How I’d use the Warren Buffett method to retire early

Our writer explains how he applies the Warren Buffett method to try and increase the long-term returns of his retirement portfolio.

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.

Buffett at the BRK AGM

Image source: The Motley Fool

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.

Retiring early does not seem to be a priority for legendary investor Warren Buffett, who continues to work full-time in his nineties. Not everybody wants to be doing that, however. By applying some lessons from Buffett’s method of investing, I think it is possible to grow the value of a retirement portfolio faster, giving one the chance to stop working sooner. Here is how I would do it.

Avoiding avoidable mistakes

Buffett is critical of what he calls “unforced mistakes”. Writing about a $2bn bond purchase in which he personally had miscalculated the probabilities of gain and loss, Buffett described the deal as “a major unforced error”. In other words, while some mistakes are very difficult to spot in advance, others are traps hiding in full sight that a smart investor should be able to avoid.

So, while Buffett recognises that forced mistakes happen, he tries to avoid unforced mistakes. I think this makes sense in the context of one of Buffett’s sayings when it comes to investment strategy: “Rule number one: never lose money. Rule number two: never forget rule number one”. Buffett is again emphasising the importance of minimising the impact of avoidable mistakes. Such mistakes can have a huge impact on a retirement portfolio. Imagine that a share I own goes down by 50%. Just to get the value of my investment back to where it started, I then need the share to increase not by 50% but by 100%. Mistakes in choosing shares for the wrong reasons can make it much harder for me to grow the value of my retirement portfolio.

It could be tempting to try and improve the size of my retirement fund more quickly by increasing in very risky shares with high potential returns. But remember Buffett’s first rule is never to lose money. So, buying shares I know are very risky just because they might give me a high return goes completely against the Warren Buffett method.

Warren Buffett on circles of competence

Another thing Buffett emphasises is the importance of investing in a limited number of great opportunities rather than a large number of good ones.

Big opportunities in life have to be seized,” according to Buffett. He goes on to explain, “we don’t do many things, but when we get the chance to do something that’s right and big, we’ve got to do it. To do it on a small scale is just as big of a mistake, almost, as not doing it at all. You’ve got to grab then when they come, because you’re not going to get 500 great opportunities”.

The approach here is very clear: in an investor’s lifetime, the  number of truly great opportunities that he has the competence to assess and that can ‘shift the needle’ on a retirement portfolio are limited. But when one comes along, an investor like Buffett will go into it on a big scale.

Sticking to what one knows

A lot of people would be able to retire sooner if they had not frittered part of their portfolio away by investing in businesses they did not understand. Buffett is emphatic about sticking to his circle of competence and only investing in businesses that he understands. That allows him to assess their future prospects better.

The reason it can be so harmful to one’s retirement savings to invest in companies without understanding them is that there are loads of businesses that will fail or see their share prices fall dramatically in future, including some huge blue chips. This is always true. It can be hard enough to assess businesses even when they fall inside one’s circle of competence. For example, Buffett bought Tesco feeling he understood the retail market, but still made a loss of around half a billion dollars on the stake. If it is possible to make such mistakes in areas one understands well, it can be even costlier investing in something one cannot properly assess. That can lead to more losses, meaning it takes longer for a retirement pot to reach its target size – if it ever gets there at all.

Focus on future value creation not just current price

When Warren Buffett considers what shares to buy and sell, he is looking at how successful he thinks a business can be in future when it comes to generating profits. For example, is its market likely to grow or shrink over time? Does the company have some unique competitive advantage that could stick around, such as the proprietary formula of Coca-Cola or installed user base of Apple? Can the company charge a premium that allows it to maintain high profit margins?

Only once he has identified a company with these desirable business characteristics does Buffett then start looking at its share price. Buffett does not buy a company just because the price looks cheap. Instead, he tries to buy slices of businesses he thinks have great potential, at a price that should allow him to benefit from the shares moving up if the business does well over the long term.

Focussing just on current share prices can lead investors to buy ‘value traps’ – shares that look cheap but in fact will see their prices fall further in future, for example, because some of their earnings will soon dry up. Making such mistakes can lead to losses, meaning one’s retirement portfolio is worth less. Like Buffett, I never buy a share only because of its price. What I am looking for is value – companies with strong business prospects whose shares trade at an attractive price.

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.

Christopher Ruane has no position in any of the shares mentioned. The Motley Fool UK has recommended Apple and Tesco. 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

Happy young plus size woman sitting at kitchen table and watching tv series on tablet computer
Investing Articles

Could Raspberry Pi shares hit £5 by 2030?

After a strong start out of the blocks this month, our writer asks whether Raspberry Pi shares could move further…

Read more »

Close-up of British bank notes
Investing Articles

Five 5%+ yielders I’d buy for an ISA today!

Our writer identifies a handful of FTSE 100 and FTSE 250 firms each yielding at least 5% he'd happily buy…

Read more »

Front view photo of a woman using digital tablet in London
Investing Articles

5 stocks with 5%+ yields I’d love to buy and hold in a Stocks and Shares ISA

Harvey Jones is keen to add these five FTSE 100 high-yielders to his Stocks and Shares ISA, ideally before they…

Read more »

A young Asian woman holding up her index finger
Investing Articles

I’d target £880 of passive income annually, spending £10K now on this FTSE 100 share

Our writer explains how he would add to his diversified portfolio happily by investing in this FTSE 100 passive income…

Read more »

Light trails from traffic moving down The Mound in central Edinburgh, Scotland during December
Investing Articles

3 reasons I think the Scottish Mortgage share price could keep rising

Christopher Ruane explains a trio of reasons he thinks the once-mighty Scottish Mortgage share price could be set to increase…

Read more »

Syringe and vial on blue background
Investing Articles

Is this forgotten FTSE share about to make investors rich all over again?

Not long ago, this FTSE share was all the rage before demand dropped off and things went south. Is it…

Read more »

Warren Buffett at a Berkshire Hathaway AGM
Investing Articles

I’d use these 5 Warren Buffett approaches to build wealth

Christopher Ruane outlines a handful of investing lessons from billionaire Warren Buffett that he thinks can help a small investor…

Read more »

US Stock

Nvidia stock: 3 things investors need to know as it surges towards $150

Nvidia is a stock that's had an extraordinary run in 2024. Edward Sheldon highlights some important things investors should know.

Read more »