The billionaire investor Warren Buffett was born into a financially comfortable family. But he has done a phenomenally good job at building wealth over the course of his lifetime.
We do not all have the opportunities open to us that Buffett does. But here are a trio of things that have helped him build wealth that I think any investor could choose to start doing — today.
1. Staying away from what you don’t properly understand
Of course, it is possible that someone puts money into shares of a company while knowing nothing about it and still makes money.
But that is not investing and it may not even be speculating – it is closer to gambling, in my view. While some such potshots may turn out positively, many do not.
Warren Buffett – who sees a lottery ticket as an inefficient use of his money – certainly does not do that.
He sticks to businesses he feels comfortable he can understand. That makes it easier for him to assess how attract a company’s commercial prospects and its current share price are.
Simply avoiding shares they do not properly understand can help an investor make fewer potentially costly errors.
2. Reinvesting earnings along the way
Another way a small-time investor can aim to build their wealth over time is not to spend the dividends they earn along the way. Instead, reinvesting them generates more capital to put to work in buying shares.
This simple but powerful technique is known as compounding.
It explains why Warren Buffett’s company Berkshire Hathaway does not pay shareholders a dividend even though it is highly profitable. Buffett prefers to compound the firm’s earnings, by using them to buy more businesses and shares.
3. Focus your resources on what you think are your best ideas
It is important for an investor to stay diversified. Of course, a savvy long-term market participant like Buffett does that.
But while risks ought to be spread, spreading them too widely can hurt results. Spreading money across 50 shares will produce lower returns than spreading across the 10 best-performing of them only.
Avoiding mediocre investments allows an investor to focus their resources on the most lucrative opportunities, boosting overall returns. Of course, while that is fine in theory, in practice, nobody knows ahead of time what will be the best-performing investments.
A share I think investors should consider is one that Warren Buffett used to own: Diageo (LSE: DGE).
The Diageo share price has fallen by a third over the past five years. While its track record of annual dividend increases stretching back decades is impressive, that share price fall is not.
However, it does mean Diageo shares can now be bought much cheaper than before (something I have taken advantage of to add some to my portfolio).
Warren Buffett likes well-established premium brands that give a company pricing power – and Diageo has plenty of them, from Johnnie Walker to Guinness. He also likes a proven business model, which hugely profitable Diageo has.
Why, then, has the share fallen so much?
Short-term risks include a weak economy hurting demand for pricy drinks. Longer-term risks involve alcohol consumption rates falling, especially among younger generations.
Still, on balance, I continue to think Diageo’s full potential is not reflected in its current share price.
