Warren Buffett - “Life and debt”: What you need to know about using leverage

Key takeaways at the end

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The fundamental principle of auto racing is that to finish first, you must first finish.

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. [...]

[...] 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. [...]

By being so cautious in respect to leverage, we penalize our returns by a minor amount. Having loads of liquidity, though, lets us sleep well. Moreover, during the episodes of financial chaos that occasionally erupt in our economy, we will be equipped both financially and emotionally to play offense while others scramble for survival. That’s what allowed us to invest $15.6 billion in 25 days of panic following the Lehman bankruptcy in 2008.

2010 Shareholder Letter

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Our consistently-conservative financial policies may appear to have been a mistake, but in my view were not. [...] Even in 1965, perhaps we could have judged there to be a 99% probability that higher leverage would lead to nothing but good. Correspondingly, we might have seen only a 1% chance that some shock factor, external or internal, would cause a conventional debt ratio to produce a result falling somewhere between temporary anguish and default.

We wouldn't have liked those 99:1 odds – and never will. A small chance of distress or disgrace cannot, in our view, be offset by a large chance of extra returns. If your actions are sensible, you are certain to get good results; in most such cases, leverage just moves things along faster. Charlie and I have never been in a big hurry [...]

1989 Shareholder Letter

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There is no such thing as a 100% sure thing when investing. Thus, the use of leverage is dangerous. A string of wonderful numbers times zero will always equal zero. Don’t count on getting rich twice.

2022 Shareholder Letter

* Bold emphasis added

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Key concepts and takeaways:

• High impact events are certain to happen: You might remember we talked here about black swan events, those rare events that one cannot predict but have large impact on financial markets and the economy. These events are, however, certain to occur over longer periods of time, in similar way probability works when you play lottery. If you use leverage, any string of great returns when multiplied by zero will always equal zero. This is the reason why some investors fail long-term investing. 

• Liquidity over leverage: Some of the best investment opportunities arise during black swan events. Having liquidity rather than using leverage, will help you take advantage of those price fluctuations. However, do not mistaken this advice with timing the market.

• Compounding over acceleration: The compounding effect when buying great businesses works over the long-term much better than the “acceleration” of returns in the short- or near-term using leverage.