As time goes by, plans can sometimes slip ever further into the future. Many of us hope to build long-term wealth, for example, but as life throws up unexpected financial challenges, even putting savings aside regularly can be a challenge. I am taking some lessons from billionaire investor Warren Buffett when it comes to trying to build serious wealth.
A key lesson from the ‘Sage of Omaha’ is that what matters is not what you start with, so much as what you do with it.
He came from a comfortably well off but not particularly rich family. By getting out on his bike before school each day and delivering newspapers, Buffett was able to earn some pocket money and start buying shares for the first time.
His approach has stayed similar ever since – keep earning money and put it back into new investment opportunities, aiming to grow the size of his fortune along the way.
Like pushing a snowball down a hill
Buffett’s approach to investing is sometimes referred to as “snowballing“.
When pushing a snowball down a hill, it can pick up more snow as it goes which, in turn, picks up more snow. So the snowball can be much larger at the bottom of the hill than it was at the top even with no effort.
Investors simply need to choose the right hill and let time and momentum work their magic.
Money can snowball too
I confess I have never done that in real life with a snow ball. But the metaphor makes perfect sense to me.
I think the stock market can illustrate the effect in practice, as Buffett has shown again and again. For example, British American Tobacco (LSE: BATS) offers a yield of 8.8% at the moment. So if I invest £1,000 today I would hopefully receive £88 in dividends annually. If I spend them, after a decade my stake would still be worth £1,000, presuming no change in share price.
But if I simply reinvest those dividends along the way – snowballing or, as we call it, compounding – then after 10 years I ought to own British American shares worth over £2,400.
I could keep on compounding for decades. Buffett has done just that, holding lots of shares for many, many years and using their dividends to invest in other businesses.
Building wealth, a step at a time
In practice, things might not work quite that smoothly. Take my shareholding in British American as an example. Cigarette use is declining in most markets, a clear threat to profits.
Non-cigarette products are a possible growth driver but for now they are nothing like as profitable. Still, British American is a proven cash generator on a large scale. It has raised its dividend per share annually for decades, meaning it is a Dividend Aristocrat like Coca-Cola, a long-term Buffett holding.
Like many shares Buffett owns, it also benefits from strong brands and competitive advantages (what he calls moats) such as a large distribution network.
By investing consistently in a diversified range of shares and compounding my dividends or capital gains like Buffett, I hope to build long-term wealth.
