Warren Buffett is closely followed within the investing community. The multi-billionaire investor has made one of the largest fortunes in the world by simply investing in high-quality companies for the long run. And it’s a strategy that even those with the modest sums of capital can use to grow their wealth.
While starting early on an investing journey can be hugely advantageous, Buffett’s method can still make a significant difference for older individuals. After all, the billionaire actually made over 99% of his $143bn fortune after he turned 50.
So how can investors leverage his strategy to improve their financial prospects? Let’s take a look.
Quality over quantity
One of the most common pieces of advice novice investors hear is to diversify. On paper, this is a fairly good idea. Diversification helps spread the risk of a portfolio so that if one company fails to live up to expectations, the other portfolio positions can help offset the negative impact.
However, the pursuit of diversification can lead to investors settling for mediocre businesses just for the sake of diversifying. And in the long run, that can actually harm portfolio performance.
Instead, investors should focus solely on finding the highest quality businesses to own and steadily diversify their portfolios over time rather than rushing to gain exposure to certain industries or sectors.
Stay in a circle of competence
Buffett has famously missed out on a lot of growth opportunities over the last two decades by steering clear of the technology sector. While his investment firm, Berkshire Hathaway, now holds tech positions, most have only been recent decisions, and not all by Buffett but rather by his team.
That’s because Buffett never invests in industries or companies he doesn’t understand. And while that can result in leaving a lot of money on the table, it also helps avoid falling into traps that lead to the destruction of wealth rather than its creation.
Pay a fair price
Just because a business is one of the best in the world doesn’t automatically make it a good investment. Overpaying for even a top-notch stock can result in mediocre returns that lag behind stock market indices like the FTSE 100 or S&P 500.
Right now, Rolls-Royce (LSE:RR.) is sitting comfortably as one of the most widely bought UK shares, according to Hargreaves Lansdown. It’s not difficult to understand why. After years of mismanagement and operations being brought to the brink of bankruptcy during the pandemic, shares of Rolls-Royce have exploded following new leadership that steered the business back on track.
Higher volumes of travel have been driving up demand for its aerospace maintenance services. Meanwhile, increased geopolitical conflicts are proving to be powerful tailwinds for its defence segment. And its promising modular nuclear reactors could be a powerful growth catalyst for its energy segment in the next decade.
Yet, with shares trading at a forward price-to-earnings ratio of 64.5, it seems a lot of this growth potential’s already been baked into the stock price, suggesting that shares are actually quite expensive right now. In other words, this increasingly higher-quality business might still be a bad investment under Buffett’s investing method.
This post was originally published on Motley Fool
