When Warren Buffett was 30, he’d invested his way to a fortune worth about $1m. So, if I had no savings at 30, zero investments and nothing but a steady income, what chance would I have of building wealth?
Plenty, as it happens. After all, Buffett today has a personal net worth of around $100bn — about 100,000 times the fortune he had at 30. And that’s after giving lots away to charity over the past few years.
Considering risks first
It’s true that he’s an extreme example, but the first trick I’d learn from Buffett is to never stop compounding the gains and advances in my investments. That’s what he’s done. He wasn’t content with the $1m he’d achieved at 30, so he kept going…
And at 30, I’d still have about 37 or-so years to invest and compound before my State retirement age — plenty of time to get the process of compounding working for me to build a retirement pot.
But one of the keys to Buffett’s success has been an understanding that permanent loss of capital is a very bad thing. A loss of money means the loss of the opportunity to compound. And even losing a lot of it, but not all of it, means I’d be in deep trouble. For example, if an investment loses 80% of its value, I’d need a gain of 400% just to break even.
It’s not for nothing that Buffett’s first rule of money management is “never lose money.” Or that his second rule is “never forget rule number one.” And so the second trick of Buffett’s I’d use to build wealth is to approach all investments by considering the risks before the potential gains.
To do that, I’d choose shares carefully. For example, profitless, ‘jam tomorrow’ stocks are out the window for me. And I’m also wary of stocks in cyclical sectors such as airlines, mining, banking, retail, and others.
The few, not the many
So what stocks are worth an investment if my aim is to compound? Buffett reckons there are only a few exceptional businesses available on the stock market. The great majority of the others are low-quality or mediocre at best — and he tends to avoid those.
Instead, Buffett shops for stocks representing what he calls “wonderful” businesses. And that’s the third trick I’m aiming to use to build wealth. But even focusing on the quality of an enterprise could lead to investment losses rather than compounding gains. And that’s because quality companies tend to attract expensive valuations. And valuations can decline, causing a falling share price, even as a business prospers.
Buffett has always been a value investor at heart, so a key piece of the investment puzzle for him is buying quality stocks when the price has been marked down by the market. And it’s the fourth trick I’m using as I aim to build wealth from stocks.
