Warren Buffett has a long track record of successfully outperforming the stock market. In doing so, he has become one of the wealthiest people in the world.
While his strategy has focused on buying cheap shares in high-quality companies, he has also concentrated his capital in industries that he fully understands. While this has meant missing out on potentially attractive investment opportunities, it has also allowed him to avoid losing money on other investments.
Following a similar strategy could be a sound move when buying cheap UK shares. It may lead to less risk and higher long-term returns.
Warren Buffett’s sphere of knowledge
Warren Buffett has typically invested in a relatively narrow range of industries during his career. For example, consumer goods companies and financial services businesses (including banks) have often made up a large proportion of his portfolio. Certainly, he has invested in other areas over the years. However, his portfolio is perhaps more concentrated on a limited number of sectors that many investors would expect it to be.
A key reason for this is that Buffett only invests in companies and industries that he fully understands. This could be a logical approach for any investor to take, since it can allow them to develop a competitive advantage versus their peers. It also means that they are likely to have a higher chance of being able to spot undervalued companies on a relative and absolute basis. They can also more easily avoid stocks that are being overhyped by other investors.
Developing knowledge of sectors slowly over time
Clearly, it is not possible to become an expert in every sector of the stock market. Even Warren Buffett does not attempt to achieve that goal. However, it could be possible for any investor to develop deep knowledge of a specific industry over time. For example, they may read industry journals and follow the investor updates of companies operating in a specific sector to gain knowledge as to which businesses have the greatest competitive advantages.
Such information is arguably more widely available now than it was in the past. Although using it to build knowledge does not guarantee investment success, it could improve an investor’s capacity to outperform the stock market over the long run.
Using tracker funds in the meantime
While following Warren Buffett’s lead in building knowledge about specific sectors, it may be prudent to use tracker funds in the meantime. They can provide exposure to the stock market prior to sufficient expertise being developed to invest directly in stocks in specific industries.
Although even the most knowledgeable of investors still make mistakes and lose money on investments, having a solid understanding of a small number of industries may be a logical approach to take in what is a fast-moving economy.
