Choosing the right investments is key to building long-term wealth in the stock market, but many investors focus heavily on picking stocks. According to legendary investor Warren Buffett, though, that may not be the ideal approach.
In Berkshire Hathaway's 2021 letter to shareholders, Buffett spoke on his and late business partner Charlie Munger's approach to choosing investments -- and his strategy is simpler than you might think.
Image source: The Motley Fool.
Buffett's advice? Be a business picker.
While many investors worry about what to buy right now that will perform best in current market conditions, Buffett has long emphasized his long-term approach to investing.
"Please note particularly that we own stocks based upon our expectations about their long-term business performance and not because we view them as vehicles for timely market moves," Buffett noted in the letter to shareholders. "That point is crucial: Charlie and I are not stock pickers; we are business pickers."
What happens if you choose stocks without considering the underlying business? Your investment could thrive in the near term, but it may struggle to pull through volatility.
Sometimes hype can drive up a company's stock price, making it seem like a strong investment even if its foundations are shaky. Recessions and bear markets will test those foundations, however, and companies that are more hype than substance are more likely to crash and burn.
A long-term outlook is more important than ever
Even strong businesses can struggle during market downturns, but those with healthy foundations are more likely to recover eventually. Buffett echoes this sentiment, consistently advising investors to hold their stocks for the long haul.
"If you aren't willing to own a stock for 10 years, don't even think about owning it for 10 minutes," he said in Berkshire's 1996 letter to shareholders. He also noted in that letter that it's wise to load up on quality stocks whenever possible.
"Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily understandable business whose earnings are virtually certain to be materially higher five, 10, and 20 years from now," he explained. "Over time, you will find only a few companies that meet these standards -- so when you see one that qualifies, you should buy a meaningful amount of stock."
Investing in quality companies and holding them for as long as they remain strong stocks is key to building lifelong wealth, and it's also much safer than trying to time the market. If you buy a strong investment but sell at the wrong moment, it could cost you. But by holding that investment for several years or decades, it can supercharge your earnings.
