MONEY Warren Buffett

33 Amazing Numbers From Berkshire Hathaway’s Golden Anniversary Shareholder Letter

Berkshire Hathaway Chairman and CEO Warren Buffett
Nati Harnik—AP

These numbers illustrate the magnitude of Buffett's achievement -- as well as the "Berkshire system."

As a boy, Berkshire Hathaway CEO Warren Buffett was obsessed with numerical data. You get some sense of this when you go through his annual letters to Berkshire Hathaway shareholders, which are peppered with statistics. The most recent letter, which celebrates 50 years of Buffett at the helm, is rich with numbers that illustrate how uncommon this conglomerate is — and how it was built to be different.

The miracle of compounding (but not at head office!)

Value of $10,000 Invested at the Start of 1964
Berkshire Hathaway S&P 500 Index (with dividends included)*
End-of-2014 value $75,121,300 $1,129,600
Compound annual gain 21.6% 9.9%

*This is a theoretical figure for comparison’s sake — the S&P 500 index is not directly investable.

Let’s look at some numbers that tell the Berkshire story, along with some quotes from Buffett.

$18.3 billion: Berkshire Hathaway’s increase in net worth during 2014. That gain in book value is greater than the book value of more than four-fifths of the companies in the S&P 500.

9 1/2: Number of Berkshire-owned businesses that would be listed on the Fortune 500 if they were independent — the “1/2″ refers to H.J. Heinz, which Berkshire owns with 3G Capital. (“That leaves 490 1/2 fish in the sea. Our lines are out.”)

340,499: Number of Berkshire Hathaway employees (including those at Heinz).

25: Number of people who work at Berkshire Hathaway’s headquarters (includes the chief executive officer and chairman).

Berkshire’s “Powerhouse Five” businesses

$12.4 billion: Pre-tax 2014 earnings of Berkshire’s “Powerhouse Five” — its five largest non-insurance businesses (Berkshire Hathaway Energy, BNSF, Iscar, Lubrizol, and Marmon).

$1.6 billion: Increase in Berkshire’s “Powerhouse Five” pre-tax earnings.

One: Number of “Powerhouse Five” businesses owned by Berkshire a decade ago (Berkshire Hathaway Energy, then known as MidAmerican Energy, which earned $393 million at the time).

$6 billion: The amount railroad operator BNSF expects to spend on capital investments in 2015 — 26% of estimated revenues!

15%: Percentage of all inter-city freight — whether it’s transported by truck, rail, water, air, or pipeline — carried by BNSF (“the most important artery in our economy’s circulatory system”).

Insurance: “Berkshire’s core operation”

“Berkshire’s huge and growing insurance operation again operated at an underwriting profit in 2014 — that makes 12 years in a row — and increased its float. During that 12-year stretch, our float — money that doesn’t belong to us but that we can invest for Berkshire’s benefit — has grown from $41 billion to $84 billion. Meanwhile, our underwriting profit totaled $24 billion during the twelve-year period, including $2.7 billion earned in 2014. And all of this began with our 1967 purchase of National Indemnity for $8.6 million.”

1 1/2: Length of contract, in pages, sealing Berkshire’s acquisition of National Indemnity and National Fire & Marine in 1967 for $8.7 million. (See for yourself: The purchase agreement is reproduced on pages 128-129 of the annual report — the link opens a PDF file.) Not surprisingly, no lawyers or investment bankers were involved in drafting or negotiating the contract.

$111 billion: National Indemnity’s net worth today, according to generally accepted accounting principles.

$22.7 billion: Amount paid out in claims by Berkshire’s insurance operations in 2014.

$7.1 billion: Single premium on a reinsurance policy written for Lloyd’s in 2007. (Berkshire Hathaway has written every property/casualty policy with a premium in excess of $1 billion — there have been eight of them.)

Odds and ends

$40.5 million: Sales at the Omaha Furniture Mart in the week surrounding the 2014 annual meeting — that’s roughly 4.5 times average weekly sales.

$30 million: The price Berkshire Hathaway paid for See’s Candy in 1972 — 7.5 times trailing pre-tax earnings.

$1.9 billion: See’s Candy’s cumulative pre-tax earnings since its acquisition.

$40 million: Aggregate incremental investment in See’s Candy required to produce those $1.9 billion in earnings.

45%: Approximate U.S. market share of Berkshire subsidiary Clayton Homes in manufactured homes.

13%: Clayton Homes’ market share in 2003, the year Berkshire acquired it.

Investments

$15.6 billion: The amount of capital Berkshire Hathaway extended to businesses in a three-week period during the height of the financial crisis, including $3 billion to General Electric GENERAL ELECTRIC COMPANY GE 0% , $5 billion to Goldman Sachs GOLDMAN SACHS GROUP INC. GS -1.43% and $6.5 billion to Wrigley.

$42 billion: Total unrealized gains at the end of 2014 on Berkshire’s “Big Four” equity investments — American Express, Coca-Cola, IBM and Wells Fargo.

