Since he took control at investment firm Berkshire Hathaway in 1965, Warren Buffett has achieved an average annual return of 20%.
That’s staggering. If I manage 20% one year, I’m happy. But 20% a year could provide a very nice income indeed.
The big question, though, is how does he do it? Oh, and if he can do it, can we learn how to do something similar ourselves?
Buffett has his famous rule number one, but I’ll hold that for a moment.
Before then, the key part of Buffett’s strategy is to buy good quality companies when he believes the stock is trading at less than its intrinsic value.
He doesn’t look for the next big thing, or go for risky growth opportunities. Or think about multi-baggers and how to get rich quick. No, he just buys quality, and holds for a long time.
Buffett sums up his ideal stock purchase by saying, “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price“.
Buffett looks for companies with good defensive positions too.
He once said: “If you gave me $100 billion and said take away the soft drink leadership of Coca-Cola in the world, I’d give it back to you and say it can’t be done“.
He did, though, invest heavily in Coca-Cola stock, and he’s done very well out of it.
Which UK stocks might have defensive moats?
I’d think of National Grid here, with its monopoly on energy distribution. And big pharma firms like GSK have such massive capital invested that it would be very hard for newcomers to muscle in.
I’m sure others can think of more.
What you know
Another thing strikes me about Coca-Cola in addition to its defensive qualities. It’s easy to understand. It makes popular soft drinks and sells them.
Sure, the company excels in marketing and all manner of other things. But the business itself is not a complex one.
And that’s another key rule, to buy what you know.
Hard to understand?
Thinking of some new high-tech thingy that everyone’s getting excited about? Do we understand its technology enough to assess the likely profitability?
If not, it might be one to pass. That’s why I’d probably avoid, say, any new artificial intelligence (AI) stock. I know nothing at all about the tech.
I reckon following these approaches gives me my best chance of retiring with a decent passive income stream.
Now, I’m sure I won’t match that 20% per year, or even come close.
But, over the past 20 years, the FTSE 100 averaged 6.9% per year. I reckon that should be enough to build up a decent income pot over the long term.
And, who knows, I might even manage the 9.6% average annual Stocks and Shares ISA return of the past decade, if I’m lucky.
Rule number 1
Oh, I’m near the end and I still haven’t got to Warren Buffett‘s rule number one. It’s simply “Never lose money.” If we follow the rest of his long-term approach, I reckon we can greatly reduce the chances of that.