Berkshire Hathaway closes in on $1 trillion … the power of compounded returns from great companies … what if you don’t have decades? … benefiting from an asset Buffett hates

Yesterday, shares of Warren Buffett’s Berkshire Hathaway (BRK.B) set an intraday all-time high as the company’s market value closes in on $1 trillion.

But more interesting than Berkshire’s valuation is Buffett’s annual letter to shareholders, released this past Saturday. The “Oracle of Omaha” has written this letter since 1965, providing a treasure trove of wisdom for investors over the decades.

The problem is too few investors are willing to act on this wisdom.

That’s because it’s boring…

And requires patience…

Buffett’s market approach is anything but flashy and holds zero promise of overnight riches.

Instead, Buffett urges investors to find great companies, reinvest dividends, and simply wait.

As two examples of the power of this approach, we have Buffett’s long-term holdings in Coca-Cola and American Express

He’s owned Coke since 1988 and AMEX since 2001.

Both companies have experienced significant stock drawdowns and management failures during those periods, but they’ve remained pillars of Buffett’s portfolio. And the payoff has been extraordinary.

Take Coca-Cola. Berkshire’s cost basis in Coke is $3.2475.

Today’s Coke’s annual dividend yield has grown to $1.96. This means that Buffett is netting a yearly return on his initial investment of 60%. Another way to look at this is Coke’s dividend payments more than doubles Buffett’s starting investment every two years.

Here’s Buffett’s takeaway from his latest letter to shareholders:

The lesson from Coke and AMEX?

When you find a truly wonderful business, stick with it. Patience pays, and one wonderful business can offset the many mediocre decisions that are inevitable.

A visual on why patience pays

The above statistic doesn’t quite capture the power of patience combined with compounding, so let’s use a visual.

The chart below shows Buffett’s net worth by age. What you’re going to see is that this value was (relatively) small for decades. It almost doesn’t even register visually on this scale for nearly 40 years.

This is because it takes time for the power of compounding to work. After all, when you’re starting with a small absolute number, even a big percentage return still produces a small absolute number. Mathematically, it takes time for things to snowball.

But here’s what time and compounding can do, even with that small snowball…

And here’s the real kicker for perspective…

Even though Buffett bought his first stock at age 11, 99% of his wealth was earned after he turned 50.

Can you wait for the snowball to compound?

Let’s look at Buffett’s other highlighted company above – American Express.

It’s a great business, but did it ride the forefront of a new technology? Not really.

Did it benefit from some new, groundbreaking legislation? No.

Franky, it’s not incredibly unique. AMEX is just a solid, strong business that has grown over time.

The truth is this investment approach requires decades before the riches become lifechanging.

Consider these numbers…

If you invested $10,000 in AMEX 10 years ago and reinvested your dividends, you would be sitting on $27,703 today.

Now, that’s great, but it’s not “retire” money.

What if go back farther and assume the same $10,000 investment 20 years ago?

Again, assuming we’d reinvested dividends, that $10K would now be worth $61,763.

That’s a 6X return. Pretty impressive, but again, not lifechanging for most people.

It’s when we go back one more decade that we see the real benefit of compounding.

If you put $10,000 into American Express in February of 1994, then reinvested dividends, you’d now be sitting on $435,432.

And if you were an investor of greater means and sunk in $50K?

You’d have $2.18M today.

But let’s be realistic: not all of us have a 30-year investment horizon, nor the patience even if we did

We need to be realistic about our shortcomings and timeframes as investors.

The truth is that few of us have Buffett’s discipline. We want the payoff tomorrow. Many of us also don’t have multiple decades to wait while a great company slowly snowballs our wealth.

Unfortunately, this leads us to make risky bets with our hard-earned money.

To be clear, a risky bet isn’t always a horrible idea. Sometimes these bets pay off. It becomes a horrible idea when we bet too much, risking an insurmountable loss of our capital.

