Image source: The Motley Fool
Legendary investor Warren Buffett is a billionaire many times over. But he started from nothing, saving a little spare money from a paper round when he was a schoolboy to fund his first share purchases.
If I had no savings today and wanted to try and build wealth by investing in the stock market, there are three techniques Buffett has used for decades that I would also adopt.
1. Invest for the long term
First is taking a long-term approach to building wealth.
Buffett is an investor not a trader.
He does sometimes sell his holdings – in the past he has owned UK shares including Tesco and Diageo that he went on to sell. But his preferred holding timeline is “forever“.
That helps explains why he has owned shares in businesses including American Express and Coca-Cola for decades.
I think this approach makes sense.
If I can buy into a great business and it continues to do well, why would I sell? After all, if the initial purchase price for my shares is attractive, over the course of decades, hopefully, my investment will increase in value as the business prospers. I may also earn dividends along the way.
2. Stick to proven businesses
Something interesting about the companies I mentioned above is that none of them are little-known firms promising to be the next big thing. That was also true when Warren Buffett bought into them.
When buying shares, Buffett tends to stick to well-known businesses that have already proven their commercial strength and have often been around for decades.
Small, unproven companies can certainly be very rewarding on occasion. But they can also be risky. As an investor, Warren Buffett does not just consider rewards – he also closely manages his risks.
As he’s said, the first rule of investing is not to lose money – and the second rule is never to forget the first one!
Inevitably, investors do lose money sometimes. But I think Buffett’s comment is a useful reminder to focus on managing risk, and not just get carried away with fantasies of potentially huge gains.
3. Circle of competence
Another technique Warren Buffett uses is to stick to businesses he feels he understands. This is described as staying inside his circle of competence.
Buffett has said that the size of the circle of competence does not matter. What is important is knowing what lies inside it and sticking to that.
Again, the logic here is simple but powerful. If I do not understand how a business works and its marketplace, I am not really able to assess its prospects and assign it a valuation. Buying shares in such a situation is therefore speculating not investing.
Everyone has their own circle of competence. It can grow over time, as one learns about new things. But like Warren Buffett, I think my best chance of investment success comes when I buy shares that fall firmly inside my own circle of competence.
