After making over $100bn in the stock market, Warren Buffett is considered by many to be one of the greatest investors alive today. His strategy can be summed up in a single sentence: “Buy wonderful businesses, and hold them for the long run“.
This approach requires quite a bit of patience – something that not every investor has. But for those who are preparing themselves for retirement, his method could be a perfect fit. Even when putting aside just a small sum each month towards a pension pot, following in Buffett’s footsteps could lead to a far wealthier retirement. Perhaps it could even be an earlier one.
So how does it work?
Preparing to be an investor
With the prospect of making a potential fortune in the financial markets, it can be tempting to jump in head first. However, investing in stocks requires a little bit of prep work. Buffett has repeatedly said that before throwing any money into investments, individuals should first focus on eliminating high-interest debt. The most obvious example of this is credit cards.
As of October, the average interest rate on credit cards is 23.8%. That’s the highest it’s been since the 1990s. And even Buffett’s expertise in stock picking falls short of generating such returns. For reference, since the 1960s, he’s achieved an annual average of 19.8%. And replicating this over long periods is exceptionally challenging.
Therefore, eliminating such debts is a far smarter initial move. While it doesn’t help build wealth, it eliminates the future destruction of it.
Once this initial step is done, another sensible move would be to build an emergency fund in cash. This money should be put into a high-interest-bearing savings account. As the name suggests, it’s there in case of an emergency. But it also acts as a cash buffer.
As everyone has recently been reminded, the stock market can be a volatile place. And when paired with economic turbulence, the situation can be far more dangerous for unprepared investors.
Imagine an individual is unfortunate enough to lose their primary income? Without a suitable emergency fund, they’ll more likely than not be forced to sell some of their investments at terrible prices. This not only interrupts the compounding process but also destroys wealth.
Investing ‘forever’
With debts cleared and a cash cushion saved up, it’s finally time to start putting money to work. But what can surprise a lot of people is that investing largely consists of just waiting around. At least, that’s what’s required when following Buffett’s approach.
Instead of focusing on the stock price, the ‘Oracle of Omaha’ aims his attention squarely on the underlying business. In the long run, the market capitalisation of a company will move in line with its intrinsic value. The latter will only increase if operations are running smoothly and management’s strategy delivers both growth and value to shareholders.
However, executing strategies doesn’t happen overnight. In fact, it can take years or even decades to achieve some of the ambitious goals set out by firms. Buffett has become a master at identifying which companies are the most likely to succeed and will happily wait “forever” to reap the rewards.
Obviously, that’s not practical in real life. But by adopting this mindset it can help avoid making rash decisions during volatile periods.
