Lessons in Investing from Berkshire Hathaway’s Shareholder Letters

If I could have lunch with anyone in the world, I’d pick Warren Buffett. He’s the CEO and Chairman of Berkshire Hathaway, the second-largest company in the U.S. He’s also an extremely successful investor who still lives in the same modest home he bought in 1958. Basically, he’s done what so many of us in the FIRE world hope to achieve, only on a much grander scale.

Unfortunately, he’s never invited me to lunch, so I do the next best thing: I read Berkshire Hathaway’s shareholder letters. Warren Buffett writes them every year and they’re published in the company’s annual report. The writing style is conversational, with a joke thrown in here and there. Basically, reading the letters is like reading a letter from your grandpa, if he was as wise as Morgan Freeman, wealthier than Mark Zuckerberg, and gave really sound investing advice. You can find them here:

They’re filled with investment observations from the man himself, and I recommend reading them in their entirety. For today’s post, though, I’ve chosen five ideas from five letters that I think are particularly interesting. Some of them may contradict what you already know or think, and while you should ultimately do what’s best for you, I think these lessons are worth considering as you make investment decisions.

Lesson #1, From the 2012 Shareholder Letter:

“The risks of being out of the game are huge compared to the risks of being in it. ”

In this letter, Mr. Buffett stresses that while uncertainty has always existed in the stock market, it shouldn’t stop you from investing. In the long run, the majority of businesses will be successful, and investors will come out on top. He points out that in the twentieth century, the country weathered four wars, the Great Depression and many smaller recessions, and the Dow Jones Industrial Index still managed to increase 17,320%.

I think this is important to keep in mind if you’re considering when to get into the stock market. 2017 has been a record-breaking year, and I know that some people are concerned about buying now. What if stocks start to fall tomorrow, and you end up with negative returns? It’s certainly a possibility, but history shows that the market will eventually rise again and investors will reap the benefits. What if you don’t buy now, and the market continues to rise for years to come? No-one knows what will happen tomorrow, but as long as you’re in it for the long haul (which you should be if you’re a FI-er) you can weather the ebbs and flows and still expect long-term profits.

Lesson #2, From the 1996 Shareholder Letter:

“In studying the investments we have made in both subsidiary companies and common stocks, you will see that we favor businesses and industries unlikely to experience major change.”

In this letter, Mr. Buffett discusses how he and Berkshire Hathaway vice chairman, Charlie Munger, like to invest in companies that already lead, and will continue to lead, their industries for the foreseeable future, like Coca-Cola and Gillette. He says that they prefer the virtually certain returns of these companies over the unpredictability of young or rapidly changing businesses and industries.

If you’re a thrill-seeker, this probably sounds like a boring strategy. It’s true – following this advice won’t make you a millionaire overnight, but it should provide you with consistent returns that will get you to that seven figure mark slowly and surely. On the other hand, if you took a riskier approach, you might retire next month, or you might lose everything and have to start all over again. I’m a fan of index funds (as is Mr. Buffett, as you’ll see in Lesson #4) because they can help you create a well-diversified portfolio very quickly, but if you’re investing in individual stocks, this is a lesson you should consider.

Lesson #3, From the 2014 Shareholder Letter:

“The unconventional, but inescapable, conclusion to be drawn from the past fifty years is that it has been far safer to invest in a diversified collection of American businesses than to invest in securities – Treasuries, for example – whose values have been tied to American currency.”

Of everything I’ve read in the shareholder letters, this is the lesson that absolutely blew my mind. I think we all know that equity has a higher rate of return than debt, and I can’t be the only one who was taught that that’s because it’s more risky. Mr. Buffett argues that while stocks are more volatile than currency-based instruments, they are much less risky.

“But that can’t be true!” the little voice inside my head shouted as I read. “U.S. Treasuries are risk-free!” Warren Buffett doesn’t dispute that you’ll receive the amount of money you were promised – that is, you’ll get your principal back and the stated interest. What he points out is that after you account for inflation and taxes, your money may have less purchasing power. In other words, the risk you face with bonds is that after making the investment, waiting for the return and paying taxes on interest received, you may be able to buy less than if you’d spent the money immediately.

