“Do not save what is left after spending, but spend what is left after saving.”
The Sage of Saving
Warren Buffet is one of the world’s richest men, and is seen as one of the greatest long-term investors of our time. But a key secret to his ability to amass great wealth gets much less attention than his savvy purchases of businesses and assets through Berkshire Hathaway.
Many investors and business owners have earned great fortunes, but have spent them almost as quickly. Buffet is famous for frugality, understanding that saving more is the first step to enjoying the fruits of compound interest. To him, each dollar is a seed that he can plant, knowing it will multiply into many more dollars over time.
Warren Buffet’s reputation for thriftiness is legendary. A man with simple tastes and a simple lifestyle, he has always lived easily beneath his means. Buffet resides in the same middle-class home he bought decades ago for $31k and draws a modest $100k salary.
According to a 2012 article in Forbes.com, Buffet turned a dresser drawer into a bassinet when his first child was born. When the second child came along, he borrowed a crib. While signing up clients to invest six-figure sums with him during the 1960s at a hotel in New York, he reportedly phoned a friend from the Plaza Hotel to bring over a six-pack of Pepsi so he wouldn’t have to pay for room service.
Buffet drove a Volkswagen until his wife decided it was bad for his image and upgraded him to a Cadillac. He doesn’t typically use cell phones or send emails, shunning much of the technology the rest of us consider a “necessity.” And when he remarried his long-time companion in 2006, after his first wife’s passing, they held the 15-minute no-frills ceremony at his daughter’s home.
Warren’s desire and ability to save has allowed his business to compound more and more money, unencumbered by a spendthrift CEO who saw his success as a license to splurge. His emphasis on saving money is a cornerstone of his personal financial philosophy and also his value investing philosophy. He looks for the same emphasis on frugality in the leadership and management of the companies he acquires. Buffet doesn’t gamble on projected profits; he invests in companies with solid revenues that know how to keep costs under control.
It seems that Buffet’s only real “extravagance” is his charitable giving (aside from a company private jet that has proven to be Indispensable for business travel.) He can now afford to give with great generosity because his lifetime devotion to saving and investing have brought him an estimated net worth of approximately 60 billion dollars.
Saving: the Ultimate Financial Fundamental
In our last article, “Back to the Basics,” we discussed investing for success and the importance of financial fundamentals, looking at hedging strategies that might be producing disappointing results.
However, there IS one hedging strategy that we heartily endorse: the practice of saving to hedge your investments with cash, or cash equivalents. By “cash,” we mean highly liquid investments and securities such as bank certificates of deposit, money market funds, U.S. treasury bills, and life insurance cash value, though it is not a bad idea to have some actual greenbacks on hand, too!
You’ve no doubt heard that you should “only invest what you can afford to lose.” While we believe you should NEVER invest in anything that has a history or expectation of loss, there is wisdom in this saying as we must first save before we invest. Then we must continue to save while we invest. And to build generational wealth, we must teach our children to save.
We must build our financial foundation so that we’ll be okay even when the roof leaks, personal emergencies strike, a job vanishes, or the market crashes. (Or perhaps… we’ll save our way to great wealth and philanthropy like Warren.)
Most American investors have the majority of their investments at risk in the stock market, but is this wise? Warren Buffet has this interesting piece of advice for investors: “Unless you can watch your stock holdings decline by 50% without becoming panic-stricken, you should not be in the stock market.”
In other words, put a large portion of your money where it is safe, liquid, and immune from market crashes.
Don’t just invest money… SAVE IT.
Where Should You Save Money?
A savings account at a local credit union or even a jar or envelope is a good place to start. Once you have at least a couple of month’s expenses saved, our favorite strategy for storing and growing liquid cash is what financial author Rick Bueter calls a “Financial Bunker” – dividend-paying whole life insurance. We generally recommend policies with a paid-up addition riders to speed up the accumulation of cash in the policy.
When comparing apples to apples (savings to savings, not savings to investments), whole life has tremendous advantages over other savings vehicles:
It’s the only kind of savings strategy that is “self-completing” should something happen to you. For instance, if you are saving in a permanent life insurance policy for your child’s college expenses or to pay off the mortgage on the family home and you pass away before you reach that goal, your death benefit can cover the tuition and the mortgage.
Funds are flexible in use and liquid when needed. IRAs or 401(k)s make poor emergency funds as the money is not liquid. You’ll be taxed and penalized if you need the money before 59-1/2, and funds are subject to rules and restrictions. This is also true for other types of government-sponsored “savings” plans, you can only use the funds for designated purposes.
Life insurance policies are tax-advantaged. Cash value is shielded from taxation as long as it remains in the policy. Dividends are tax-free up to their basis, and additional money in the policy can be accessed by tax-free policy loans (which can be either repaid or eventually paid from the death benefit). Additionally, death benefits are income-tax free (though not immune from estate taxes.)
Life insurance policies are extremely efficient wealth transfer vehicles. Cash value can be gifted to account beneficiaries without income taxes, gift taxes, capital gains taxes or estate taxes as long as the cash remains within the policy. And these transfers can occur at anytime; the policyholder doesn’t have to die first! Compare that to the problem of leaving an heir a 401(k), which requires the heir to pay income taxes in order to access the funds.
The internal rates of return usually exceed that of other cash equivalents. Life insurance cash value has been outperforming bank rates and other liquid investments for decades. Cash value at a mutual insurance company is currently growing at a rate of about 4 – 4.5% after expenses, depending on the age of the insured, many times faster than bank rates. And should the insured pass away, heirs will receive more than the policy’s cash value and thus an even higher rate of return.
Buffet is Bullish on Life Insurance
You’ll see lively debates online (often fraught with misinformation) about whether or not life insurance is a “good investment.” (We don’t like to call it an investment as that is not technically correct – it is life insurance with a powerful savings component.)
Warren Buffet showed his confidence in life insurance as an asset when he revealed in the 2004 Berkshire Hathaway Annual Report, “Berkshire purchases life insurance policies from individuals and corporations who would otherwise surrender them for cash. As the new holder of the policies, we pay any premiums that become due and ultimately – when the original holder dies – collect the face value of the policies. The original policyholder is usually in good health when we purchase the policy. Still, the price we pay for it is always well above its cash surrender value.”
What Warren is talking about is a life settlement, which we are bullish on as well. Perhaps Oracle of Omaha’s enthusiasm for permanent life insurance policies should encourage skeptics to take another look. After all, if Buffet is buying life insurance policies, they must be worth owning!
Start Saving for Life
Contact Partners for Prosperity for a no-obligation quote and an analysis of the long-term internal rate of return you might reasonably expect. We’ll need your state of residence and age in order to get you an illustration (and of course, your name and contact information!)
You will want to approach life insurance in a way to capitalize on its long-term benefits. You should have an ability to save consistently for the long-term (for a minimum of ten years) for this strategy to be effective from a cash perspective, although you may desire the permanent life insurance coverage in any case.
For more information on whole life insurance and also creative insurance strategies that can help you maximize your entire personal economy, you’ll want to read our little life insurance book, Live Your Life Insurance.