$1.6 billion: Dividends received by Berkshire on its “Big Four” stocks in 2014.

$12.5 billion: Year-end value of Berkshire’s “phantom” stake in Bank of America. (Berkshire has the option to purchase 700 million shares of Bank of America before September 2021 at a cost of $5 billion, an option it expects to exercise just before its expiration. Money has a time value, after all — no sense in making the outlay today.) Berkshire will almost certainly become Bank of America’s largest shareholder, in addition to being Wells Fargo’s largest shareholder.

And the mistakes (there have been some doozies!)

$444 million: Berkshire’s after-tax loss on its investment in UK retailer/grocer Tesco.

$5.7 billion: Current value of Berkshire Hathaway shares that Buffett paid for the acquisition of Dexter Shoe (the 1993 purchase price was $433 million).

Zero: Current value of Dexter Shoe.

$50 billion: The minimum amount by which Berkshire Hathaway’s net worth would exceed its current value “if it had seized several opportunities it was not quite smart enough to recognize as virtually sure things,” according to Vice Chairman Charlie Munger’s estimate. Those mistakes include “not purchasing Wal-Mart stock when that was sure to work out enormously well.”

$100 billion or so: The amount “diverted … from BPL partners to a collection of strangers” by Buffett’s decision to acquire National Indemnity through Berkshire Hathaway rather than via Buffett Partnership Limited directly. BPL owned a 61% stake in Berkshire Hathaway — the “collection of strangers” Buffett refers to are Berkshire Hathaway’s then-minority shareholders.

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MONEY mutual funds

The Easy Way Even Newbies Beat 86% of Professional Money Managers This Year

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Hiroshi Watanab/Getty Images

And there's an easy way to be on the winning side.

Mutual funds generally fall into one of two camps: On the one hand, there are actively managed portfolios that are run by stock pickers who attempt to beat the broad market through skill and strategy. Then there are passive funds, which are low-cost portfolios that simply mimic a market benchmark like the S&P 500 by owning all the stocks in that index.

The question for individual investor is, which one to go with.

On Thursday, yet more evidence surfaced demonstrating just how hard it is for actively-managed funds to win.

S&P Dow Jones Indices releases a report every six months which keeps track of how well actively-managed funds in various categories perform against their particular benchmark. The “U.S. S&P Indices Versus Active Funds (SPIVA) Scorecard” came out yesterday and told a familiar tale: active fund managers struggled mightily.

Last year only 14% of managers running funds that invest in large U.S. companies beat their benchmark. That means 86% of professionals who get paid to beat the market lost out to novices who simply put their money in a fund that owned all the stocks in the market.

It’s further proof that the genius you invest your money with isn’t that smart — or isn’t smart enough.

It’s not that professional stock pickers don’t have skills. The problem is, actively managed funds come with higher fees than index funds, often charging 1% or more of assets annually. And those fees come straight out of your total returns.

What this means is that even if your fund manager is talented enough to beat the market, he or she would have to consistently beat the market by at least one to two percentage points — depending on how much the fund charges.

A similar rate of futility appeared even if you extend the investing horizon to five or ten years. If you look at all U.S. stock funds, 77% of them lost out to their index.

International funds fared no differently. Only 21% of global active managers enjoyed above-index returns over ten years. Active managers also fell short in most fixed-income categories, for instance 92% underperformed in high-yield bonds.

One area where active managers have outperformed over the past one, three, five, and 10 years is in investment-grade intermediate-term bonds.

MONEY has warned investors against indexing the entire U.S. bond market because so much of such fixed-income indexes are made up of government-related debt, which happens to be very expensive right now.

So where should you put your money?

Look to MONEY’s recommended list of 50 mutual and exchange-traded funds. With a few of our “building block” funds you can cover achieve broad diversification in domestic and foreign stocks and bonds.

To be fair, our list also includes several actively managed funds, which can help you customize your portfolio by tilting toward certain factors that tend to outperform over time, such as value stocks.

Still, the bulk of your portfolio belongs in low-cost index funds.

MONEY Odd Spending

A Dozen Scary Weird Things to Know About Friday the 13th and Money

We've dug up 12 alternately creepy and amusing Friday the 13th factoids for your pleasure—including how superstitions around this number and day can affect sales of homes, flights, and, strangest of all, tattoos.

  • “Friday the 13th” movies have grossed $380 million.

    Friday the 13th Part VI Jason Lives 1986
    Mary Evans—Ronald Grant Archive/Mary Evans/ Friday the 13th Part VI Jason Lives 1986

    BoxOfficeMojo added up the ticket sales of all 12 movies in the “Friday the 13th” franchise, and the sum came to $380 million, or a whopping $770 million after adjusting for inflation. The overall highest-grossing film was 2003’s Freddy Vs. Jason ($82.6 million), but after adjusting for inflation the original Friday the 13th came out on top, with its 1980 haul of $40 million translating to $123 million today. Oh, and you might have noticed that with a dozen Jason movies, another one would seem inevitable to make it 13. Sure enough, there’s one in the works that was originally supposed to be released on March 13, 2015, but has been pushed back to next year.

