Financial resilience

Recently, I happened upon Berkshire Hathaway’s spartan website and, not surprisingly, encountered many plainly packaged gems.  One was listed in Warren Buffett’s special letter addressing his company’s outstanding success.  He wrote the following:

Financial staying power requires a company to maintain three strengths under all circumstances: (1) a large and reliable stream of earnings; (2) massive liquid assets and (3) no significant near-term cash requirements.                                                                                                                                                                                              – Warren Buffett

This statement got me thinking about its application to personal finance and keeping one’s self and family afloat in good times and bad.

Large and reliable stream of earnings.  How large is “large” likely depends on your bills and liabilities, but I would imagine this statement means that you need substantially more than enough to cover expenses, and that the sources of income should be diversified.  In the terminology of Stanley’s Millionaire Next Door, play good offense and defense. Regarding reliability of the stream of income, a household with one wage earner is vulnerable.  Even two wage earners in the same industry could be at risk, as well.  Having multiple streams of income would be ideal.  This diversification could be in the form of multiple jobs, dividend income, interest income, real estate holdings, etc.

Massive liquid assets.  Most personal finance experts advise having a rainy day fund separate from retirement savings.  This fund needs to be in cash or cash equivalents.  It may be tempting to put this money in stocks or bonds, as returns with a CD or money market will be low, but having the funds liquid is the best.  If all other asset classes are tanking, at least your cash will buy necessities like food and electricity.

No significant near-term cash requirements.  In his letter, Buffett talks of this point in the context of a business issuing bonds and underestimating how much money it will have to pay them off when the principal is due.  But I think it applies to an individual’s finances, as well.  For example, if you have adjustable rate debt that can suddenly increase your monthly payments, as in the 2009 housing crisis, your situation can quickly get out of hand.  Keeping your expenses as low as possible is probably good – pay off house, cars, education loans ASAP, depending on how large the payments are in aggregate.  There may be some opportunity cost in terms of losing out on investments, but you will likely sleep better at night knowing that your finances are secure.

I think the three pillars addressed here are an interesting framework to think of personal finance, and highlight sound financial management principles that have been echoed in many of the books I’ve read on the topic.

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