There’s a saying, you can save your way out of an investing mistake but you can’t invest your way out of a savings mistake.
Meaning, a good budget is the engine that keeps a financial plan chugging along.
Without one, you’re not going anywhere.
This is something Warren Buffett knew well from a young age.
People always look at his amazing investing track record in awe — after all, who else can say they’ve returned more than 1 million percent?
But that’s only part of the success story. And Buffett started much earlier than his Berkshire Hathway track record would suggest.
When he was younger, Buffett spent less than he earned (budgeting) and became a millionaire in his 20’s by investing the difference.
But a few small businesses wasn’t enough for Buffett. Once he had his spending and financial goals in place he knew he was ready for an even bigger budget. And a bigger source of income.
Insurance: The Ultimate Budget
If you know you’re a good saver and
you can invest well, the next thing you need to do is find more money.
And what business produces a steady flow of income, like a salary?
An insurance business.
At its core an insurance business works as follows:
- It receives premiums upfront, and
- Pays out some of the money from the premiums in the future
Money comes in then some of the money goes out.
Key your eye on an insurer’s ‘combined ratio’, it tells you whether or not an insurer made an insurance profit.
Few insurers can get the balance between premiums and payouts right.
But if they can it’s like a personal budget on steroids.
The insurer collects people’s money upfront, which means they don’t have to outlay cash for working capital. It’s just like a person’s salary.
Then come the expenses and payments for covering some risks.
If the income is less than the outgoings it’s a saving for the insurer.
Investing Prowess
The ‘insurance’ of risks is just one side of the coin, the other side of an insurer is the investing component. Buffett does this exceptionally well.
You see, most money inside an insurance business is tied up in cash, bonds and other investments that can be quickly sold to pay claims under insurance policies.
But there’s usually a tiny slither of investments, maybe a couple percent of the entire portfolio, that can be used to make long-term investments.
This is similar to a household budget which might spit out savings of 5% or 20% of the income for long-term financial goals.
In the beginning, these are often very small amounts, even for an insurer.
Tom Gayner
, who runs the investing at a Berkshire-like insurance company called Markel Corporation (NYSE: MKL), was investing a few million dollars for the insurance business just 30 years ago.
But with growing yearly profits/savings from the insurance side of Markel, plus some above-market investing returns from Gayner, he now has over $20 billion at his disposal.
The moral of the story is simple: having a consistent and sustainable budget with some sensible investments over long periods of time has been proven to be a great way to grow wealth.
You don’t need to have 100 investment properties, trade cryptocurrencies or a six-figure salary.
Just let some consistent savings grow over many years thanks to the magic of compound interest.
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P.S. Buffett’s Berkshire Hathaway is hosting its annual shareholder meeting this weekend — you can watch the live stream on Yahoo! Finance.
