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D.Muthukrishnan (Muthu), Certified Financial Planner- Personal Financial Advisor

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Buffett: Why Liquidity is important?

Posted by Muthu on February 18, 2014

“A little personal history may partly explain our extreme aversion to financial adventurism. I didn’t meet Charlie (Munger) until he was 35, though he grew up within 100 yards of where I lived for 52 years and also attended the same inner-city public high school in Omaha from which my father, wife, children and two grand children graduated. Charlie and I did, however, both work as young boys at my grandfather’s grocery store, though our periods of employment were separated by about five years. My grandfather’s name was Ernest, and perhaps no man was more aptly named. No one worked for Ernest, even as a stock boy, without being shaped by the experience.

On the facing page (given below) you can read a letter sent in 1939 by Ernst to his youngest son, my Uncle Fred. Similar letters went to his four other children. I still have the letter sent to my Aunt Alice, which I found- along with $1000 of cash- when, as executor of her estate, I opened her safe deposit box in 1970.”

(Letter written by Warren Buffett’s grandfather Ernest Buffett in 1939 is given below)

Dear Fred & Catherine,

Over a period of a good many years I have known a great many people who at some time or another have suffered in various ways simply because they did not have ready cash. I have known people who have had to sacrifice some of their holdings in order to have money that was necessary at that time.

For a good many years your grandfather kept a certain amount of money where he could put his hands on it in very short notice.

For a number of years I have made it a point to keep a reserve, should some occasion come up where I would need money quickly, with out disturbing the money I have in my business. There have been a couple occasions when I found it very convenient to go to this fund.

Thus, I feel that everyone should have a reserve. I hope it never happens to you, but chances are that some day you will need money, and need it badly, and with this thought in view, I started a fund by placing $200.00 in an envelope, with your name on it, when you are married. Each year I added something to it, until there is now $1000.00 in  the fund.

Ten years have elapsed since you were married, and this fund is now completed.

It is my wish that you place this envelope in your safety deposit box, and keep it for the purpose that it was created for. Should the time come when you need part, I would suggest that you use as little as possible, and replace it as soon as possible.

You might feel that this should be invested and bring you an income. Forget it- the mental satisfaction of having $1000.00 laid away where you can put your hands on it, is worth more than what interest it might bring, especially if you have the investment in something you could not realize on quickly.

If in after years you feel this has been a good idea, you might repeat it with your own children.

For your information, I might mention that there has never been a Buffett who ever left a very large estate, but there has never been one who did not leave something. They never spent all they made, but always saved part of what they made, and it has all worked out pretty well.

This letter is being written at the expiration of ten years after you were married.

(Signed – Ernest Buffett, “Dad”)

 

“Ernest never went to business school- he never in fact finished high school- but he understood the importance of liquidity as a condition for assured survival. At Berkshire, we have taken his $1000 solution a bit further and have pledged that we will hold at least $10 billion of cash, excluding that held at our regulated utility and railroad business. Because of that commitment we customarily keep at least $20 billion on hand so that we can both withstand unprecedented insurance losses (our largest to date having been about $3 billion from Katrina, the insurance industry’s most expensive catastrophe) and quickly seize acquisition or investment opportunities, even during times of financial turmoil.

We keep our cash largely in U.S. Treasury bills and avoid other short-term securities yielding a few more basis points, a policy we adhered to long before the frailties of commercial paper and money market funds became apparent in September 2008. We agree with investment writer Ray De Voe’s observation, “More money has been lost reaching for yield than at the point of gun.”. At Berkshire, we don’t rely on bank lines, and we don’t enter into contracts that could require postings of collateral except for amounts that are tiny in relation to our liquid assets.

Furthermore, not a dime of cash has left Berkshire for dividends or share repurchases during the past 40 years. Instead, we have retained all of our earnings to strengthen our business, a reinforcement now running about a $1 billion per month. Our net worth has thus increased from $48 million to $157 billion during those four decades and our intrinsic value has grown far more. No other American corporation has come close to building up its financial strength in this unrelenting way.

By being so cautious in respect to leverage, we penalize our returns by minor amount. Having loads of liquidity, though, let us sleep well. Moreover, during episodes of financial chaos that occasionally erupt in our economy, we will be equipped both financially and emotionally to play offense when others scramble for survival. That’s what allowed us to invest $15.6 billion in 25 days of panic following the Lehman bankruptcy in 2008.

(Source: Warren Buffett- 2010 annual letter to shareholders- http://www.berkshirehathaway.com/letters/2010ltr.pdf)

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