This violates Buffett’s cardinal rule of investing, which he stressed again in Saturday’s letter:

One investment rule at Berkshire has not and will not change: Never risk permanent loss of capital.

But for investors who don’t have decades for compounding, who feel the need to take on greater risk of loss in search of faster returns, what’s the answer?

Balancing sensible investing with “swing for the fences” speculations

Lower your position size.

That’s it.

Sure, this means you might not become obscenely wealthy tomorrow even if your gamble works out, but a smaller position size also ensures that you won’t go broke if your gamble goes wrong.

To illustrate, we could pick any number of “riskier” assets – biotechs, junk bonds, penny stocks… But for a fun juxtaposition, let’s pick an asset that Buffett would most certainly not approve of…

Bitcoin.

He has called the cryptocurrency “rat poison squared.”

A few other colorful comments include: “It’s a mirage, basically. The idea that it has some huge intrinsic value is just a joke, in my view” and “I can say with almost certainty that [cryptocurrencies] will come to a bad ending.”

However, Buffett’s longtime business partner Charlie Munger had the best Bitcoin quote by far:

It’s like somebody else is trading turds and you decide “I can’t be left out.”

Despite the disdain for Bitcoin from Buffett and Munger, this asset has created lifechanging wealth for many investors over the past decade – even from a relatively tiny initial investment amount.

Consider putting just $5,000 into Bitcoin five years ago. Today, even after the myriad busts, you’d have just under $70K. How many vacations is that for your family?

Flatly refusing to take advantage of this type of firepower (regardless of the asset behind it) feels foolish in our opinion. After all, you don’t have to agree to hold Bitcoin in your portfolio forever; rather, you view it as a tool to grow your wealth for as long as the tool is effective. When it stops working for you, you trade it in for a different tool.

So, how do we balance Buffett’s disciplined market approach with a safe speculation?

You compartmentalize. Different investment “buckets” are there for different investment strategies.

With the lion’s share of your investment capital, follow a wise, prudent strategy that more closely resembles Buffett’s slow and steady approach.

But with an amount of money that won’t derail your financial goals if you’re wrong, you take the gamble. If you’re right, and your speculation explodes, then even your small initial investment can result in the equivalent of decades’ worth of “slow and steady” returns. This will accelerate when you hit the steep part of the exponential growth curve.

Even though I initially included Bitcoin today as a fun foil to Buffett’s investment style, it’s a perfect illustration of this point.

As we’ve detailed here in the Digest, the “halving” takes place in two months. This is an event specific to Bitcoin which, historically, has been very bullish for Bitcoin’s price.

When measured from the day of the prior halvings to the ensuing peak Bitcoin price about one year later, the first three halvings resulted in gains of 8,761%, 2,577%, and 594%.

If Bitcoin mirrors past performance from the previous two halvings, its price could hit $225,000 by next year. That’s about 330% higher.

Is this worth a few of your dollars as a gamble?

For perspective, the ten-year Coca-Cola average annual return with dividends reinvested has been 8.41%. At this rate, you’d need roughly 15 years for a $1,000 investment in Coke to climb about 330%.

As we just saw, history suggests that Bitcoin could do this for you in about a year.

Even if Bitcoin is “rat poison squared,” is it not worth putting yourself in position for this return with a small, reasonable investment size? I should note that Bitcoin is up 43% in just the last month.

We won’t dive farther down the Bitcoin rabbit hole in today’s Digest, but if you’re a subscriber to Luke Lango’s Ultimate Crypto service, click here to read his latest update on the market.

Coming full circle, Buffett’s extraordinary return is a great illustration of the power of time and compounding

It’s a reminder to stay the course in great companies.

Every time you find yourself worried about a blue-chip in your portfolio, remember the chart of Buffett’s personal net worth. The snowball needs time to reach that stage of exponential growth.

But if time is what you lack, and you feel the urge to take riskier bets, please be smart about it. As the old saying goes, “return of capital is more important than return on capital.”

Have a good evening,

Jeff Remsburg