Warren Buffett: How to Invest Small Amounts of Money

So it's no secret that if you're watching this video, you probably want to be a billionaire just like Warren Buffett. But believe it or not, if you have a relatively small amount of money in your portfolio, you actually have a huge advantage over Buffett when it comes to generating returns. That advantage is that you aren't a billionaire. Okay, I'll admit, when you first hear that statement, it doesn't sound very convincing. But in this video, I'm going to explain why actually having less money in your investment portfolio than Buffett can actually help you generate better returns than the famous Oracle of Omaha.

So Buffett's net worth is currently over 100 billion, but it wasn't always that way. Buffett grew up in Omaha, Nebraska, during the 1930s and 40s, far from a booming financial center of the world at that time. His family was middle class, and he didn't start out with a trust fund to start building his investment empire. This means that there was a time when his investment portfolio consisted of relatively modest sums of money. In fact, Buffett's highest returns of his career were generated when he was in his 20s and 30s and was only managing money for wealthy people in Omaha. A far cry from the 650 billion dollar empire he's managing now.

For us investors who don't yet have billions of dollars in our investment portfolios, it's super important for us to study how Buffett invested during this time. But before we hear from Buffett, make sure to hit the like button and subscribe to the channel because a ton of work goes into making these videos. Now let's see what Buffett has to say.

"My question is, you've repeatedly said that you've seen many wonderful stock ideas but can't invest because they're too small. Given that many in the audience today have a lower dollar investment threshold, do these stocks have names?"

“Well," said Buffett, "the answer to that is that we don't look anymore. We assume that there are a reasonable number of opportunities as you work with smaller amounts of capital, because it's always been true. I mean, it was over the years, as I looked at things, clearly you run into companies that are less followed as you get smaller, and there's more chances for inefficiency when you're dealing with something where you can buy $100,000 worth of it in a month rather than 100 million. But that is not because I'm carrying around in my head the names of 25 companies that we could put $1,000 into; I just don't look at that universe anymore. Sometimes people send me annual reports or I get letters from managers and they say, ‘Won't you know I've got this wonderful thing?’ And I look—I usually know ahead of time, but I mean, I would first look at the size, and if the size isn't right and it isn't going to be virtually anytime, I don't look any further because there's just no time to be looking at all kinds of smaller opportunities. I do think if you're working with very small amounts of money that there are almost always some significant inefficiencies someplace to find things that I've mentioned to some people. When I started out, I actually went through all of the Moody's manuals and the standard manuals page by page. You could—you know it's probably 20,000 pages, but there were a lot of things that popped out and none of them were in any brokerage report or anything of the sort. They were just plain overlooked, and you had to—you could find out about, but nobody was going to tell you about them, and my guess is that that continues to be true, but not on anything like the scale it was then.”

Charlie chimed in, “Well, I can remember when you bought one membership in some Duck Club that had oil in under it when you were young.”

“Yeah,” Buffett replied. “They called—when you get down to one duck club membership, well you're really scavenging for cigar butts. But not a bad cigar butt. There were 98 shares outstanding; it was the Delta Duck Club. The Delta Duck Club was founded by 100 guys who put in 50 bucks each, except two fellows didn't pay, so there were only 98 shares outstanding. They bought a piece of land down in Louisiana, and one time somebody shot downward instead of upward, and oil and gas started spewing forth out of the ground. So they renamed it 'atlid,' which is Delta spelled backwards, which illustrated the sophistication of this group. And a few years later, they were taking $3 barrel oil, and they were taking about a million dollars a year in royalties out of the place. The stock was selling at $29,000 a share and it was earning about $10,000 a share—no, it was earning about $7,000 a share after tax, about $11,000 pre-tax, and it had about $20,000 a share in cash, and it was a long-lived field. So, you know, I use that sometimes as an example of efficient markets because somebody offered me a share of it. And those things—you know, is that an efficient market or not? You know, $29,000 for $20,000 of cash plus $11,000 of royalty income at $0.25 gas and $3 oil? I don't think so. You can find things out there. I'll give you hunting rights on all my duck clubs in the future.”

The first advantage is that you don't have to make large investments. Let me explain what I mean. Berkshire Hathaway, the company Warren Buffett runs, has a current market cap of $660 billion. How large of an investment do you think Buffett has to make to 'quote move the needle,' as he puts it? Using round numbers, let's just say that in order for an investment to have a meaningful impact on the results of the company, that investment has to represent 10% of the entire value of the company. So that investment would have to be roughly worth $65 billion or $70 billion to hit that 10% threshold.

So just to put that in perspective, let's look at some companies that are currently valued around that range. One of the world's most iconic companies, General Electric, is currently valued at around $80 billion. Airbnb is currently valued at $70 billion. Package delivery company FedEx is currently valued at $61 billion. Car maker Ford is valued at $58 billion. Hotel chain Marriott is currently valued at $52 billion. So all of these companies are absolutely massive. However, it would take Buffett buying one of these huge companies in an elephant-sized acquisition, as he puts it, in order to have a truly meaningful impact on Berkshire Hathaway.

Because of this, it limits the pool of potential companies Berkshire can invest in in any meaningful way. Buffett's investable universe keeps getting smaller and smaller as Berkshire keeps getting larger and larger. Compare that to an individual investor with only a small sum of money. So let's use that same 10% rule and say that an investment needs to constitute 10% of this investor's net worth in order for it to be classified as meaningful. This individual investor's investable universe is essentially infinite. This investor can invest in anything from the largest companies in the world all the way down to his neighborhood small business.