  • Tattoos cost just $13 on Friday the 13th.

    devil tattoo
    Alamy

    If you are going to mark your body permanently, you’d think you’d want to pay good money to get it right. You’d perhaps also think you wouldn’t want to tempt fate by doing it on a day known for bad luck. The proliferation of $13 tattoo deals that periodically pop up on Friday the 13th in cities such as Las Vegas, Tampa, St. Louis, and Charleston fly in the face of that kind of thinking. Generally speaking, participating tattoo parlors offer a limited number of small tats for $13, and customers are expected to tip $7. Some vendors also discount all tattoos by 13% or sell T-shirts for (you guessed it) $13.

  • You can fly one way to HEL on Flight 666 for $148.

    underbelly of jet plane at night
    Eric Meola—Getty Images

    Finnair offers a daily 95-minute flight, AY666—a.k.a. Flight #666—straight to HEL. The odd coincidence was noticed a few years ago by the media, and it’s not quite as ominous as it sounds: The entirety of the flight is in Scandinavia, not the underworld, as it departs CPH (Copenhagen) bound for HEL (Helsinki). Earlier this week we searched to see how much a flight to HEL would cost on Friday the 13th. The total was 1,028 Danish Krone, or about US$148. We only looked up the one-way price, because we’re assuming there are no round trips to HEL.

  • People seem to shy away from Friday the 13th flights.

    LAX Terminal 2
    Alamy

    Some studies have indicated that Friday 13th is a relatively cheap day to fly because demand is so low, presumably due to the superstitious not wanting to travel that day. This might be a myth, or at least there should be a caveat because Fridays and Sundays are universally considered the most expensive days of the week to fly. Still, as Donald Dossey, a folklore historian and founder of the Stress Management Center and Phobia Institute in Asheville, N.C., explained in a National Geographic story, “It’s been estimated that [U.S.] $800 or $900 million is lost in business on this day because people will not fly or do business they normally would do.”

  • That Dossey guy sells a book about superstitious holidays for $15.

    Dossey Book

    Holiday Folklore, Phobias, and Fun: Mythical Origins, Scientific Treatment and Superstitious “Cures” is one of several products sold by Dossey on his Phobia Institute site. The regular price for the 1992 book is $15, though a “web price” is listed at $10 (then add $5 for shipping). Used copies of the book are also listed for $4 at Amazon (1¢ + $3.99 shipping).

  • Friday the 13th weddings can be cheap.

    dark wedding banquet hall
    JG Photography—Alamy

    Perhaps unsurprisingly, Friday the 13th tends to be a slow day for weddings compared with other Fridays. Hence the occasional 10% to 15% discount offered by venues for couples unafraid to seize the date.

  • But you’ll pay extra for a Friday the 13th theme wedding.

    Zombie Wedding at Viva Las Vegas
    Viva Las Vegas

    Viva Las Vegas Weddings has been promoting the fact that 2015 has three Friday the 13ths (in February, March, and November), and offers a variety of special creepy themes appropriate for the date—Zombie Wedding (pictured), Dracula’s Tomb, Ghoulish Gazebo, Graveyard Wedding, and so on. Friday the 13th wedding packages start at $600, compared with $450 for normal ones.

  • A #13 address can hurt home sales.

    #13 house number
    Georges Diegues—Alamy

    According to research cited by Zillow, 40% of real estate agents say that houses with a No. 13 address are known to cause resistance among buyers, and that sellers often have to lower prices as a result.

  • Investors shouldn’t be scared of Friday the 13th.

    150313_EM_Fri13th_Investors
    David A. Cantor—Associated Press

    Yes, the stock market’s mini-crash in 1989 took place on a Friday the 13th in October. But overall, Friday the 13ths tend to be fairly lucky days for investors, with greater odds for a positive gain in the S&P 500 compared with other days.

  • For one mall, Friday the 13th means coupons and freebies.

    Blueberry Bliss and Pineapple Kona Pop tea mix with Teavana glass teapot
    ZUMA Press—Alamy

    The Solomon Pond Mall in eastern Massachusetts has declared this week’s Friday the 13th as a “Lucky Day” for shoppers. Simply show the linked message to guest services, and you’ll receive a goody bag filled with freebies like Teavana tea and hair care samples, as well as a coupon for a $1 Auntie Anne’s pretzel.

  • Friday the 13th is big business for haunted houses.

