Many investors are fascinated by Warren Buffett – and understandably so. The ‘Sage of Omaha’ has become one of the world’s richest people, thanks to his ability to spot very lucrative investments.
Buffett already has a lot of wealth, which can make investing easier. But what about those with only modest amounts of money to invest? Here is how I would try to use the Buffett method to try and build my wealth over time.
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Wait for great, not just good
Rather than rushing into the first investments that looked promising, I would do what Buffett does and wait for one to come along that I felt was not just good but great. That might take years – in which case, like Buffett, I would wait patiently.
One of the keys to his wealth building has been focussing on buying shares in businesses with prospects he thinks are not just good, but great.
Why does this matter? It is partly down to the long-term impact of compounding returns. Imagine I could buy a share that grew by 5% each year, or one that grew by 8% each year. The difference may not sound huge. But, over time, the impact of compound growth would mean the 8% growing share would produce dramatically better returns.
After 25 years, £1,000 invested in a share with a compound annual growth rate of 5% should be worth £3,481. But the same money invested for an equal time in a share with a compound annual growth rate of 8% should have grown to £7,340. That is more than twice as much.
Warren Buffett sees shares as part of a business
Some investors starting from scratch try to get ahead fast by taking big risks. A common one is investing in shares of businesses they do not really understand, for example because they think the price chart suggests it is undervalued.
Buffett does not buy shares that way. Instead, he looks for a business he thinks has attractive long-term prospects, like Apple or Coca-Cola. Then he considers whether the current share price lets him buy a slice of the business at an attractive valuation.
I think that is a helpful frame of mind when it comes to building my own portfolio over time with the objective of increasing my wealth. If I can find businesses I think have great prospects for years to come there is no reason for me to keep jumping in and out of their shares in reaction to every market movement.
Instead, like Buffett, I would adopt a buy-and-hold philosophy. If I see my shares as a tiny stake in a business I think has a strong future, I would most likely hold onto them. That way I could, hopefully, see good business results reflected in an increasing share price over time.