Because the pool of potential investments is larger, it's much more likely that our individual investor will be able to find an undervalued investment. The investment in the Delta Duck Club that Buffett talked about is a perfect example of this dynamic at work. The Delta Duck Club started out as a hunting club, but it quickly turned into a business when they found out that the land the club members owned actually contained valuable oil underneath. There were only 98 shares of this company in existence. Each share was trading for $29,000, and each share represented $20,000 in cash and produced $11,000 of after-tax income every year. After subtracting out the $20,000 in cash from the $29,000 purchase price of the share, you were essentially paying $9,000 for an investment that produced $11,000 in after-tax profit for you.

In the investing world, this is what would be called a complete no-brainer. But there's an important caveat as to whether this is a good investment: it depends on the size of the portfolio that is making this investment. If Berkshire was making this investment today, it would represent only 0.004% of the market cap of the company. Honestly, it wouldn't even be worth Buffett's time to make this investment because it represents such a tiny portion of the value of Berkshire that it would be virtually meaningless.

On the other hand, let's say we have an individual investor whose entire investment portfolio is $30,000. This investment in the Delta Duck Club would be amazing for him because it would represent a meaningful portion—aka nearly all of his net worth. In other words, it truly would move the proverbial needle for our investor with a relatively small sum of money.

So this leads us to our second advantage of investing small sums of money: less competition. Generally speaking, in the world of stocks, as the size of the company increases, there are more investors closely following the company. The more investors that closely follow the stock, the less likely it is to be undervalued. Of course, there are exceptions to this rule, but generally speaking, this rule holds up.

Let's use Apple as an example. Apple is a stock that is extremely closely followed by thousands, if not tens of thousands, of smart investors, and these investors work at some of the most prominent hedge funds and investment banks in the world and went to elite universities. Given Apple's large size, the company is currently valued at $2.6 trillion. It gets a ton of attention, and there are so many smart people following the company's every move. The odds of Apple becoming extremely undervalued is low due to how closely followed the company is.

Compare that to a stock that is only valued at, let's say, $100 million. Just due to its smaller size, this stock will naturally get less attention from investors. The stock likely has a tiny fraction of the people following it compared to a massive company like Apple. Because of this dynamic, smaller companies are more likely to be misvalued by the market. This is why Buffett said if he was managing small amounts of money, he would focus on investing in smaller-sized companies because there is more opportunity in these kinds of companies. If your goal is to find undervalued stocks, the less competition, the better.

So I know that most videos here on YouTube that talk about Warren Buffett's investment strategies aren't the most practical, meaning there aren't super tangible pieces of advice that you can begin applying to your own investment strategy immediately. My goal for this video is to be able to actually provide you with tangible takeaways you can begin to help grow your portfolio. If you appreciate this approach, make sure to like this video because it helps me stay motivated to keep making these videos.

So here's the three pieces of practical advice on how to invest small amounts of money from my study of Buffett. The first piece of advice from Buffett is to look where other people aren't. When you're investing small sums of money, you have the advantage of being able to invest in things that are simply too small for large institutional investors. Don't throw away that advantage by always trying to compete against these large players. Instead, focus on investment opportunities that are simply too small to be meaningful for investment funds with billions of dollars. One tangible example of these could mean looking for stocks in certain countries that aren't popular with institutions. Professional investors tend to focus on American-based stocks; however, there are plenty of great companies in various countries throughout the world that may be undervalued relative to their American counterparts.

So the second piece of advice is to focus on smaller companies. Warren Buffett has said previously that if he was managing a much smaller amount of money, he would spend his time focusing on smaller companies because there are more likely to be bargains in this area of the market. This sentiment is shared by other well-respected investors, including Peter Lynch.

Lynch coined the term “10 Baggers,” meaning investing in a stock that goes on to increase by a factor of 10 from the time at which you made the investment. 10 Baggers are every investor's dream. He has talked about how much easier it is for a small company to 10x compared to a large company, and this makes sense intuitively. It's much easier for a company to go from $1 billion in sales to $10 billion than it is for a company to go from $1 billion in sales to a trillion dollars in sales. The larger a company gets, the harder it is for that company to keep growing at the same rate.

The third piece of advice is to look in what is referred to as an inefficient market. An inefficient market is one in which an asset's price does not accurately reflect its true value. The best way to show what I mean is to use an example of an inefficient market I personally invest in. So even though I live in the New York City area, I invest in real estate in a particular large city in the Midwest of the United States. In this city, I'm able to buy real estate that is in poor condition and pay to have the property renovated.

The purchase price of the property plus the cost of renovations is still significantly less than the cost of a renovated property. This is an example of an inefficient market. I can buy a property for $80,000 and spend, let's say, $90,000 to have that property renovated, giving my total investment in the property $170,000. However, the value of the house is worth $280,000 in this real-life example, giving me a profit on my investment of $110,000. This is one example of a so-called inefficient market, but there are plenty of others out there.

So there we have it. I really hope you learned something from this video, and make sure to check out this other video from the channel here. Hundreds of thousands of other people have really enjoyed this video, so I'm sure you will too. It's also my goal to provide you with as much value as possible. If you appreciate that, please like the video and subscribe to the channel. Looking forward to talking again soon.