    Cutting Edge Haunted House
    Ron Jenkins—Star Telegram

    This Friday, like every Friday the 13th, is potentially a big moneymaker for haunted house and other creepy attractions. Entrance can cost a pretty penny too, especially in Texas, which seems to be ground zero for haunted houses. For instance, the Cutting Edge Haunted House in Fort Worth charges $25 to $35 plus a $3.50 per-ticket service fee ($5 off for kids!), while the VIP Experience at the Dark Hour Haunted House in Plano runs $65 plus a $4.25 fee. At the lower end, there’s the Zombie Apocalypse for $16.50 in Colorado Springs, or the Scared City Haunted House in Jonesboro, Arkansas, which is charging $10 admission for “ONE LAST NIGHT” before they remodel for the 2015 Halloween season.

  • Or partake in a “highly immersive terror” campout.

    Great Horror Campout
    Great Horror Campout

    This Friday, Los Angeles’s Griffith Park—probably best known as the setting for key scenes in Rebel Without a Cause—is hosting the “Great Horror Campout.” Billed as a “12-hour, overnight, interactive horror camping adventure” that includes “highly immersive terror” activities like the Hell Hunt Experience and an after-dark screening of Friday the 13th. Naturally, tickets cost $13 when purchased in advance. Among the suggested items campers should bring for the evening are drinks, snacks, sleeping bag, and a “Few Changes of Underwear.”

    Why end it here, you might ask, instead of pushing the list to 13 Friday the 13th-related things instead of 12? We were just too scared to go there.

MONEY stocks

Why You Shouldn’t Reach to Grab New Stocks

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Taylor Callery

As Shake Shack's recent slide demonstrates, while the IPO boom gives you lots of hot companies to take a flier on, you’ll most likely fall flat.

Do you regret missing out on the stunning debuts of Alibaba ALIBABA GROUP HOLDING LTD BABA -2.57% and Shake Shack SHAKE SHACK INC SHAK 0.13% ? Are you now waiting to hail Uber or snap up Snapchat when they go public, as expected?

Before you jump in, remember that when you pick a stock, you’re already taking a leap of faith—but with a newly public company, you’re taking two leaps. First, do you really know enough about the business? Second, has the market had sufficient time to draw its own conclusions so that you are buying at a fairly rational price?

“Anything that’s been trading for a while has been vetted by a whole host of investors,” says John Barr, a manager with the Needham Funds. Not so at or just after an initial public offering, and that’s why you have to tread carefully.

You’ll pay for the honeymoon

IPOs attract big headlines on day one, but surprises inevitably crop up. From 1970 to 2012, the typical IPO gained just 0.7% in its second six months, after the honeymoon effect had a chance to wear off. That’s five percentage points less than other similar-size stocks, finds Jay Ritter, a finance professor at the University of Florida. The year after that, the average IPO lagged by eight points.

Chinese e-tailer Alibaba, which soared 38% on its first day in September, is getting its dose of reality a bit ahead of schedule. Shares are down 28% lately, after the company surprisingly missed revenue-growth forecasts.

Themes get overdone

It’s easy to be lured by a story. Shake Shack doubled on its first day, thanks to the buzz surrounding high-quality fast-food chains like Chipotle CHIPOTLE MEXICAN GRILL INC. CMG 0.35% . But riding a food trend is hard. A decade ago, overexpansion killed investors’ ravenous appetite for Krispy Kreme doughnuts KRISPY KREME KKD -1.86% , and the company’s shares remain 56% off their peak.

Shake Shack has also entered a crowded battle for foodie dollars: the Habit Restaurants HABIT RESTAURANTS HABT -1.66% , Potbelly POTBELLY CORP COM USD0.01 PBPB -0.85% , and Noodles & Co. NOODLES & CO COM USD0.01 CL'A' NDLS 0.61% all went public recently, and all more than doubled in the first day. Odds are the market is overoptimistic about most of them. Since 2013, 15 stocks have doubled on day one; only two—both biotech firms—are trading above their first day’s close.

The fact is, unless you gain access to an IPO at a great price at issuance, you can’t view those stocks as buy-and-hold investments. And you should avoid any richly priced new stock altogether.

Shake Shack trades at 650 times its earnings. To justify that valuation, Ritter figures the burger chain must grow from 63 stores to nearly 700, each half as profitable as a Chipotle restaurant. That’s a big leap indeed, given that Shake Shack locations aren’t even a third as profitable at the moment.

This story was originally published in the April issue of MONEY magazine. Subscribe here.

MONEY mutual funds

Mutual Funds: Not Dead Yet

tombstone proclaiming that Mutual Funds aren't dead yet
Zachary Zavislak

ETFs pose a real threat, but mutual funds can still play a key role in your portfolio. Here are 3 ways to put them to good use.

In many industries, new competition is disrupting the way business is conducted. Think department stores and cable television. Now the $12 trillion mutual fund industry is threatened too.

Since 2007, mutual fund assets have grown less than 50%, while the collective amount invested in exchange-traded funds—baskets of securities that can be traded like individual stocks—has more than tripled, to $2 trillion.

