We customarily keep at least $20 billion on hand so that we can both withstand unprecedented insurance losses ... and quickly seize acquisition or investment opportunities, even during times of financial turmoil.
Warren Buffett has shown us much through the nearly 50 letters he's written to Berkshire Hathaway (NYSE: BRK-A)(NYSE: BRK-B) shareholders through the years. But it turns out one thing we quickly forget are the remarks above he wrote in 2010, which show us how strongly he clings to the power of cash.
Times of prospering
Much has been made of the "elephant gun" analogy Buffett has used to describe the acquisitions Berkshire Hathaway may make. In 2010 he said of the future success of Berkshire Hathaway:
We will need both good performance from our current businesses and more major acquisitions. We're prepared. Our elephant gun has been reloaded, and my trigger finger is itchy.
Even after Berkshire bought a 50% stake in Heinz for $12.1 billion in 2013, Buffett noted he and Charlie Munger still "search for elephants" as they seek businesses which will cost them between $5 and $20 billion. And when you consider Berkshire had more than $48 billion in cash on hand at the end of the year, he may be on the lookout for more than one elephant.
And Buffett doesn't only use his cash when times are good --the S&P 500 was up 33% in 2013 -- but also when times are troubling as well.
In the 25 days after Lehman Brothers collapsed in 2008 Buffett made $15.6 billion in investments.
Later, after the stock of Bank of America (BAC 0.07%) fell nearly 40% during the first 23 days of the month, Buffett poured more than $5 billion into in August 2011. To say nothing of the dividends which have been collected, Buffett's return has already doubled.
With that in mind, it's no wonder Buffett said this year:
Indeed, tumbling markets can be helpful to the true investor if he has cash available when prices get far out of line with values. A climate of fear is your friend when investing; a euphoric world is your enemy.
But the thing to know about the cash Buffett insists on holding is the reality he doesn't only use it prosper Berkshire Hathaway, but he knows cash can be used to prosper and protect Berkshire Hathaway.
Times of protection
The critical word to see in Buffett's quote surrounding the $20 billion in cash is "both," as that cash is used for two critical things. It isn't intended to just allow Berkshire to "quickly seize acquisition or investment opportunities," but also to protect it from "unprecedented insurance losses."
While we may not face the prospect of "insurance losses" like Berkshire does -- it paid $3 billion as a result of the disastrous Hurricane Katrina -- in our lives we too will face moments and seasons in which unexpected major costs arise.
Source: Flickr / Luz Bratcher.
We can take steps to ensure we live in ways that are safe and the likelihood of incredible fiscal losses are minimized, but as Buffett's grandfather said, there are "a great many people who at some time or another have suffered in various ways simply because they did not have ready cash."
This is why emergency savings -- three to six months' of living expenses -- is so critical if something simply happens. Whether it be an annoyance like a heater breaking, a distressing job loss, or a devastating health tragedy, Buffett provides an important example of someone who forsakes potential benefits to make sure safety is guaranteed.
With any major financial decision, consider the costs and benefits. And while the cost of missing out on possible gains from unmade investments is real, the benefits of rainy day savings are so much greater.
And maybe if we're lucky, we'll have enough cash to be like Buffett, who has been able to protect and prosper, when times are both good and bad.
