Unconventional wisdom: Lessons from Buffett’s biggest mistake
The history of Berkshire Hathaway as Warren Buffett steps down as CEO.
Conventional wisdom is a byproduct of groupthink that presents solutions good enough for the average person while simultaneously not being right for any individual. You follow it at your peril. Each Monday I will challenge the investing norms that just may be holding you back from living the life you want.
Unconventional wisdom: Lessons from Buffett’s biggest mistake
“Time is the nurse and breeder of all good”
― William Shakespeare
There have been many well-deserved tributes to Warren Buffett as he stepped down as CEO of Berkshire Hathaway after 60 years. Most of those tributes list examples of his investing acumen during Buffett’s celebrated Berkshire Hathaway reign.
Buffett’s career provides many valuable lessons. But it is also worth exploring the origins of the Berkshire story and the lessons from Buffett’s self-declared ‘biggest mistake’ in your own efforts to build wealth.
Warren Buffett found himself at a crossroads in 1967. He was struggling to navigate a market that just didn’t seem to fit the deep value investment philosophy he learned from Ben Graham.
He also just did something very un-Buffett like. The CEO of a failing textile manufacturer tried to change the agreed upon buy-out price for Buffett’s shares by 12 and a half cents. In a fit of rage Buffett bought the whole company and fired the management team.
In 1967 that company – Berkshire Hathaway – bought two relatively small insurance companies in Omaha named the National Indemnity Company and National Fire & Marine.
When Buffett finally gave up on trying to figure out the market and ended the Buffett partnership this was what he was left with – a struggling textile company and two small insurance companies. It was from this relatively humble base that Buffett built an empire.
Buffett’s no-moat businesses
When Buffett originally invested in Berkshire Hathaway he was practicing something called cigar butt investing. The idea was to buy companies with one puff left.
The idea was to exploit these companies for a short-term profit. They were not intended as long-term investments. That is what Buffett was attempting with his investment in Berkshire Hathaway.
The company was selling off textile mills and buying back shares with the proceeds. Buffett was looking for a quick profit by tendering his shares to the company. Now thanks to his temper Buffett owned the whole thing.
For a man who would later popularise moats Buffett found himself the owner of companies that lacked any competitive advantages. The textiles and insurance industries are price takers. They are at the mercy of market forces beyond the control of management.
This is not a great position to be. Ideally an investor wants to own companies that are price makers with the power to set prices. Price makers have options. Price takers can only hope to control costs because when prices are low high-cost producers go bankrupt. The only way to gain any competitive advantage as a price taker is to build scale and become a low-cost producer.
Despite this high-level similarity the insurance business and the textile business are fundamentally different. The textile business requires periodic large capital expenditures to update equipment to keep up with low-cost foreign competition. The insurance business came with float.
After you pay for an insurance policy the money is invested until claims are filled. In some cases, those claims don’t occur until years down the line. If you manage to earn a high return on the float an insurance company can become a very profitable.
The distinction between Berkshire’s two ‘commodity’ businesses contains an important lesson for investors. All assets are not the same.
An asset is anything, tangible or intangible, that has economic value to its owner. This high-level definition covers different types of assets. Some require constant effort and expense to maintain value and some don’t.
The textile business was an anchor holding Buffett back because of the constant need for capital that couldn’t be invested elsewhere. The insurance business was a source of capital. Eventually Buffett gave up on the textile business and shut it down in 1985. In a 2010 interview he told a journalist buying Berkshire was a $200 billion mistake.
Three lessons from Buffett’s biggest mistake
Lesson one: Build your own float
Sub-scale insurance companies like the ones Buffett purchased don’t have a moat. Yet the ultimate moat for Berkshire was Buffett himself. Buying those insurance companies gave a pool of capital to the world’s best allocator of capital. That is a winning combination.
When Buffett purchased National Indemnity the float was $19.4 million. In 2023 National Indemnity’s float was $169 billion. Over time Buffett’s ability to earn high returns slowly accrued to Berkshire Hathaway’s shareholders as the float grew at a rate that exceeded the reserves needed to pay off insurance policies.
