Image source: The Motley Fool
As time goes by, plans can sometimes move even further into the future. Many of us hope to build long-term wealth, for example, but as life presents unexpected financial challenges, even saving savings regularly can be a challenge. I'm learning some lessons from billionaire investor Warren Buffett when it comes to trying to build significant wealth.
A key lesson from the 'Sage of Omaha' is that what matters is not what you start with, but what you do with it.
He came from a comfortably well-off but not particularly wealthy family. By hopping on his bike every day before school and delivering newspapers, Buffett was able to earn some pocket money and start buying stocks for the first time.
His approach has been similar ever since: keep making money and reinvest it in new investment opportunities, aiming to increase the size of his fortune along the way.
How to push a snowball down a hill
Buffett's investment approach is sometimes called “snowball“.
By pushing a snowball down a hill, it can pick up more snow as it goes, which, in turn, picks up more snow. Therefore, the snowball can be much larger at the bottom of the hill than at the top, even without effort.
Investors simply need to pick the right hill and let time and momentum work their magic.
Money can also grow like a snowball
I confess I've never done that in real life with a snowball. But the metaphor makes a lot of sense to me.
I think the stock market can illustrate the effect in practice, as Buffett has demonstrated time and time again. For example, British American Tobacco (LSE: BATS) is currently offering a yield of 8.8%. So if I invest £1000 today, I expect to receive £88 in dividends annually. If I spend them, after a decade my share would still be worth £1,000, assuming no change in the share price.
But if I simply reinvest those dividends along the way (in the form of snowballing or, as we call it, compounding), then after 10 years I should own British American shares worth more than £2,400.
I could continue composing for decades. Buffett has done just that: He has held many stocks for many, many years and used their dividends to invest in other businesses.
Generate wealth, step by step
In practice, things may not work so well. Take my involvement with British American as an example. Cigarette consumption is declining in most markets, a clear threat to profits.
Non-cigarette products are a potential growth driver, but for now they are not as profitable. Still, British American is a proven large-scale cash generator. It has increased its dividend per share annually for decades, which means it is a dividend aristocrat as Coca-colaa long-term stake for Buffett.
Like many stocks Buffett owns, it also benefits from strong brands and competitive advantages (what he calls moats), such as a large distribution network.
By consistently investing in a diversified range of stocks and compounding my dividends or capital gains like Buffett, I hope to build long-term wealth.