I struggled with this concept. I didn’t want to believe it, because it seemed to go against everything I’ve been taught so far. I spent way too many hours on the Internet. I researched inflation and historic Treasury Bond rates, and made multiple charts trying to make sense of what I found. The conclusion I came to is that Mr. Buffett is correct: investing in Treasuries, or other currency-denominated instruments, may not result in you having any more purchasing power – which is really the ultimate goal in investing.

To illustrate:


This graph contains data from the last 50 years. The blue line represents the percent change from the same point one year prior in the Consumer Price Index, which is an indicator of inflation. The green line is the annual interest rate on 10-Year U.S. Treasuries, and the red line is the difference between the two. Any time the red line dips below zero, the amount someone made off their 10-Year Treasury wouldn’t have been enough to cover the increased cost of goods due to inflation.

There’s another important factor that isn’t reflected in this graph: taxes. In reality, you’d be paying taxes on the interest you received from the bond. If we assume your tax rate is 25%, we’d need to lower the green line by a quarter, which would drive the red line down, too.

Of course, a key part of diversification is including both stocks and bonds in your portfolio. I don’t plan on eliminating bonds from my portfolio because of a potential loss of purchasing power, but I think it’s important to be aware of the risk.

Lesson #4, From the 2016 Shareholder Letter:

“When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients. Both large and small investors should stick with low-cost index funds.”

This may not be a new idea, but Mr. Buffett backs up his claim with a real-life example, which I think is interesting. The story goes like this:

About ten years ago, Warren Buffet publicly offered to wager $500,000 that no professional investment manager could select a portfolio of at least five hedge funds that would outperform an S&P 500 index fund over the following ten years. Performance would be measured based on the return after fees, costs and expenses. One manager took the challenge, and in the 2016 letter, Mr. Buffett reported on the results after nine years. The index fund had a compound annual return of 7.1%, while the hedge funds delivered an average of 2.2%.

Mr. Buffett’s concludes that there is a small group of investment managers who will outperform the S&P 500 in the long run. However, it’s by no means a sure thing while the high fees are guaranteed.

Lesson #5, From the 2011 Shareholder Letter:

“People will forever exchange what they produce for what others produce.”

In this letter, Mr. Buffett separates your investment options into three buckets:

  1. Currency-denominated instruments like bonds, deposits and money market funds.
  2. Assets that don’t produce anything, but that investors hope will increase in value over time, such as gold.
  3. Productive assets like businesses, farms and real estate.

As you can probably tell from the excerpt, he prefers investing in Bucket #3. He dislikes currency-based instruments because of their dependence on the value of the underlying currency, as I discussed in Lesson #3. In fact, he offers the following example:

Annual Return, 1965-2011
Continuous rolling of U.S. Treasury bills 5.7%
Personal Income Tax (assumed at 25%) (1.4%)
Inflation (4.3%)
Increase in Purchasing Power 0


When you see those statistics, I’ll admit Bucket #1 looks pretty bleak.

Warren Buffett’s argument against Bucket #2 – using gold as an example – is that it won’t grow. If an investor buys one gold brick, it will still be one gold brick 100 years from now. The only hope is that people will become more fearful of other assets (like paper money) and the value of commodities like gold will increase.

Mr. Buffett writes that he prefers to invest in Bucket #3: productive assets. He points out that these assets will always be valuable, regardless of what currency we may use in the future. They are also minimally impacted by inflation if they have the ability to produce goods without a great deal of new capital investment.

I want to point out that Mr. Buffett has gone against his own advice and invested in both Buckets #1 and #2 at certain points in history. In the 1997 Shareholder Letter, he discusses the company’s purchase of silver and in the 2011 letter, he says the company holds a minimum of $10 billion in currency-denominated instruments. I think this illustrates that although some investments are riskier than others, they can still provide valuable diversification to a portfolio.

I’d like to hear from you. Did you find any of these lessons surprising?

Five of the most unexpected and valuable investment lessons we can learn from Warren Buffett through the Berkshire Hathaway Annual Letters to Shareholders.

3 thoughts on “Lessons in Investing from Berkshire Hathaway’s Shareholder Letters

  1. Mr. Buffett shares so many good lessons it’s hard to keep track of them all. This is a nice roundup. Bucket two “assets that don’t produce something” makes me think of crypto currency. I’ll stick with the productive stuff.

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