Image source: The Motley Fool
A lot of people realise at some point that their savings account adds up to a big fat zero. By contrast, legendary investor Warren Buffett has a lot of zeros in his bank account – as in billions!
Buffett built his wealth from scratch by careful, considered investing in well-chosen businesses. If I was starting from zero today, I think applying his technique could also help me build wealth over the long term.
Buffett invests using a long-term approach. He buys into businesses he thinks have outstanding long-term potential relative to their current share price, then holds his stake for years, or decades, at a time.
Even with no savings, I could start doing that by putting aside a small amount of money regularly into a share-dealing account, or Stocks and Shares ISA. By regularly drip-feeding an amount that matched my own financial circumstances, I could build up an investment fund from a standing start.
Risk and reward
One mistake people sometimes make when they have little to invest is taking big risks, hoping for large rewards. If anything, I think with little to invest it makes sense to take even fewer risks.
Buffett is a billionaire, so losing a million pounds here or there is a drop in the ocean for him. But for many small investors, a loss of just a few thousand pounds could wipe out a large part of their portfolio.
Even with his billions, Buffett is laser-focused on managing risk in his portfolio. When choosing shares to buy, if he feels uncomfortable with the risk he does not invest. I think that approach makes sense for a small private investor like me too.
Value and dividends
But how might buying shares actually help me build wealth? Owning shares can potentially generate money in one of two ways.
The first is an increase in the value of the shares themselves. For example, the biggest holding in Buffett’s portfolio is Apple. The Apple share price has increased 243% over the past five years, so Buffett’s shares are worth more than triple what they were five years ago. That is a paper gain though, until the shares are sold.
The second way I could build wealth from owning shares is if I earn dividends. Those are basically how a company shares its profits with shareholders. Dividends are never guaranteed but can be substantial. Right now, for example, Vodafone yields 10.7%. So if I invest £1,000 in Vodafone shares today, hopefully I will earn £107 annually in dividends.
Buffett has spent his career keeping things simple. He has raised funds to invest, put them into well-run businesses with strong prospects, then sat back for years and waited in the hope of accumulating wealth.
On a smaller scale, the same approach should also help me build wealth over time. But for that to happen, I need to invest – and make the right choices.