The simple strategy driving Warren Buffett’s 20% annualised gains from stocks 

Charlie Munger has revealed the simple strategy behind Warren Buffett’s life-transforming gains from businesses and stocks.

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.

Over the past 56 years, billionaire investor Warren Buffett has achieved compounded annual investment gains of just over 20% a year.

We know this because he set out the performance figures in his annual letter to the shareholders of Berkshire Hathaway. And it’s via that company set-up that he invests in entire businesses and the shares of stock market companies.

That doesn’t mean he actually achieves that 20% return every year. It’s an annualised figure. And in reality, Buffett has experienced volatility along the way. For example, in 2021, his return was just over 29%. But in 2008, Berkshire Hathaway posted an almost 32% decline in its per-share market value. And back in 1998, the gain was a little over 52%.

Buffett harnessed the power of compounding

But averaging 20% a year for almost six decades is no small achievement. However, at first glance, the figure might not look that high. After all, some stocks make gains of 100%, 1,000%, and even 10,000% or more over just a few short years. So how impressive can 20% a year really be? 

And to answer that question I’d point to the consistency of the outcome. The ‘magic’ happens when we compound such gains over a long period of time. And compounding average annual gains of 20% for more than 50 years can lead to life-transforming financial outcomes.

For example, if we invest £1,000 and compound annual gains of 20% for 10 years, we’d end up with a portfolio worth just over £6,000. But if we compound for 20 years, the value shoots up to more than £38,000. And compounding 20% for 40 years causes the figure to shoot up to almost £1.5m.

Indeed, it’s clear to see how Buffett’s focus on compounding gains has propelled him into the multi-billionaire club over time.

Charlie Munger reveals the strategy

I watched an interesting video recently featuring Charlie Munger. He’s Berkshire Hathaway’s vice-chairman and right-hand man to Buffett. Munger explained the simple strategy that both men use to select investments for Berkshire Hathaway.

First, they only deal in things they’re capable of understanding. Second, they search for businesses possessing characteristics giving them a durable competitive advantage. And third, they look for a management team in place with a lot of integrity and talent.

Fourth, Munger said no matter how wonderful a business is, it’s not worth an infinite price: “We have to have a price that makes sense and gives a margin of safety considering the natural vicissitudes of life.”

Munger then went on to say “it’s a very simple set of ideas.” And he reckons the reason those ideas haven’t spread faster is they are too simple.

Indeed, it’s easy to stray into the territory of making things complicated in all areas of life. But Munger’s and Buffett’s simple strategy for investing has clearly worked well for them.

However, it’s worth remembering that although their strategy is simple, it may not prove to be easy to replicate in practice. All shares carry risks as well as positive potential, even when selected using this simple strategy.

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.

Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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

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 »

Bus waiting in front of the London Stock Exchange on a sunny day.
Investing Articles

If interest rate cuts are coming, I think these UK growth stocks could soar!

Falling interest could be great news for UK growth stocks, especially those that have been under the cosh recently. Paul…

Read more »

Investing Articles

Are these the best stocks to buy on the FTSE right now?

With the UK stock market on the way to hitting new highs, this Fool is considering which are the best…

Read more »

Petrochemical engineer working at night with digital tablet inside oil and gas refinery plant
Investing Articles

Can the Centrica dividend keep on growing?

Christopher Ruane considers some positive factors that might see continued growth in the Centrica dividend -- as well as some…

Read more »

Smiling family of four enjoying breakfast at sunrise while camping
Investing Articles

How I’d turn my £12,000 of savings into passive income of £1,275 a month

This Fool is considering a strategy that he believes can help him achieve a stable passive income stream with a…

Read more »

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

2 top FTSE 250 investment trusts trading at attractive discounts!

This pair of discounted FTSE 250 trusts appear to be on sale right now. Here's why I'd scoop up their…

Read more »