This Warren Buffett investing tip could help you to make a million

By following this piece of advice from Warren Buffett, you could improve your portfolio returns in the long run.

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

There are various pieces of advice from Warren Buffett that could help investors to maximise their return potential. However, there’s one simple tip that could make a vast amount of difference to all investors without requiring any extra effort.

Buffett has only ever invested in companies and sectors that he understands. This has allowed him to leverage the knowledge he has on specific areas in order to improve his overall returns.

Certainly, Buffett has missed out on a number of investing opportunities during his lifetime that could have increased his net worth to an even larger figure. However, by investing only in areas he fully understands, he has undoubtedly avoided losses that have allowed him to generate high returns over the long run.

Avoiding risks

With the cost of buying and selling shares having fallen significantly over recent decades, it’s now cheaper than ever to build a portfolio of varied companies. While this makes it easier to obtain a high degree of diversification in order to reduce risk, it also means it’s less costly to ‘dabble’ in a wide range of stocks, in terms of commission costs. In other words, many investors will buy companies without undertaking comprehensive research into their operations and future growth prospects.

This could be a dangerous move, since it may mean an investor has failed to ascertain the potential risks a specific stock may present. For example, its business model may be unfavourable, or it could face risks that haven’t been factored into its share price. As such, undertaking research into the company and its industry could avoid potential losses that would harm overall returns.

Competitive advantage

As well as avoiding risks, investing in companies you understand can lead to improved returns. For example, if an investor determines they will focus on a particular industry and will gain a significant amount of knowledge on how it operates, they may have a competitive advantage over other investors that enables them to select the most attractive companies within the sector. Over time, this may mean they’re able to outperform their peers, as well as the wider stock market.

Clearly, it’s very difficult to be an expert in every industry. Therefore, it may be worth initially utilising tracker funds for the majority of your capital, since they offer exposure to a diverse range of companies. Then, investing a modest proportion of your capital in industries and companies within your sphere of knowledge could provide the opportunity to outperform the index. Over time, your portfolio may gradually become increasingly weighted to direct equities, rather than being invested in a tracker fund.

Takeaway

Diversification is crucial to reduce risk. However, it can lead to investors buying all sorts of companies they don’t fully understand. As such, following Buffett’s advice on only investing in companies that are within your sphere of knowledge could reduce risk and improve your chances of making a million. 

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Investing Articles

1 of the best UK shares to consider buying in April

Higher gold prices and a falling share price have put this FTSE 250 stock on Stephen Wright's list of UK…

Read more »

Person holding magnifying glass over important document, reading the small print
Investing Articles

The market is wrong about this FTSE 250 stock. I’m buying it in April

Stephen Wright thinks investors should look past a 49% decline in earnings per share and consider investing in a FTSE…

Read more »

Black father and two young daughters dancing at home
Investing Articles

1 FTSE 250 stock I own, and 1 I’d love to buy

Our writer explains why she’s eyeing up this FTSE 250 growth phenomenon, and may buy more shares in this property…

Read more »

View of Tower Bridge in Autumn
Investing Articles

The FTSE 100 is closing in on 8,000 points! Here’s what I’m buying before it’s too late!

As the FTSE 100 keeps gaining momentum, this Fool is on the lookout for bargains. Here's one stock he'd willingly…

Read more »

Investing Articles

3 ideas to help investors aim for a million-pound Stocks & Shares ISA

The UK has a growing number of Stocks and Shares ISA millionaires, and this plan may be one of the…

Read more »

Illustration of flames over a black background
Investing Articles

2 red-hot UK growth stocks to consider buying in April

These two growth stocks are performing well, but can they continue to deliver for investors through 2024 and beyond?

Read more »

Charticle

Is JD Sports Fashion one of the FTSE 100’s best value stocks? Here’s what the charts say!

The JD Sports Fashion share price remains a wild ride during the first quarter. Could it be one of the…

Read more »

Investing Articles

Could the JD Sports Fashion share price double in the next five years?

The JD Sports Fashion share price has nearly halved in the past five years. Our writer thinks a proven business…

Read more »