Traditional mutual funds are suffering from the growing popularity of low-cost passive investing. Last year investors poured nearly 10 times as much money into index portfolios, which simply buy and hold all the securities in a sliver of the market, as they put into actively managed funds. And the vast majority of ETFs are index portfolios, many charging lower expenses than mutual funds.

Meanwhile, ETF-like investments could gain traction in the realm of active management.

So far, few actively managed ETFs have been launched because the Securities and Exchange Commission requires them to divulge their holdings in real time — something stock pickers are wary of doing.

However, the SEC recently greenlighted an ETF-like vehicle that solves the disclosure problem. Exchange-traded managed funds, or ETMFs, will be required to reveal their holdings only a few times a year, like traditional mutual funds.

Eaton Vance, which won approval for its NextShares ETMF structure and is licensing it to other money managers, expects to launch its first ETMFs this year.

Because ETFs and ETMFs are traded on an exchange and don’t require back-office and marketing functions, they can charge less. Eaton Vance expects that on average a NextShares ETMF could cost about 0.63 percentage points less than a mutual fund version. So while the average actively managed mutual fund charges $133 a year for every $10,000 you invest, ETMFs may cost just $70 a year.

Still, mutual funds have been around for 91 years and aren’t going the way of the dinosaur tomorrow.

A big reason is that 401(k) plans, which control more than $4.4 trillion in assets, have yet to embrace ETFs. Until that happens—and until ETMFs arrive in full force—here are ways you can still put traditional funds to good use.

Satisfy Your Core Stocks
When it comes to the bulk of your equity portfolio, it doesn’t matter if you use index ETFs or index mutual funds as long as you pick a cheap option. “Low cost is low cost, period,” says Dave Nadig, chief investment officer of ETF.com.

Case in point: MONEY 50 pick Schwab S&P 500 Index mutual fund charges 0.09% annually, the same as SPDR S&P 500 ETF .

As you can see from the chart below, though, not all index mutual funds charge rock-bottom prices.

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Fix the Bond Problem
MONEY has warned of the risks of putting all your bond money into traditional index funds and ETFs. Those portfolios are obliged to load up on what are now the most expensive parts of the fixed-income market: U.S. Treasuries and agency-backed mortgage debt that the Federal Reserve bought in droves to stimulate the economy.

Jeff Layman, chief investment officer at BKD Wealth Advisors, says his firm has switched from passive core bond funds to active managers, who have the leeway to diversify into less frothy parts of the market. With few exceptions, most actively managed high-grade bond portfolios are mutual funds. A good option is MONEY 50 pick Dodge & Cox Income DODGE & COX INCOME FUND DODIX 0.07% , which charges just 0.43% in annual fees.

Fill a Niche
For narrowly focused assets, Samuel Lee, editor of Morningstar ETFInvestor, says you can find traditional mutual funds with deft active managers who have the flexibility to “avoid horrendous transaction costs.” Surprisingly, some of these funds charge lower expenses than ETFs. For example, he prefers Vanguard High Yield Corporate VANGUARD HIGH-YIELD CORPORATE INV VWEHX -0.17% , an actively managed fund that charges 0.23% a year, over SPDR Barclays High Yield ETF, which charges 0.40%.

Commodities are another area where mutual funds may make more sense. ETFs that invest in physical commodities or futures contracts are less tax-efficient than a regular fund that owns commodity-related stocks.

Collectively these investments represent just a minority of your overall portfolio. Still, it means the death of the fund may be exaggerated—for now.

MONEY investing strategy

Most Americans Fail This Simple 3-Question Financial Quiz. Can You Pass It?

piggy bank with question marks on it
Peter Dazeley—Getty Images

These questions stump most Americans with college degrees.

Following are three questions. If you’ve been around the financial block a few times, you’ll probably find all of them easy to answer. Most Americans didn’t get them right, though, reflecting poor financial literacy. That’s a shame — because, unsurprisingly, the more you know about financial matters and money management, the better you can do at saving and investing, and the more comfortable your retirement will probably be.

Here are the questions — see if you know the answers.

  1. Suppose you had $100 in a savings account and the interest rate was 2% per year. After five years, how much do you think you would have in the account if you left the money to grow? (A) More than $102. (B) Exactly $102. (C) Less than $102.
  2. Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year. After one year, how much would you be able to buy with the money in this account? (A) More than today. (B) Exactly the same. (C) Less than today.
  3. Please tell me whether this statement is true or false: Buying a single company’s stock usually provides a safer return than a stock mutual fund.

Did you get them all right? In case you’re not sure, the answers are, respectively, A, C, and False.

Surprising numbers

The questions originated about a decade ago, with Wharton business school professor and executive director of the Pension Research Council Olivia Mitchell, and George Washington School of Business professor and academic director of the Global Financial Literacy Excellence Center Annamaria Lusardi. In a quest to learn more about wealth inequality, they’ve been asking Americans and others these questions for years, while studying how the results correlate with factors such as retirement savings. The questions are designed to shed light on whether various populations “have the fundamental knowledge of finance needed to function as effective economic decision makers.”

