Editor's note: This Weekend Edition, we're taking a break from our usual fare. In this essay, most recently published in the Stansberry Digest Masters Series, editor Corey McLaughlin shares a piece of timeless advice from investing legend Warren Buffett to help you be the "last man standing" in any financial crisis.
Warren Buffett was in Alaska on a sightseeing trip...
And the charter-boat captain announced he was going to pilot closer to the sea lions resting on the river's chilly edge. Buffett said, "No, no!" fearing the satellite-phone connection he was using would stop working if the boat got too close to the towering canyon walls.
This was September 1998, and there was blood in the water... not in Alaska, but back in New York.
A financial crisis was brewing that, for him, marked a potential moneymaking opportunity... His mind was on that, rather than Alaska's natural wonders.
"We were sailing up through these canyons," Buffett recalled, "which held no interest for me whatsoever."
Buffett's view from the boat marks the "other side" of the crisis that I wrote about in the Stansberry Digest in early April... That is the failure of Long-Term Capital Management ("LTCM"), one of the boldfaced and telling financial blunders of recent decades.
Through a series of massively overleveraged bets, a group of some of the supposed smartest people on Wall Street in the late 1990s ended up on the hook for nearly $4 billion. That was money that they didn't have.
Buffett got more than one phone call about what was happening. And he was even asked if he was interested in buying the firm's remaining financial assets.
It's a relatively famous story in financial circles today...
For much of the fall of 1998, former colleagues of Buffett at the Wall Street firm Salomon Brothers had been telling him that LTCM was in bad shape, stemming from exposure to Russia's recent debt default... and the Asian financial crisis of 1997 before that.
Right before Buffett was leaving home for a 12-day vacation to Alaska and other sights, the trouble for LTCM got serious.
The timing of LTCM's failure and the tender technology of the moment (satellite phones!) meant that Buffett didn't have seamless communication with Wall Street. If he did, things might have gone differently... But as it was, he made an outline of an offer by phone.
As he recalled in a talk at the University of Florida in October 1998...
In the end, it was a bid for $250 million for, essentially, the net assets but we would have put in $3.75 billion on top of that. It would have been $3 billion from Berkshire Hathaway, $700 million from AIG, and $300 million from Goldman Sachs.
In a power position himself – since he had plenty of cash and they didn't – Buffett gave LTCM no more than an hour to accept or decline the deal. He didn't want prices moving around too much... Plus, he was on vacation.
They said they couldn't accept his offer.
Ultimately, that same day, the Federal Reserve bailed out LTCM with its own $3.6 billion deal that it orchestrated with many of Wall Street's biggest investment banks.
Eventually, those banks made some money back... And in 2000, LTCM liquidated its assets in a more orderly fashion. In the meantime, Buffett kept on rolling, none the worse for the experience other than to say, "It was an interesting period."
Yes, it was. And as I'll explain today, it's an experience anyone interested in building serious wealth can learn from...
The first and biggest point we need to look at is why Buffett was in a position to buy LTCM to begin with.
He had cash – and lots of it – easily available.
Thanks to Buffett's frugal lifestyle and the way he and his business partner Charlie Munger structured Berkshire Hathaway (BRK-B), they are never beholden to debt... while much of the rest of the world is.
Buffett and Munger have pledged to always have more than $30 billion or more of cash on Berkshire's books. As Buffett wrote in his annual letter to Berkshire shareholders this year...
We want your company to be financially impregnable and never dependent on the kindness of strangers (or even that of friends). Both of us like to sleep soundly, and we want our creditors, insurance claimants, and you to do so as well.
In other words, they don't want to rely on someone lending them money. And by taking this approach, they can actually make more money and take advantage of great buying opportunities... like the LTCM deal.
I recently finished a terrific book, Richer, Wiser, Happier: How the World's Greatest Investors Win in Markets and Life by William Green. I bring it up now because as you might imagine, Buffett is featured throughout.
And this quote about him from professional investor Guy Spier, who runs a hedge fund that has owned Berkshire Hathaway shares for more than 20 years and once paid $650,000 to have lunch with Buffett, stuck with me. Spier said...
Buffett has systemically set himself up to be the "last man standing."
Think about how valuable being the "last man standing" could be...
What if you have cash on hand to take advantage of the next 30% drop in the markets? In a crisis, Wall Street often sells everything and asks questions later...
And it's sometimes good to be the one buying, like at the March 2020 bottom of the COVID-19 crash.
