How to Apply Warren Buffett’s “Financial Forest” Concept to Your Personal Finances
Evaluate the Forest, not each Tree
Warren Buffett has a way of communicating financial principles in ways that hit home, and this year’s annual letter to shareholders is no exception. He’s managed Berkshire Hathaway since 1965, growing the company into a $500 billion conglomerate that owns and operates 66 different businesses generating $225 billion in sales.
You’d think that analyzing such a financial behemoth would be a daunting task, but Buffett easily changes this perspective in this year’s letter:
“Investors who evaluate Berkshire sometimes obsess on the details of our many and diverse businesses – our economic “trees,” so to speak. Analysis of that type can be mind-numbing, given that we own a vast array of specimens, ranging from twigs to redwoods. A few of our trees are diseased and unlikely to be around a decade from now. Many others, though, are destined to grow in size and beauty.
Fortunately, it’s not necessary to evaluate each tree individually to make a rough estimate of Berkshire’s intrinsic business value. That’s because our forest contains five “groves” of major importance, each of which can be appraised, with reasonable accuracy, in its entirety.”
Net Worth Groves
Investors might also fear the work and analysis required to assess their own net worth. Too often, such an exercise stops at the portfolio and leaves other important issues unaddressed. But if we think of our net worth in “groves”, the path to analyzing and assessing your finances becomes much more achievable, no?
One’s net worth can be divided up into the following groves:
- Balance sheet – assets (house, portfolio, etc.) less liabilities (mortgage, student loans, etc.)
- Cash flow – inflows & outflows, their variability, degree of control, correlations, etc.
- Investments – a balance sheet component broken out since its where your life’s work is typically accumulated
- Risk management – insurance policies (life, property & casualty), self-insurance, etc.
- Estate planning – after you pass, how your assets pass (spouse, children, charity, Uncle Sam)
- Legacy planning – probably the most important yet least assessed “grove” of one’s net worth
Explore your Financial Forest
If you haven’t explored your finances in depth lately, don’t panic. As Buffett said, look at the groves within your forest. Interested in learning more? Let’s talk.