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Forget gold! I’d follow Warren Buffett and buy undervalued shares to make a million

Warren Buffett’s investment returns have been exceptional over such a long time period. He has consistently outperformed the S&P 500, which has enabled him to become one of the richest people in the world.

His investment strategy has focused on buying undervalued shares that have the potential to deliver sustainable growth as a result of a competitive advantage. He has also held on to his best-performing shares over a period of decades.

One investment he has been continually negative about is gold. Here’s why investing in the precious metal may be a bad idea for those aiming to make a million.

Gold prospects

The price of gold has risen by around 16% since the start of the year. Much of this growth has been due to falling US interest rates, which makes gold appear to be more attractive versus income-producing assets, as well as weak investor sentiment.

Given there are continued risks facing the world economy, such as Brexit and the global trade war, further growth could be ahead in the short run for the gold price.

However, in the long run, investor sentiment is likely to improve. This could mean those who choose to purchase defensive assets such as gold miss out on the present-day low valuations of high-quality businesses. Moreover, it may lead to buying gold while it’s at a relative high, only to see it decline in value over the medium term as investors become more bullish about risky assets such as shares.

Undervalued stocks

As mentioned, Buffett has historically invested in undervalued shares. They provide him with a relatively favourable risk/reward ratio that leads to high returns in the long run.

At present, there appears to be a number of undervalued FTSE 100 and FTSE 250 stocks. In many cases, this is because of fears surrounding the wider economic outlook, rather than problems within a specific company. This could provide buying opportunities for many investors, since a period of stronger economic growth may mean they can offer improving financial performance and warrant higher valuations.

Certainly there may be volatility ahead in the short run. But an investor who has a long-term timeframe is likely to be rewarded through utilising a value investing strategy, since the track record of the stock market shows it has always recovered from its lows to post new record highs.

Consistent strategy

Of course, buying undervalued stocks can be a challenging process. It requires an investor to ignore market ‘noise’ and the opinions of many other market participants. They may be focusing on the potential challenges that could be ahead in the short run.

In this area, Buffett seems to excel. He has an ability to evade the worries that often cause investors to buy defensive assets such as gold and, instead, grab the opportunities to obtain favourable risk/reward ratios that ultimately lead to high returns. Doing likewise could improve your chances of making a million.

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Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.