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Despite making billions in the stock market, Warren Buffett’s investing strategy is pretty simple. Invest in fantastic companies and hold onto them as long as possible.
While this approach to building wealth is far from exciting, it enables compounding to do its magic. And by consistently injecting more capital into top-notch enterprises, a small monthly sum can be transformed into a monumental pile of money. A portfolio can even be geared to start delivering chunky passive income.
Achieving market-beating returns
Many try, but few investors have come close to matching Buffett’s average annualised return of 19.2%. At least none that have maintained such gains for more than 60 years.
Stock picking isn’t an exact science. Analysing financial statements will only take investors so far. In reality, the most successful companies in history weren’t due to a strong balance sheet but rather because of competitive advantages.
Having a unique edge that rivals couldn’t replicate enabled today’s leading firms to capture and retain market share.
Such advantages can come in many forms, each with strengths and weaknesses. For example, having a powerful brand grants pricing power since customers are willing to cough up for perceived quality.
But if that brand’s reputation is somehow tarnished, then this pricing power can disappear rapidly.
Similarly, a firm may have discovered a new way to run operations that improves efficiency and, in turn, profitability. But this edge may not last long if competitors can replicate the same efficiencies.
When Buffett is looking for a strong competitive moat, the focus isn’t solely on what advantages a firm has. But rather investigating whether they can maintain them and expand their moat in the process.
A firm that can consistently stay ahead of its competitors, operating in a critical industry that’s unlikely to disappear, is how Buffett made his fortune. And while there’s no guarantee of replicating his near-20% annualised gains, adopting his strategy can still help investors aim for market-beating returns.
Building a passive income
Growth stocks may be more appealing to investors looking to expand their wealth. But dividends may be the more interesting proposition for those seeking a passive income stream.
Companies that generate more money than they know what to do with usually return it to shareholders via a dividend. Looking at the FTSE 100, the UK’s largest 100 companies currently offer an average yield of 3.8%. But some firms are offering considerably more, reaching even into double-digit territory.
In some instances, a high yield can be a warning sign of unsustainability. But by being selective and focusing only on top-notch enterprises, building a portfolio that can generate a 6% yield without taking on excessive risk isn’t unrealistic.
At a 6% yield, to generate £1,000 a month, or £12,000 passive income a year, an investor would need a portfolio worth approximately £200,000. Needless to say, that’s not pocket change. But given time, an investor can still reach this threshold, even with just £500 a month.
Even if a stock-picking strategy only manages to replicate the stock market average return of 10%, hitting this target would take around 15 years. Needless to say, Buffett’s investing style isn’t a get-rich-quick scheme.
But combining patience with smart decision-making can pave the way to a far superior long-term financial position, and perhaps an even better quality of life.
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