I was reading some of the Warren Buffett’s older letters to Berkshire Hathaway shareholders. I love the clarity in thinking that they display. The true mark of an expert is someone who has the ability to take a complicated topic and distill it into simple language, and these letters display that virtue in abundance.
I was reading the 2008 letter because I wanted to see what Warren wrote about the turmoil in the financial markets in that year. This letter contains the following passage, which I immediately saved to Evernote:
In good years and bad, Charlie and I simply focus on our goals:
1) maintaining Berkshire’s Gibraltar-like financial position, which features huge amounts of excess liquidity, near-term obligations that are modest, and dozens of sources of earnings and cash;
2) widening the “moats” around our operating businesses that give them durable competitive advantages;
3) acquiring and developing new and varied streams of earnings;
It’s wonderful in its simplicity. But the best part: you can apply this exact model to your own life.
1) Get your financial house in order. Know where your money is going (I use You Need A Budget, which is fantastic). Make sure you’ve always got enough cash on hand to cover any short-term liquidity problems – and I mean cash on hand, not home equity or available credit cards or money invested in index funds. Don’t get into credit card debt, and limit your other obligations as much as possible. Then, start investing the spare cash to produce additional income.
2) When applied to an individual, this basically means: find ways to increase your earning power day-to-day. For most people, myself included, your main economic engine is your day job. So this means getting great at your job, and taking advantage of the opportunities that arise because of this – promotions, pay rises, and so on. Being great at your job not only means you’ll get paid more, but also means you’re a lot less likely to ever be laid off – a great, protective moat around your earning power.
3) Now that you’re in a healthy financial position and earning good income, you need to redeploy this capital in ways that generate yet more income. That could be shares, bonds, peer-to-peer lending, starting a side business – whatever suits your particular talents and expertise. It’s your job to collect assets that generate excess cash for you, as the owner, to do with whatever you please.
A simple, three step model to becoming fabulously wealthy over time. Get your ship in order to avoid wipeout risk, increase earnings, and invest excess cash into assets that produce even more excess cash. Not easy, but simple.