Buffett used the insurance money to put together a collection of publicly traded and private companies that feed money back to him for deployment elsewhere. This source of cash gave Buffett options and gave him freedom to invest the way he wanted. It also allowed Buffett to hold cash with gave him flexibility to invest when opportunities arose and protection from risk.
Think about setting up a similar model for your own life. If you want financial freedom and options in life you need to build your own float. As your pool of money grows you incrementally gain independence.
Most people never gain financial independence. If you want better outcomes than the average person you need to do things differently. People are terrible at building wealth because they don’t have a plan, save too little and sabotage their investment results.
Put a plan together, save as much as possible when you are young and stay patient. If you get that right you can gain financial freedom even if you can’t match Buffett’s returns.
Lesson two: It is all about cash in and cash out
Most people start out with a single stream of income from a salary. Like any set of future payments that salary has a value and there are many parties willing to lend against it. There are mortgages, car loans, credit cards and buy now / pay later providers.
You can finance almost anything and people are too willing to jump at the opportunity and convert their salaries into a stream of future obligations.
It is these large fixed obligations which prevent people from gaining financial independence and not the small discretionary items like buying a cup of coffee that are so often the focus of financial resolutions.
Concentrate on the simple measure of cash in and cash out. Use your salary to buy assets that increase your cash flow instead of funding future liabilities.
Buffett’s biggest mistake was buying an asset that didn’t provide cash flows and many people make the same mistake by taking on too much debt that swallows up their salary.
For Buffett it was the opportunity cost of the financial efforts to keep the textile business going that made it a $200 billion mistake.
Focus on allocating the capital that you have access to wisely. Mistake aside that is how Buffett built Berkshire and that is how you can build a better life.
Lesson three: Consider your financial anchors and enablers
The message we receive from Australian society is that the purpose of owning residential real estate is to grow your wealth. This includes both your own home and rental properties.
Our tax system encourages this through negative gearing and the lack of capital gains taxes on primary residences. Our lackluster efforts to make housing more affordable are designed to stimulate demand and raise prices through schemes for low down payments and re-directing super.
These incentives and the lack of any effort to control housing price growth has changed behaviour. Things have become common that make little sense unless housing prices continue their astounding climb. There is widespread belief that owning a home will make you rich and people are reacting accordingly.
There is rent-vesting where people live at home or in a rental unit and buy property in a cheaper location.
It is common for people to pay a percent of their income for a mortgage beyond what anyone but a self-interested bank would consider wise.
There are 5% downpayments which greatly reduce one of the benefits of owning your home as little principle is paid-off.
There are self-managed super funds invested in a single cash flow negative asset with high upfront fees and zero liquidity.
The lesson is not to avoid buying assets like houses and cars. The lesson is to be thoughtful about how you can use your finances to make your life better.
On paper many Australians are wealth because of rising housing prices but many don’t use that wealth to improve their lives.
It is worth considering the balance of the assets that you own that are liquid and provide cash flow and those that are cash flow negative and require costly upkeep.
Think about what assets are like the anchor of the textile business and which are enablers like the insurance business. Don’t be afraid to challenge the conventional wisdom around housing that has taken root in Australia.
Final thoughts
All three of these lessons are related and focus on being more intentional about how your financial assets support your life.
Buffett had a plan from a young age about the type of life he wanted. If one of your goals for 2026 is to get your finances in order spend some time figuring out what type of life you want. Without knowing that you can’t come up with an investment strategy that works for you.
Please share your thoughts by emailing me at [email protected].
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What I’ve been eating
After touring Bhaktapur Darbar Square about 30 minutes outside of Kathmandu I walked over to the Basuki Ghar where Tusa restaurant is located. After days of eating momos and street food I was ready for something different.
Tusa is the type of restaurant you want to succeed. Started by three internationally trained Nepalese chefs the vision is to highlight the varied culinary traditions of Nepal. Pictured is the water buffalo meatballs with potatoes and white beans in a water buffalo broth. I’m not quite ready to throw water buffalo on the barbie at home but the dish was quite tasty. Part of a 6-course tasting menu the preparation highlights Newari cuisine which is the ethnic group that resides in the Kathmandu valley. Tusa is a bit of a pain to get to but well worth the effort.
