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Debt advice from the "Oracle of Omaha"

For the first Friday of each month, we invite a guest blogger to write our Personal Finance Friday feature. Today's guest writer is famed investor Warren Buffett!

Uh, perhaps we should explain that a bit more accurately. Once a year, Buffett — known as the "Oracle of Omaha" — issues a letter to the shareholders of his investment company, Nebraska-based Berkshire Hathaway. (For a list of the companies Berkshire Hathaway owns in whole or in part, go here.)

Buffet's latest letter (PDF) came out last weekend, and we thought we'd pass on a few of his comments about an important area of personal (and business) finance: debt.

So, here is our March 2011 SMI guest blogger (sort of) Warren Buffet!

Unquestionably, some people have become very rich through the use of borrowed money. However, that's also been a way to get very poor. When leverage works, it magnifies your gains. Your spouse thinks you're clever, and your neighbors get envious.

But leverage is addictive. Once having profited from its wonders, very few people retreat to more conservative practices. And as we all learned in third grade — and some relearned in 2008 — any series of positive numbers, however impressive the numbers may be, evaporates when multiplied by a single zero. History tells us that leverage all too often produces zeroes, even when it is employed by very smart people.

Leverage, of course, can be lethal to businesses as well. Companies with large debts often assume that these obligations can be refinanced as they mature. That assumption is usually valid. Occasionally, though, either because of company-specific problems or a worldwide shortage of credit, maturities must actually be met by payment. For that, only cash will do the job.

Borrowers then learn that credit is like oxygen. When either is abundant, its presence goes unnoticed. When either is missing, that's all that is noticed. Even a short absence of credit can bring a company to its knees. In September 2008, in fact, its overnight disappearance in many sectors of the economy came dangerously close to bringing our entire country to its knees....

My grandfather's name was Ernest, and perhaps no man was more aptly named. No one worked for Ernest, even as a stock boy, without being shaped by the experience.

[Below] you can read a letter sent in 1939 by Ernest to his youngest son, my Uncle Fred. Similar letters went to his other four children.... Ernest never went to business school — he never in fact finished high school — but he understood the importance of liquidity as a condition for assured survival.

Over a period of a good many years I have known a great many people who at some time or other suffered in various ways simply because they did not have ready cash....

[E]veryone should have a reserve. I hope it never happens to you, but the chances are that some day you will need money and need it badly, and with this thought in view, I started a fund by placing $200.00 in an envelope, with your name on it, when you were married. Each year I added something to it, until there is now $1000.00 in the fund....

It is my wish that you place this envelope in your safety deposit box, and keep it for the purpose it was created for. Should the time come when you need part, I would suggest that you use as little as possible, and replace it as soon as possible.

You might feel that this should be invested and bring you an income. Forget it — the mental satisfaction of having $1000.00 laid away where you can put your hands on it, is worth more than what interest it might bring....

If in after years you feel this has been a good idea, you might repeat it with you own children.

That's our Personal Finance Friday post for this week. Have a great weekend!

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