Is it possible to build wealth from a standing start? I think it is and I would try by learning from very successful investors like Warren Buffett.
Although I may never match Buffett’s incredible financial returns, I can apply lessons from his technique to my own investing. Putting aside some money regularly, I could build a pot of cash to invest. I would do so using the approach of the ‘Sage of Omaha’.
Hunting for long-term value
So what is the Buffett approach? Essentially it boils down to finding businesses that are reasonably likely to be worth a lot in the future – but selling at a sizeable discount to that value.
How does that work in practice? First, Buffett looks for companies he thinks have attractive economic characteristics. For example, demand for soft drinks is likely to remain high. One company – Coca-Cola – has a unique formula no one can copy. That means the business has pricing power, which can help it make profits.
But simply finding a company that seems to have attractive business prospects is not enough. Crucially, Buffett also looks at its valuation. No matter how much a company may generate in future profits. If it sells for too high a price it could turn out to be an unrewarding investment.
Managing risk
But even Buffett makes mistakes – sometimes big ones. So what does he do to reduce their impact that I can also apply when trying to build wealth?
One principle is diversification – Buffett always spreads his investments across a range of companies. Another is that he only invests in companies he feels equipped to understand. That means he misses out on loads of great investment opportunities – and he is fine with that.
Buffett recognises that he can try to reduce his losses by avoiding companies he does not have enough knowledge to assess. Building wealth is not only about jumping on great opportunities, it also involves trying to reduce losses.
Margin of safety
Buffett also tries to build in a margin of safety when investing. That is what I meant above when I mentioned a share trading at a “sizeable discount” to its future value.
If I buy a share a little bit cheaper than I think it is worth and the company faces a problem, I may end up losing money. But if I only buy shares I think are priced at a sizeable discount to their value, I build in a margin of safety like Buffett. I could still lose money, but hopefully the likelihood would be reduced if I had a big enough margin of safety.
Investing like Buffett
Even with no cash in the beginning, I could put this Buffett approach into practice. I would put aside money regularly in a share-dealing account, or Stocks and Shares ISA. Then I would use that to build a diversified portfolio of attractive shares, using the above principles.
