In the Berkshire Hathaway 2010 Annual Report, Warren Buffett shared a letter from his grandfather to his uncle’s family in 1939, and the advice contained within the letter formed the basis of Berkshire Hathaway’s commitment to weathering any financial storm.
I can’t say if the idea of an emergency fund was novel in 1939, but the advice contained within the made enough sense to Warren Buffett that the idea stuck with him and helped to form his philosophy for operating his business. Here’s the letter, scanned and included in the annual report to shareholders.
Warren Buffett’s grandfather, Ernest, owned a grocery store, and as a business discovered the importance of having cash available immediately in the event that it is needed to keep the business running. The letter also emphasizes the idea of assisting future generations, but not with so much money that those within the younger generation do not become self-sufficient. The $1,000 provided with the letter in 1939, and provided with similar letters to other family members as Buffett discovered in 1970, is equivalent to about $15,500 today due to inflation. This is a significant emergency fund and a significant gift, something that might only be possible when the giver has experienced his own financial success.
Berkshire Hathaway holds about $10 billion in cash, which helps its company survive even the toughest financial setbacks. With the company invested heavily in the insurance industry, the Katrina hurricane and flooding resulted in an unexpected $3 billion loss. The company survived thanks in part to its cash reserves.
Taking this advice to the personal level, the attitude towards cash reserves passed from one generation to the next is a great model for managing the finances of a family or individual, not just a business. Despite the opportunity cost when you figure money held in cash could be more effective invested to earn a greater return or used for paying off debt to reduce interest expenses, holding cash where it is accessible in the event it is needed on short basis can save a family’s finances from collapsing.
An emergency fund of $15,500 could mean a big difference for a family, and a patriarch provided this security in addition to the lesson about management is a great example for the financial discussions families should be having today.
Hat tip to @ramit for pointing out the letter.