Famed investor Warren Buffett has developed a clear set of principles he uses when deciding whether or not to buy shares in a company. I think parts of his approach can also help me as a private investor with very limited funds available. But can the Warren Buffett method really help me if I only want to invest a few hundred pounds?
I think it can – here’s why.
Managing risks
The smaller the amount I invest, the bigger risks I face in some ways. With billions of dollars to invest, Buffett can spread it across a large number of companies. That is more difficult for me to do if I only invest £300. I can still diversify, but realistically probably only across only two or three shares. In such a concentrated portfolio, one share performing badly has more impact than if I had 10 or 20 different companies in my portfolio.
Buffett’s comment that “rule number one is never lose money. Rule number two is never forget rule number one” definitely applies to me as a small investor. Of course, it is impossible to know how a share may do in future. But by only investing in companies I think come with small risks, I can put the Sage of Omaha’s words into action. As an example, consider Cineworld and Vodafone. There is a risk that both companies could find earnings are not big enough to pay their debt. But I see this as a much bigger risk at Cineworld than at Vodafone.
Sticking to my circle of competence
One mistake some investors make when investing small sums of money is chasing high returns by investing in companies they do not understand.
The Warren Buffett method emphasises sticking to one’s “circle of competence”. In other words, Buffett reckons an investor ought not to put money into companies or business areas he does not understand.
Whether investing £300 or £300m, I think that rule still applies. Even in industries I understand, I can make mistakes when assessing a company’s prospects. If I do not understand the industry in the first place, my chance of being able to judge a share’s prospects falls even more.
The Warren Buffett method and the long view
With £300 to invest in shares, lots of buying and selling could mean much of my money gets eaten up fast in commissions and trading fees.
Again, I think I would do better to apply the Warren Buffett method. The famed investor applies a long-term approach to investing. He follows a buy-and-hold investment strategy. As the name suggests, this involves buying shares and then holding them for the long term. If one selects companies with strong prospects, this could help returns compound over time. It also has the benefit of reducing transaction costs due to making fewer trades. With just £300 to invest, such costs could reduce my capital fast. So once again, applying the Buffett approach could help me.