As individual investors, if we're not beholden to debt payments and liability calls (which we shouldn't be), you can stick to your plan (like stop losses or profit targets) and sell. And with cash on hand, you can then step in and buy when the time is right.
It's important to define what we mean by "cash"...
Our colleague and Stansberry Research partner Dr. David "Doc" Eifrig has written frequently on this topic. As he shared in the August 12, 2021 edition of his free Health & Wealth Bulletin...
By cash, we don't mean actual dollar bills stacked up in your sock drawer. We mean money you can access quickly, with no loss of capital and few transaction fees.
This includes checking accounts, savings accounts, and a few short-term investment accounts, like money-market mutual funds.
Basically, cash is the money you can use to pay for things with no worry or hassle.
From there, when we talk about how cash fits in your financial picture, we're really talking about two different things: your emergency fund and the cash allocation of your portfolio.
Your emergency cash fund is money set aside for unforeseen emergencies, especially the loss of your income. As Doc wrote, the dollar amount of a comfortable emergency fund is different for everyone and depends on what responsibilities you have...
It depends on how safe you want to be.
You can find experts saying that you should have between three and 36 months of living expenses in your emergency fund. I'd narrow that range to between six and 12 months.
Once you have an emergency cash cushion, you can think more seriously about the long-term cash allocation in an investment portfolio.
This is the money that you can put to work like Buffett does when opportunity knocks... or when it calls you while you're on vacation in Alaska. Real estate after the housing bubble popped in 2008 was a good example. Those with cash on hand were able to take advantage of a bad time.
This is what Buffett calls "optionality." Cash gives you choices, which has value itself during times of market crisis.
Once you have these concepts squared away, usually the next question is... How much cash should I have?
Again, this answer is going to be different for everyone.
If you're Buffett or Berkshire Hathaway, as of February 26 – when he released his annual shareholder letter – cash meant $144 billion, mostly in U.S. Treasurys, all maturing in less than a year.
This is a massive cash pile. As Buffett wrote, a $120 billion stake in Treasurys left Berkshire financing half of 1% of all the publicly held U.S. debt... No wonder Buffett refers to the U.S. government as a "silent partner."
For most of us mere mortals, our cash reserves will be much less in nominal terms, but they might be similar in percentage terms. Berkshire has about $1 trillion in assets, so its cash position earlier this year was around 15%.
As Doc wrote in his Health & Wealth Bulletin piece...
For a young person with 30 years to retirement, there is little reason to have any cash holdings in your portfolio after you set aside your emergency fund.
As you get closer to retirement, you should start moving some of your investments over to cash. You should start this phase five or 10 years before retirement. And you could gradually grow your cash allocation from, say, 5% to as high as 20%, depending on your goals.
If you're closer to retirement, you might want more of your portfolio in cash. If you're loaded up on stocks and bonds just ahead of a bear market and you have to sell assets to generate cash for day-to-day expenses, you end up selling at just the wrong time – like those supposed geniuses at LTCM who ended up almost selling to Buffett.
All that said, cash does have a big downside...
The biggest is inflation, which destroys the value of cash and your purchasing power. Many of us are feeling the effects of this right now.
We don't know for sure, but this might be one reason why Buffett has been on a buying bender as of late...
It's not hard to imagine that Buffett would rather have the cash rolling in from appreciating profit makers like oil and gas company Occidental Petroleum (OXY) – stemming from higher energy prices and interest rates – than the relatively paltry yields on bonds that aren't keeping pace with inflation...
As we've written a few times, this is why the conventional 60/40 stock-bond portfolio has been performing so poorly this year. Passive strategies like that may work in bull markets in stocks and bonds... but they can hurt everyday investors in more volatile times like today.
It has been ugly out there... And we don't know how much longer this will last. The good news is that while none of us here is the world's fifth-wealthiest person, you can still apply Buffett's approach to be the "last man standing" in any market environment.
Today, I am here to remind and encourage you to do just that...
It's easy to get caught up in tracking market trends, trying to predict what's going to come next, or analyzing great opportunities. Financial research and money-management industries typically obsess over these tasks...
Meanwhile, a fundamental idea like "having cash" and knowing what it can do for you, your portfolio, and your life over the long term – including inflationary times – is often ignored or overlooked.
But not here at Stansberry Research.
Given the market volatility we've seen this year – just like in the fall of 1998 – and warning signals we're seeing about potentially more trouble ahead, this timeless advice from the "Oracle of Omaha" is timely yet again.
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