They first surveyed Americans aged 50 and older and found that only half of them answered the first two questions correctly. Only a third got all three right. As they asked the same questions of the broader American population and people outside the U.S., too, the results were generally similar: “[W]e found widespread financial illiteracy even in relatively rich countries with well-developed financial markets such as Germany, the Netherlands, Switzerland, Sweden, Japan, Italy, France, Australia and New Zealand. Performance was markedly worse in Russia and Romania.”

If you think that better-educated folks would do well on the quiz, you’d be wrong. They do better, but even among Americans with college degrees, the majority (55.7%) didn’t get all three questions right (versus 81% for those with high school degrees). What Mitchell and Lusardi found was that those most likely to do well on the quiz were those who are affluent. They attribute a full third of America’s wealth inequality to “the financial-knowledge gap separating the well-to-do and the less so.”

This is consistent with other research, such as that of University of Massachusetts graduate student Joosuk Sebastian Chae, whose research has found that those with higher-than-average wealth accumulation exhibit advanced financial literacy levels.

The importance of financial literacy

This is all important stuff, because those who don’t understand basic financial concepts, such as how money grows, how inflation affects us, and how diversification can reduce risk, are likely to make suboptimal financial decisions throughout their lives, ending up with poorer results as they approach and enter retirement. Consider the inflation issue, for example: If you don’t appreciate how inflation shrinks the value of money over time, you might be thinking that your expected income stream in retirement, from Social Security and/or a pension, will be enough to live on. Factoring in inflation, though, you might understand that your expected $30,000 per year could have the purchasing power of only $14,000 in 25 years.

Mitchell and Lusardi note that financial knowledge is correlated with better results: “Our analysis of financial knowledge and investor performance showed that more knowledgeable individuals invest in more sophisticated assets, suggesting that they can expect to earn higher returns on their retirement savings accounts.” Thus, better financial literacy can help people avoid credit card debt, take advantage of refinancing opportunities, optimize Social Security benefits, avoid predatory lenders, avoid financial scams and those pushing poor investments, and plan and save for retirement.

Even if you got all three questions correct, you can probably improve your financial condition and ultimate performance by continuing to learn. Many of the most successful investors are known to be voracious readers, eager to keep learning even more.

MONEY Warren Buffett

Warren Buffett Just Predicted the Next 50 Years for Berkshire Hathaway

Warren Buffett
Lacy O'Toole—NBCU Photo Bank via Getty Images

While the days of Berkshire's amazing 20% average annual returns are likely a thing of the past, Buffett expects Berkshire to outperform the market.

Berkshire Hathaway is one of the most fascinating stories in the history of investing. In the 50 years Warren Buffett and his management team have been running things, a struggling textile company has transformed into one of the largest corporations in the world, with dozens of household-name subsidiary companies and an equally impressive stock portfolio. In the process, early investors have gotten very rich, with the per-share book value rising from $19 to $146,186 during the past half-century.

In Buffett’s most recent letter to shareholders, he discussed his thoughts on Berkshire’s next 50 years. Here’s what Berkshire investors can expect — straight from the pen of the Oracle of Omaha:

Berkshire will not be a good short-term trade, ever

Buffett said that the chance of permanent capital loss with Berkshire is the lowest among any single-company investment. But he added a caveat: If the company’s valuation is high, say approaching two times book value (it’s at about 1.5 times book value now, so not too far off), it could be years before investors realize a profit.

In other words, Berkshire has never been, and will never be, a good “traders’ stock.” The company has one of the most shareholder-friendly business models in the world, but it is geared exclusively toward long-term investors. As a result, Buffett recommends that investors should look elsewhere for investment options if they plan to hold their shares for less than five years.

Berkshire can survive the “thousand-year flood”

Not only will Berkshire be prepared to withstand any economic storm, but the company is positioned to capitalize when things go bad. The company maintains a huge earnings stream, a great deal of liquid assets, and virtually no short-term cash requirements.

This combination keeps Berkshire immune to virtually any adverse market conditions. This is illustrated by the company’s performance during the financial crisis of 2008-09, when Berkshire not only survived, but took advantage of “discounts” in companies like Goldman Sachs.

Berkshire will maintain rather large stockpiles of cash (at least $20 billion at all times, according to Buffett) in order to weather any storm and capitalize on developing opportunities. As Buffett said, “if you can’t predict what tomorrow will bring, you must be prepared for whatever it does.”

Earnings power will continue to grow

Perhaps Buffett’s boldest prediction is that Berkshire can build its per-share earning power every year. This might sound like a lofty expectation, considering he’s talking about a five-decade period. However, it could be achievable.

Now, this prediction doesn’t mean earnings will increase every year. It does, however, mean that each and every year, Berkshire will create the potential to earn more than it did the year before. Actual earnings gains (and declines) will depend on the U.S. economy, but the company will keep moving forward no matter what the economy is doing.

