Why Warren Buffett Loves Fed Rate Hikes
As a bondholder, owner of insurance companies and a big investor in banks, Berkshire Hathaway profits from rising interest rates in a number of ways.
The Federal Reserve raised its target of the federal-funds rate, the interest rate banks charge each other for overnight loans, by a quarter point to a range of 0.75% to 1%, and that’s great news for Warren Buffett’s Berkshire Hathaway (symbol BRK.B) and its shareholders. As a bondholder, owner of insurance companies and an investor in big banks, Berkshire profits from rising interest rates in a number of ways, says David Kass, a professor at the University of Maryland's Robert H. Smith School of Business who studies Buffett and is a Berkshire investor.
"Since Berkshire currently has about $85 billion in cash invested primarily in short-term Treasuries, a [one percentage point] increase in short-term interest rates results in an additional income of $850 million per year for Berkshire," Kass says. "Furthermore, Wells Fargo, one of Berkshire's largest equity investments, will benefit from an increase in earnings as interest rates rise.”
Berkshire owns nearly 500 million shares of Wells Fargo (WFC) alone. Other bank holdings include 85 million shares of U.S. Bancorp (USB), 5 million shares of M&T Bank (MTB), 11 million shares of Goldman Sachs (GS) and 22 million shares of Bank of New York Mellon (BK). Berkshire also has a substantial investment in Bank of America (BAC) through dividend-paying preferred shares and warrants that can be exchanged for common stock at a deep discount. (Holdings are based on Berkshire's securities disclosures and CNBC's Berkshire Hathaway Portfolio Tracker.)
![https://cdn.mos.cms.futurecdn.net/hwgJ7osrMtUWhk5koeVme7-200-80.png](https://cdn.mos.cms.futurecdn.net/hwgJ7osrMtUWhk5koeVme7-320-80.png)
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Then there's Berkshire's sprawling insurance empire, which is a big under-the-radar beneficiary of rising interest rates. Insurance firms have a continuous inflow of cash from premium payments that isn’t immediately paid out in claims. The difference, known as the float, is held mostly in safe, liquid investments. That makes insurers large investors in high-quality short-term debt, which will start to pay higher interest rates in response to the Fed's latest rate hike.
"If our premiums exceed the total of our expenses and eventual losses, our insurance operation registersan underwriting profit that adds to the investment income the float produces," writes Buffett in his 2016 letter to shareholders. "When such a profit is earned, we enjoy the use of free money – and, better yet, get paid for holding it."
Since short-term debt rolls over relatively quickly, insurance companies can earn more interest on their holdings in a rising-rate environment as they buy new debt issued at higher rates. Berkshire owns more than a dozen insurance subsidiaries, including biggies Geico and General Re, all of which benefit from rate hikes.
As Buffett points out in his annual letter to shareholders, between its investments and subsidiary ownerships, Berkshire is always "asset-sensitive," meaning that higher short-term rates help its consolidated earnings. On the other end of the spectrum, Buffett says rising rates make stocks like Berkshire a bargain at today’s prices. "Stocks are cheap if long-term rates are at 4%, four to five years from now," Buffett said at a November meeting with University of Maryland students.
The bottom line is that Berkshire's businesses, which comprise 81% of its assets, and its portfolio of stocks, which account for 19%, will become increasingly valuable as rates rise, says Kass. By extension, so will Berkshire Hathaway's stock.
Get Kiplinger Today newsletter — free
Profit and prosper with the best of Kiplinger's advice on investing, taxes, retirement, personal finance and much more. Delivered daily. Enter your email in the box and click Sign Me Up.
Dan Burrows is Kiplinger's senior investing writer, having joined the august publication full time in 2016.
A long-time financial journalist, Dan is a veteran of SmartMoney, MarketWatch, CBS MoneyWatch, InvestorPlace and DailyFinance. He has written for The Wall Street Journal, Bloomberg, Consumer Reports, Senior Executive and Boston magazine, and his stories have appeared in the New York Daily News, the San Jose Mercury News and Investor's Business Daily, among other publications. As a senior writer at AOL's DailyFinance, Dan reported market news from the floor of the New York Stock Exchange and hosted a weekly video segment on equities.
Once upon a time – before his days as a financial reporter and assistant financial editor at legendary fashion trade paper Women's Wear Daily – Dan worked for Spy magazine, scribbled away at Time Inc. and contributed to Maxim magazine back when lad mags were a thing. He's also written for Esquire magazine's Dubious Achievements Awards.
In his current role at Kiplinger, Dan writes about equities, fixed income, currencies, commodities, funds, macroeconomics, demographics, real estate, cost of living indexes and more.
Dan holds a bachelor's degree from Oberlin College and a master's degree from Columbia University.
Disclosure: Dan does not trade stocks or other securities. Rather, he dollar-cost averages into cheap funds and index funds and holds them forever in tax-advantaged accounts.
-
Visa Is the Worst Dow Stock Wednesday. Here's Why
Visa stock is down sharply Wednesday after the credit card company came up short of revenue expectations for its fiscal Q3.
By Joey Solitro Published
-
Another Analyst Moves to the Sidelines on Tesla Stock After Earnings
Tesla stock is spiraling Wednesday after the EV maker's big earnings miss and Wall Street has been quick to weigh in. Here's what you need to know.
By Joey Solitro Published
-
Stock Market Today: Stocks Tumble on Disappointing Big Tech Earnings
Poorly received quarterly results from Alphabet and Tesla sparked a steep selloff in equities.
By Dan Burrows Last updated
-
Stock Market Today: Mega-Cap Tech Rallies to Drag Markets Higher
Markets focused on upcoming earnings from Magnificent 7 stocks rather than chaos in D.C.
By Dan Burrows Published
-
Stock Market Today: Stocks Tumble After Spectacular Global Internet Crash
Market participants rushed out of risk assets to end a wild week of trading.
By Dan Burrows Published
-
Stock Market Today: Dow Sinks 533 Points as Big Banks, Mega Caps Slump
Goldman Sachs and Apple were two of the worst-performing blue chip stocks on Thursday.
By Karee Venema Published
-
Stock Market Today: Semis Get Slammed and Blue Chips Bounce
The potential for more curbs on tech sales to China set off a rotation into blue chips.
By Dan Burrows Published
-
Stock Market Today: Dow Spikes 742 Points After UnitedHealth Earnings
The S&P 500 and Nasdaq also scored wins Tuesday albeit with much smaller gains than the blue chip Dow.
By Karee Venema Published
-
Stock Market Today: Dow Adds 210 Points as Apple, Goldman Hit New Highs
A big rally in blue chips and some dovish Fed speak boosted the equities market Monday.
By Karee Venema Published
-
Stock Market Today: Markets Bounce Back on Rate-Cut Optimism
The latest readings on consumer sentiment and inflation helped lift the odds of the Fed easing in September.
By Dan Burrows Published