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Tuesday, June 29, 2010

Utilize Berkshire Hathaway Wealth Model in Your Own Life

One of the least understood secrets behind the success of Berkshire Hathaway and its rise from an $8 stock in the 1960’s to more than $118,000 per share today, is that Warren Buffett focuses on two value “buckets” as he put it in a recent shareholder letter. The first bucket consists of the operating businesses in which the company holds a controlling stake and the second of marketable securities such as stocks, bonds, mutual funds, most of which are held through the insurance subsidiaries. such as GEICO, General Re, or National Indemnity, just to name a few.

This arrangement provides several major advantages to Berkshire Hathaway. First, when stocks collapse, Buffett is able to rely on the cash generated by the operating businesses to provide him with funds to redeploy into the market, buying up assets on the cheap. If he were running a mutual fund, this would not be the case and as the value of his holdings fell, Warren would be forced to sell something that was already undervalued to buy something that was even more undervalued. Second, the operating businesses are insulated from daily valuations (except to the extent that the parent holding company is publicly traded), giving it a much more stable net worth and estimated private market value than a mutual fund would have. Thus, banks are more likely to loan on a long-term, fixed-rate basis to a stable business with real assets such as factories, retail stores, computers, and such than they would be on a portfolio of stocks representing shares of those same companies.

In your own life, you are likely to find that it is considerably easier to raise your net worth quickly when focusing on both of these, taking the same “double barrel” approach Buffett and his long-time business partner, Munger, have made a cornerstone of their empire.

For most people, their primary “operating business” would be their day job. Whether you are a teacher, firefighter, accountant, or part-time supervisor, it is this stream of funds that allows you to pay your bills, watch television, buy groceries, and put fuel in your car. It is also this income that provides you with your first real capital to acquire investments.

Just like any good business, you want to grow your profits, or in this case salary, wages, and other income from the job, as much as possible with the smallest investment. Thus, if your choices are working more hours to make more money or going back to school to become a doctor, you might opt for the latter due to the much higher earnings down the road by putting in a comparable amount of double and triple-shifts. This leads to a golden rule of wealth building: You must invest in yourself if you want to experience true financial freedom. This means gaining new skills and turning those skills into monetary gain.

The reality is that those with specialized skills such as heart surgeons, auto mechanic engineers, dentists, software professionals are not being left out of the global economy. Virtually all of us have the potential to add some of these unique skill sets to our vocational toolbox, but the notion that you are going to be able to graduate from high school with nothing more than a diploma, get a job for life, and retire well is na├»ve. The genie is out of the bottle in the world of globalization and nothing could reverse that (even if the U.S. were to enact massive trade protections, U.S. would experience horrific recession or depression and China and India would eclipse U.S. at an even faster pace).

This article is part of our How to Get Rich guide for new investors. For more information on how to take control of your finances, generate passive income, control your debt, and become financially independent, you can read various articles published in Saral Gyan - Investors guide providing insight to equity market