Past performance will not be duplicated

Many casual observers were put off by the following line from the letter: “Berkshire’s long-term gains … cannot be dramatic and will not come close to those of the past 50 years.”

However, this really shouldn’t be much of a surprise. There is only a finite amount of money and investment opportunities in the world, and as companies grow, it gets tougher and tougher to maintain a high growth rate. For example, Apple has increased in value by more than 100-fold since 2004. Would it be reasonable to expect the same over the next decade? Of course not! That would make Apple a roughly $70 trillion company.

The same principle applies to Berkshire. Repeating its performance of the past 50 years would produce a book value per share of roughly $1.2 billion, along with a market capitalization of more than $900 trillion, which would be completely impossible in the absence of extreme inflation.

But the right people are in place to deliver for shareholders

While his time at the helm might be nearing its end, Buffett reassured investors that over the next 50 years, no company will be as shareholder-oriented as Berkshire. Buffett is completely confident the company will have the right CEO, management team, and investment specialists in place, as well as safeguards to protect shareholders in the event that the wrong person is put in charge.

As Buffett stated in a past letter to shareholders: when the market soars, Berkshire may underperform; when the market is down, Berkshire will outperform; and over any full economic cycle, Berkshire will outperform the markets. While the days of Berkshire’s amazing 20% average annual returns are likely a thing of the past, the company’s winning philosophy and business model remain the same, and will deliver for shareholders for decades to come.

MONEY financial advice

What Every Investor Should Know About Schwab’s “Free” New Advice Service

Charles Schwab logo on window
Paul Sakuma—AP

Robo-Chuck Has Landed! Do you want this free new online service to design your portfolio?

A new group of financial websites has been making investment advice cheaper and cheaper. Now the brokerage and mutual funds giant Charles Schwab is getting into the game, with a new online service called Intelligent Portfolios that can design a portfolio for you without charging any fee at all. You’ll need only $5,000 to open an account. But, as you might well have guessed, there’s an asterisk on that “free” price tag.

We’ll get to the asterisk in a moment. First, here’s why Schwab’s entry into online advice is such a big deal.

Every financial firm in America is fighting to offer investment advice to the middle-class, especially about what to do with their IRAs and rollovers from 401(k) retirement accounts. But the cost of getting a financial pro to sit down and help you design a personalized portfolio of stocks, bonds, and funds is often high—think 1% of assets per year or more—and the minimum required investment can be forbiddingly steep.

New web-based companies like Betterment, Wealthfront, and FutureAdvisor have lately been chipping away at this model. They don’t let you talk to a person. Instead, you go to their sites to answer questions about your age, financial position, and how much risk you are willing to take, and computer models generate a portfolio of stock and bond exchange-traded funds (ETFs). These “robo-advisers” often charge investors razor thin fees of 0.2% to 0.5% of assets per year, with low (or no) minimum investments.

The investment advice robo-advisers give isn’t terribly complicated. But for most people, that’s a good thing. You typically end up in a handful of broadly diversified index funds, which you buy and hold for the long run. This service can be a simple entry point to investing for those who don’t know how or where to get started, and they can automate chores like annual rebalancing and adjusting your mix as you age. And, again, they are cheap.

And yet, Schwab’s new version appears to undercut even the other robo-advisers’ slender fees by charging nothing.

Does that make it a sure winner? Not necessarily. As with all such programs, you have to take a look under the hood.

In addition to whatever investors pay for online financial advice, they also have to pay the fees of the underlying funds. The robo-advisers Schwab will compete with don’t offer their own mutual funds, but instead typically rely on Vanguard and iShares products. Those are very cheap funds that usually charge less than 0.2% of assets per year, so the net cost of investing with an online adviser stays low.

Schwab’s approach looks a little different. While Schwab is offering its investment strategy gratis, the company has said it plans to recommend some of its own funds, as well as third-party funds.

Schwab hasn’t made clear specifically what ETFs it plans to use with Intelligent Portfolios. Schwab spokesman Michael Cianfrocca told MONEY the investment strategies it uses “have nothing to do with generating revenue for the firm.” But a quick glance at the kinds of portfolios it recommends suggests that some of its underlying investment will be relatively costly.

For instance, Schwab appears to make liberal use of “fundamental” index funds. Some investors think this type of index fund, which tends to tilt its weightings toward value-priced stocks, may outperform the market in the long-run. But fundamental index funds are pricier than plain-vanilla stock index funds, which simply hold stocks in proportion to their market value. Schwab’s fundamental large-company stock fund charges investors a fee of 0.32% of invested assets annually compared to just 0.04% for the plain-vanilla index funds the company offers. (A 0.32% fee is still low compared to actively managed funds.)

