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A lot of people dream of investing in the stock market and building their wealth. But many only dabble a little in the odd share here and there. If I seriously wanted to try and improve my financial position by investing in shares, I would seek to emulate the approach of billionaire investor Warren Buffett. Here’s how.
Use my knowledge to investing advantage
Buffett sticks to his circle of competence when investing. Another way of saying that is that he tries to profit from what he knows rather than speculate about what he does not.
Buffett has said: “You don’t have to be an expert on every company, or even many. You only have to be able to evaluate companies within your circle of competence.”
That means that he sticks to sectors he understands. Within them he also only invests in companies he reckons he can understand too. That is because as an investor, not a speculator, Buffett needs to be able to assess the commercial and financial prospects of any business in which he owns a stake.
I think adopting a similarly disciplined approach when it comes to investing only in firms I understand can potentially give me a competitive advantage in the stock market.
Buy – and be willing to sell
Warren Buffett is commonly described as a buy-and-hold investor. Like me, he believes in long-term investing.
Indeed he has described his favourite period to hold shares as “forever” and his stakes in firms like Coca-Cola and American Express have been owned for decades.
But he also once had a stake in Tesco, which he later sold. The same is true of Johnnie Walker owner Diageo. And Buffett got out of his IBM position entirely. The list goes on.
So, is he really a buy-and-hold investor?
I think he is: ideally he likes to invest in a great company at an attractive price then hold the stake indefinitely.
But crucially, he is disciplined enough not to get emotionally attached to a shareholding. If he thinks the investment case for a business has changed dramatically, he is willing to sell his holding – at a sizeable loss, if necessary.
Building wealth over the long term is not just about making great investments – it also involves cutting one’s losses on bad ones. I think that Buffett wisdom can apply to my own stock market approach and hopefully improve my long-term returns overall.
Diversifying
Even when Buffett does spot a great investment, he always maintains another key discipline. He avoids putting too much of his portfolio into a single company.
Diversification can help reduce the risk to a portfolio if one of the shares in it ends up performing poorly. Warren Buffett uses this approach in his portfolio – and I think it makes sense for mine too.
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