Improve Your Finances With This Warren Buffett Wisdom

If only there were a caped hero who would leap out of a telephone booth to save our financial lives. These days, we don't even have many telephone booths around, not to mention financial heroes. There is Warren Buffett, though, and he has long offered excellent advice that can benefit us all.

The chairman of Berkshire Hathaway offers his annual letter to shareholders -- the latest of which, for 2017, was just released -- and also gives countless interviews, pens occasional articles, and answers questions for hours at his annual meetings. Here are some of the valuable things he has said (or done) that are instructive for our personal finances.

Image source: The Motley Fool.

Save first

Most of us know we need to save money and not spend every dollar in our paycheck. But many people will spend first and then save whatever is left over. That's not the most effective approach. Indeed, Buffett has advised: "Don't save what is left after spending; spend what is left after saving."

Take some time to figure out how much income you'll need in retirement, which will give you an idea of how much you need to save. In recent years, the average contribution rate to Vanguard- and Fidelity-managed 401(k) accounts was, respectively, 6.2% and 8.4% of pay. Add in employer matches and the totals exceed 10%. That's still not going to be enough for many people, though, especially if they started saving late. You might want to aim to sock away 15% or more of your income.

Start early

Buffett has been at the top of the list of the richest people in the world for many years, and unlike many people who started out wealthy, he built his wealth all on his own. He started early, too, buying his first share of stock at age 11. That's a good reminder that we'd do well to start early, too, especially when saving for retirement. It's easy to put off thinking about retirement when we're in our 20s and even our 30s, but money we sock away then could grow for us for 30 or 40 years, which can be extremely powerful. Check out how a single $10,000 investment would grow over time:

Data source: author.

Here's how much you might accumulate over various periods if you sock money away each year:

Data source: author.

Image source: Getty Images.

Don't ignore inflation

Buffett has said, "The arithmetic makes it plain that inflation is a far more devastating tax than anything that has been enacted by our legislature." He explained that while an income tax taxes earnings, inflation is applied to everything. So while you might earn 5% interest on a bank account in some years, if inflation is 5%, it will wipe out that gain entirely.

Over long periods, inflation has averaged about 3% per year, but in any given year or period, it can be much higher or lower than that. In 2015, for example, it averaged close to 0%, while it was 6% in 1982, 9% in 1975, and more than 13% in 1980. Even at 3%, it can really shrink the purchasing power of your future dollars, as something that costs $100 now may cost about $181 in 20 years.

Imagine that you're aiming to amass $875,000 by the time you retire in 20 years, figuring that that sum will be enough to support you. Well, if inflation averages 3%, that $875,000 will end up having the purchasing power of just $484,000 in today's dollars. You'd need to amass about $1.6 million by retirement in order to end up with the purchasing power of $875,000 today. Keep inflation in mind when planning for retirement -- and perhaps ratchet up your savings goal and your annual contributions. (Know, too, that there are a bunch of ways to increase your retirement income.)

Beware of steep fees

Another danger to your financial health is outlandish fees. Buffett noted this point in his 2016 letter to shareholders:

When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsize profits, not the clients. Both large and small investors should stick with low-cost index funds. ... My regular recommendation has been a low-cost S&P 500 index fund.

Consider, for example, that a typical managed stock mutual fund might have an expense ratio (that is, an annual fee) of, say, 1.1%, while you can be invested in an index fund that tracks the S&P 500 for 0.1% -- or less. Here's how annual investments of $10,000 would grow, if they averaged returns of 10% annually, with those two fees subtracted:

Data source: author.

Note, too, that not only do low-cost index funds charge much less in fees -- they also tend to outperform the vast majority of managed stock funds over long periods. So there's really a good case to be made for just sticking with index funds.

Fees also matter in many other facets of your financial life. Banks charge fees, credit cards charge fees, mortgages charge fees... be sure to always be aware of how much you're being charged and of what your alternatives are.

Spend a little more time learning about and from Warren Buffett, and your portfolio and wallet might thank you.