Warren Buffett, the US investing legend, says it’s much easier to achieve high returns on a smaller amount of money. This is how I’d do it with £10k.
Why did Buffett achieved better returns in the past?
It’s simply because he didn’t have to manage such enormous sums of money. You see, when you have to look after hundreds of billions dollars, there’re certain diseconomies of scale. That is, it’s quite expensive to manage large companies and it requires plenty of attention.
What is more, large hedge funds usually devote large sums of money to buying big companies. It’s not just because they become complacent and risk-averse by managing other people’s money. It’s because when you buy a small cap, you don’t want to invest too much in it. So, if you manage so much money, you’d have to find plenty of small caps to invest in. Doing so requires many labour resources. But the result is not easily felt. That’s why many large funds invest in a small handful of large reliable companies.
I personally consider this to be a low-risk strategy. However, this reduces the potential to earn extra money. Large caps are actively researched by many analysts and investors. So, they often trade at high accounting multipliers.
This is how I’d get rich
When deciding to invest my £10k, I’d follow Buffett’s decision-making process. First, I’d identify an industry. It must be an industry I like and understand well. Then, I’d look for particular companies in this sector. This wouldn’t have to be very thorough research on each and every company. At the same time, don’t forget that scanning plenty of companies raises your chances of finding a handful of great investment opportunities.
I was surprised to learn that Warren Buffett likes reading Moody’s manual to get a sense of every single listed company. I also like checking companies’ credit ratings, especially the “ratings rationales“. Moody’s is the first agency I check. The process isn’t too long but it allows me to exclude some of the ‘bad’ options straight away.
I think the best idea is to invest in UK companies. British companies are subject to strict accounting and corporate governance regulations. Firms in many other countries might not have to follow such standards. What’s more, shares denominated in foreign currencies might depreciate substantially against the pound. So, investors from the UK will face some additional risks.
Buffett just like his teacher, Ben Graham, often looks for stocks trading far below their intrinsic value. In other words, he looks for companies with a history of rising profits. At the same time, these stocks should trade at a price-to-earnings (P/E) ratio of less than 20 and a price-to-book (P/B) ratio of less than 3.
Last but not least, to achieve a 50% return per year on your £10k I’d suggest taking advantage of stock market crashes. The last thing you should do is to buy when everyone else is buying. Instead, you should buy when everyone panic sells. Just like Buffett, who says “Be fearful when others are greedy and greedy when others are fearful”.