expectations should include being prepared for bad periods of the stock market. We remind clients that the stock market has declined around 20% or more, once every 5 years, on average, since World War II. If you are not mentally prepared for this type of decline, which can occur at any time, even when you least expect it, you may not have realistic expectations.

You can realistically expect us to provide you advice that is in your best interest, even if it’s not in our best interest. We have a legal obligation to act as a fiduciary, to provide advice that is in your best interest. It is important that you understand that other types of financial professionals may not have to adhere to this higher standard of advice. Most national brokers and financial consultants working at a bank or insurance company do not have to act in your best interest.

We believe that in the long run, having a globally diversified portfolio will provide you with greater expected future returns than holding a portfolio of just large US stocks, such as the S & P 500. However, we want you to realistically expect that there may be periods or years when a US based portfolio will outperform a globally diversified portfolio.

We believe that in the long run, owning a globally diversified portfolio, with a tilt towards small companies and value companies, both in the US and Internationally, will provide you with greater expected returns. However, we want you to realistically expectthat there may be periods or years when these small and value “premiums” do not appear.

We encourage you to ask us questions and for guidance about a wide range of financial areas, so you can strive to be more financially realistic and make good decisions.

We think the more realistic that you are, the better long-term investor that you will be. And hopefully, happier, more secure and more successful.

Let’s Talk