Warren Buffett Reveals The Biggest Mistake We Make When it Comes to Money

January was probably a month best left in history, with the S&P/ASX 200 index dropping 3%.  It certainly marked an inauspicious start to the year.  But February has ALREADY more than made up for it, with the ASX jumping 3.7% last week alone, its BEST WEEK in two years.  Year-to-date the index is up for 2014, albeit just 0.1%. All those daily ups and downs, the euphoria and heartache, have so far amounted to close to virtually zero.

2014 is following a familiar tune to last year… the big four banks, Telstra Corporation (ASX: TLS) and the two big miners Rio Tinto (ASX: RIO) and BHP Billiton (ASX: BHP) are all in positive territory.  Considering they make up a disproportionately large percentage of the index, where these big blue chips go, so too does the index.  But unlike 2013, share prices this year are being driven higher by positive earnings reports.  That’s a major positive, and bodes very well for the rest of 2014.

As a reminder, Bell Potter’s Charlie Aitken has previously set a target of ASX 6,000 — choo choo.

I want dividends

This year’s gains may come from an unlikely source.  You see, resource and energy companies have finally realised many SMSF investors want dividends more than they care about capital growth.  SMSF investors hold around a third (and growing) of the $1.5 trillion stockmarket, making them increasingly important shareholders.  Traditionally, resource companies have paid out very little in the way of dividends, but that appears to be changing.

Resource stocks: The new dividend plays

Last year Woodside Petroleum (ASX: WPL), Australia’s largest independent oil and gas company, adopted a policy of paying out 80% of underlying profit as dividends.  This year, a tax benefit of more than US$200 million is expected to flow straight into the dividend calculation.

Not to be outdone, Rio Tinto lifted its dividend by 15% on Thursday, and Citi analyst Clarke Wilkins expects another 15% hike in the dividend in 2014.  Even gold miners are getting in on the act, with Northern Star Resources (ASX: NST) and Kingsgate Consolidated (ASX: KCN) paying dividends.

For those investors that think big, juicy, fully franked dividends are the sole province of a select few blue chip stocks, you might want to cast your eye further afield. Buying stocks just for the sake of their dividend yield is a mistake you want to avoid.

Qantas Airways (ASX: QAN) was a dividend-paying stock in 2007. Back then, its shares were flying high at $6.  Today, the dividends are long gone, Qantas is begging for a government bailout, and its shares are languishing at $1.20.

Speaking of mistakes, Warren Buffett, the world’s greatest investor, has accumulated a wealth of $59 billion largely through his stock market investing skills.  Even still, Buffett has made his fair share of investing blunders. But luckily for us, as Motley Fool colleague Patrick Morris says, he never tires of helping us mere mortals avoid some of the mistakes he’s made.

Over to Patrick…

Warren Buffett Reveals The Biggest Mistake We Make When it Comes to Money 

by Patrick Morris

According to Warren Buffett, there are two simple and costly mistakes most of us make when managing our personal finances.  The Chairman of Berkshire Hathaway is the third richest man on the planet, and knows a thing or two about success when it comes to money and investing.

Source: Coca-Cola

When he first took over Berkshire Hathaway in 1964, the book value of the company stood at $19. At the end of last year it was $114,214 – a growth rate of 19.7% every year for 48 years! Similarly, $19 placed in the S&P 500 would’ve only grown to around $1,400 over that same time period.  He is a man whose wisdom should be trusted. And while he is full of investment advice, he also doesn’t stray to give insight when it comes to personal finances as well.

You can’t get rich quick
Buffett recently teamed up with Quicken Loans to offer someone the chance to win $1 billion for a perfect NCAA bracket.  When he went on the Dan Patrick Show to discuss the bracket-challenge, Dan asked him a simple question, “What’s the biggest mistake we make when it comes to money?”  Buffett had a direct, but vitally important response:

“Well, I think the biggest mistake is not learning the habits of saving properly early. Because saving is a habit. And then, trying to get rich quick. It’s pretty easy to get well-to-do slowly. But it’s not easy to get rich quick.”

So often when money and investing is considered, it’s easy to fall into the trap of thinking that saving can wait until a later date, and that the best investments are the ones that no one knows about. However, those thoughts are undeniably mistaken.

A powerful example

Consider a scenario of two people, each 25 years old.  David makes $40,000 a year and Michael makes $80,000 a year.  Each year, they get a 2.5% raise and work until they are 73. Let’s say the only difference is David starts saving 10% of his income when he’s 25, but Michael decides to wait until he’s 40, while he’s making $115,000 a year.

Let’s also err on the conservative side of things and say that money grows at an annual rate of 7% each year, which is actually less than the average historical annual return of the S&P 500.  By the time each is 50, they would’ve each taken a little more than $144,000 out of their pay cheques and put it toward retirement. But when they retire at 73, do you know who would end up with more money? Despite earning half as much money over the course of his lifetime, David would end up with roughly 10% more than Michael. David would have $2.3 million in savings when they retired, and Michael would have $2.1 million:

What is even more remarkable than David ending up with more money despite earning half as much in salary, is that ultimately Michael saved 60% more money than David (roughly $610,000 in savings for Michael versus $375,000 for David).  If you decide to get ambitious and say the money grows at 8.5% a year, David actually ends up with almost 30% more than Michael, with $3.7 million in savings versus $2.9 million.

What we can learn
All too often in investing people are taught, “in order to make money, you must have money,” and the stock market is only useful if you find the next big company where your money is doubled in a matter of days.  Yet as Buffett expounds, and the example above shows, the true key to becoming rich is patient saving, starting today and an understanding that wealth accumulation happens over the course of a lifetime.

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Mike King holds positions in Telstra Corporation and Woolworths.

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