For example, he famously said, “You only learn who has been swimming naked when the tide goes out.” Now, this was in 2004 and the subject was the instability of the derivatives market. At that time, the derivatives tide was at an all time ebb, leaving some previously-covered institutions showing their ugly bits. Now Warren’s saucy sentiment is often repeated as an object lesson for the financial world.
Good Night, Munger
As it happens, one of Buffett’s most common themes is not ennobled in a fancy quote. But it come up in a surprising number of shareholder letters, and it stands for one of his highest standards.
The theme is sleep. To Buffett, sleep is something that you enjoy if you’ve made prudent decisions in business. You’ve especially earned a peaceful rest if the current fashion in business is not particularly prudent. There is always a kind of “be an adult–defer rewards until earned” theme to his thinking. The reward for that mindset is found in improved rest.
There are three conditions that Buffett suggests will hurt his–and by extension, your, sleep patterns:
1. Leverage or borrowing. Berkshire avoids borrowing in general, and almost never uses debt to buy company or as a structural part of the capital structure. In part, this is because he has insurance float that provide the cash needs on an ongoing basis. (Let us pause while I write a little note to myself: You shoulda gone into the insurance business.) But, even if he were not in insurance, one senses that borrowing would be something that would disrupt his nightly seven hours of rest. So, this is what he says about doing deals in the current environment, quoting from the 2017 Annual Report:
“Our aversion to leverage has dampened our returns over the years. But Charlie and I sleep well. Both of us believe it is insane to risk what you have and need in order to obtain what you don’t need.”
2. Insufficient Cash reserves. Cash on hand is another important measure of financial strength. So, when the financial markets were again in turmoil in 2008, Buffett suggested that having adequate cash reserves was one of his highest duties: “We never want to count on the kindness of strangers in order to meet tomorrow’s obligations. When forced to choose, I will not trade even a night’s sleep for the chance of extra profits.” This is classic. Simply, more risk reduces sleep.
3. Prudent investing. In 2009, interest rates had declined in the US as a consequence of aggressive action on the part of the federal reserve to reduce borrowing costs. Of course, a reduction in cost for the borrower also means a reduction of income for the lender. And, in the insurance world, you need to invest cash in short term securities to both earn a return and to have a quick way of paying claims if called upon.
Apparently, there was some call in the investing world to take on riskier short term assets in order to juice the income from cash on hand. In the shareholder letter, Buffett responded to those investors:
“The $20 billion-plus of cash- equivalent assets that we customarily hold is earning a pittance at present. But we sleep well.”
Good night, Warren
Read in the context of business, it is clear that Buffett likes to reduce risk, and his personal risk meter is his sleep pattern. If he’s losing sleep, he’s doing something wrong.
I think this is relevant to everybody. I have had countless conversations with managers who complain of sleeplessness. If you are in business, and you are losing sleep, if might be a good idea to ask, what would Warren do?
I think the likely answer is to consider all the risks to your business–whether structural or transitory. Then identify three ways of reducing those risks. The test of your thinking process will be found in the quality of your rest.