Schwab also stands to earn money from investors’ cash positions, since they will be held in Schwab cash vehicles, which Schwab makes money on by collecting a spread between what it earns reinvesting the money and what it pays out to Schwab customers. In one scenario, for an investor in his or her 40s with a moderate risk appetite, the Schwab product recommended putting nearly 9% of the money into cash. The Schwab spokesman said that was typical for other types of accounts housed at Schwab. But it’s far more cash than some other investment managers recommend. To take one example: The Vanguard target-date fund designed for a similarly-aged investor would put less than 1% in cash.

In the long run, Schwab’s new product may prove a convenient tool for some investors. But don’t assume you’re getting something for nothing.

MONEY Investing

Two Charts That Show This Bull Market Is Truly Historic

Bull statue on Wall Street
Murat Taner—Getty Images

The bull market is six-years old, and it's looking like a truly historic run.

If you hear music in the air, particularly from the direction of the financial district, that’s because the six-year anniversary of our current bull market has arrived.

According to the S&P, this particular run has lasted 2,191 days, the fifth longest since 1921, only surpassed by a 3,452 day stretch from October, 1990 through March, 2000; a 2959 day period from August 1921 to September, 1929; a 2067 day stretch from June, 1949 to August, 1956; and 2248 day run between October, 1974 and November, 1980.

But while today’s bull market might rank fifth overall, it’s even more impressive when compared to similar economic recoveries. The six-year rally following the financial crisis is topped by only by the recovery following World War II (2,607 days) and the 1919 deflation (2,959 days).

Screenshot 2015-03-09 10.31.01

And when it comes to price gains during the first six-years of a recovery, the current market is second to none. Between March 9, 2009 and March 9, 2015, the S&P 500 has increased by 202%. The only other market run that comes close is the postwar expansion, where the S&P returned 192% in the same time period.

The bad news? Valuations now look high.

Screenshot 2015-03-09 13.42.36

As of February, the Shiller price-to-earnings ratio, which measures the S&P 500’s price against the average of the past 10 years of earnings, was nearly 28. That’s almost twice as high as the P/E six years into the “Great Bull” market of the 1980s and 1990s. That’s lead many commentators to speculate about whether the market is overvalued and due for a correction.

Of course, the Shiller P/E climbed above 40 by end of the Great Bull in 2000—so it’s not much of a guide to when the market will turn. But even if you aren’t trying to time the market, high valuations do suggest that future long-term returns may be comparatively muted. After all, a high P/E means each dollar you spend on stocks is now buying a smaller pile of earnings.

All data from MONEY’s Investor’s Guide 2015 by Penelope Wang with Kara Brandeisky.

MONEY stocks

3 Simple Equations All Investors Should Know

hand doing math equations on chalkboard
Getty Images

You might be wasting money on high fees in your 401(k) or chasing the wrong stocks. This easy math will bring you back down to earth.

Whether you love to buy and sell stocks or barely understand what’s going on in your retirement account, there’s a good chance you could benefit from learning more about the math behind the stock market.

Here are three fundamental equations that the savviest investors know. Relatively easy to understand, they will help you choose the right stocks and funds and, most important, keep your expectations about future returns grounded in reality.

Equation 1

S&P 500 dividend yield + about 4.5% = the expected long-term return on stocks

This formula, known as the Gordon equation, assumes stocks get their ultimate value from being able to one day return earnings to investors. (That’s true whether or not a company currently pays a dividend or reinvests in the business.) Anything above or below that is a result of investor sentiment.

You can look up the current S&P 500 dividend yield, which is about 2% now, at multpl.com; the 4.5% is how much you can expect dividends to grow based on the past. So today the expected long-run return is 6.5%. Adviser and author William Bernstein says thinking about this number brings you down to earth in boom years, and can reassure you when the market is down.

Equation 2

A 1.5% expense ratio = more than 40% of your money after 40 years

Mutual fund and adviser expenses seem so tiny— just 1% or so. But math professor Jordan Ellenberg, author of How Not to Be Wrong, says that over many years “expenses add up—or, more mathematically precisely, they multiply up.”

Put $100,000 into a fund with a 1.5% expense ratio, assume a 6% underlying return, and you’ll get about $560,000 after 40 years. With the same pre-expense return in a very low-cost index fund charging 0.1%, you’d have $990,000. To see for yourself the true long-term costs of a fund you are considering, use the mutual fund fees calculator at Bankrate.com.

Equation 3

Net income / shareholder equity = return on equity

Return on equity is a classic measure of a company’s ability to put shareholders’ money to good use. (Equity is roughly the cash investors put into the business, plus retained earnings.) Calculate a stock’s ROE using the balance sheet and income statement.

Looking for consistent ROE of 15% or more “helps steer you toward profitable companies and away from speculation,” says Robert Zagunis of the Jensen Funds, which screen for stocks with 10 years of high return on equity, like 3M.

Read more investing fundamentals from Money 101:
How do I know if I should buy a stock?
Should I invest in stocks or in a stock mutual fund?
How often should I check on my retirement investments?

Correction: This story has been updated to reflect the current S&P 500 dividend yield.

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