Warren Buffett, the fourth richest person in the world, has amassed great wealth by becoming one of history’s most successful investors. Throughout his 87 years he has obtained a net worth of $84 billion and has donated a total of $30.8 billion. His method of investing (value investing) which is extremely easy to follow, and he states time and time again that this method is the best way to invest. If you can learn these principles by which Warren Buffett swears by, you too can amass wealth beyond your dreams.
Investing in Index Funds / Passive Investing
Many Americans do not have the time nor the desire to research the financials of countless companies, learn how to read charts and watch the stock market every day. It’s almost impossible to be a professional trader and keep your day job. Warren Buffett has a strategy used by many if not all the world’s richest and busiest men and women. If you could beat over 90% of mutual funds and hedge funds all while not even trying and almost no fees, would you?
“By periodically investing in an index fund … the know-nothing investor can actually outperform most investment professionals.”
Buffett has stood by index funds since the early 1990s. Index funds are very simple to invest in, hence why they are called passive investments. Investing in these funds are great for people who don’t want to become retail traders (do-it-yourself investors). They are very cheap, diversified, and make consistent annual returns. To learn how to buy these funds and shares of any company read the link below.
Understanding Value Investing
Warren Buffett follows a method of investing (value investing) which was invented by his former teacher and mentor Benjamin Graham. Value investors look for companies that are valued higher than their actual stock price. They believe that the stock market will always correct a stock’s price by bringing a company’s price down or up to correctly represent its value. Warren Buffett could care less what the stock, economy, or “experts” are saying about a certain company. If the fundamentals are good and the company is growing every year then he believes that the company’s price will, over time, reflect that. He does his research and if he thinks it’s a great company then he will buy and hold.
Typically, you can tell if a company is “under-valued” if a company’s price-to-book ratio or price-to-earnings ratio is lower than average. However, there are many rules and formulas out there that can tell you if a company’s stock price is true to its value.
Value Investing is very opinion based. Because of this, many value investors use different formulas when determining a company’s value. To keep it simple you should invest in stocks more like you would a business.
Also Read: Formula for Value Investing
Investing in Stocks Like Your Investing in Business
Warren Buffett believes that you should think of yourself as “part owner” of the company you invest in. You should only be investing in companies that have stood the test of time and will continue to do so. You should be looking at the company’s financials, their management, and their competition. If you do your research correctly and would have no problem owning part of the company for 10 years then you can invest your money in the company’s stock.
Not concerned with the short term, Warren Buffett has stated, “Our favorite holding period is forever.” The majority of investors lose money in stocks because they buy and sell too often and too soon. Following the value investing strategy can remove this human error and can lead to huge gains.
Investing like this, you avoid making hasty decisions based off of very little information. This way, when the stock price moves in the opposite direction you don’t sell but rather buy more, because you know the price will eventually go up. This strategy of buying more when the price goes down can benefit you greatly. It can reduce the number of bad timing trades that you make as a buy-and-hold strategy removes the timing factor altogether. Also, you can remove the mistake that emotional traders make of buying high and selling low because you’re not selling.
Warning: Trading like this can have catastrophic effects on your portfolio. If you pick the wrong stock and just keep buying on its fall to 0 it can destroy you financially. It is better to take a different strategy of only buying more shares only when you are at a profit. This way if you ever go negative your not just adding to the damage but keeping it to a minimum.
The Power of Compounding Interest
When asked the main reason for how Warren Buffett got so rich, he will say without so much as a heartbeat, “compounding interest.” Einstein has called compounding interest the eighth wonder of the world. If you can stick to Buffett’s simple investing strategy and can put compounding interest on your side, there is no limit to the amount of money you can make.
If you only invested the make a Roth IRA lets you of $18,000 and make an annual return of 7% a year which is what the typical S&P500 index fund will get you, in 24 years you’d be a millionaire. After that, it would only take another 8 years to make your next million. The saying, “money makes money” is so true.
If you want to invest like Warren Buffett invest in a company’s stock like your investing in it’s business for life. Own it and hold it. Don’t make the mistake that too many traders make of buying things and when they go down, start selling. Find a company and know it inside and out. This way the ups and downs are nothing to freak out over but just a small bump in a long and prosperous road. Use compounding interest to make you rich. Invest in a way that can get you a consistent return and hold that for as long as you can. Following these simple steps is probably the easiest way to become a millionaire!