The way to really power your wealth is to nab the odd ten-bagger.
Quite a few people in the financial media (including me, I confess) have been eyeing the rather peaky-looking state of the stock market and pondering defensive moves. Make sure you're really comfortable with your level of risk, we say. Look for value. Buy companies paying juicy dividends.
That's all good advice. But every time I write one of those articles, I hear from Fools who say something like, "Worrying about the state of the market sounds too much like market timing for me. I want shares I can hold for a long time that will make me wealthy."
So here's what I've been pondering: Can you get wealthy -- really wealthy -- by holding shares for a long time?
Really Long-term Investments
Over the years, my career has brought me into contact with a few wealthy families and their investment portfolios. I'm talking about old-money types, who trace their current wealth to an industrious ancestor a century or more ago, and who have had that wealth professionally managed -- for growth and for income -- for decades.
What's relevant to us is that these family portfolios tend to be built around the shares people now see as rock solid companies, such as Diageo (LSE: DGE), Sainsbury (LSE: SBRY), and BG Group (LSE: BG). These are companies with traditions of excellent management, and their shares, for the most part, have shown decent appreciation over time while paying a good solid dividend.
I like shares like that. And it's easy to look at a wealthy family's portfolio and think, "Hey, they're rich and they own those shares. If I buy shares like that, maybe I'll get rich too."
But is that really how one builds wealth?
"Warehousing" vs Wealth-building
In his best-selling book The Millionaire Mind, wealth researcher Thomas J. Stanley notes a survey of millionaires that found that less than half -- 42% -- indicated that "investing in the equities of public corporations" was an important factor in explaining their economic success.
Stanley writes -- and this is consistent with what I've heard elsewhere -- that many millionaires think of the stock market as a great place to "warehouse" wealth built elsewhere, but not as a wealth generator in and of itself.
I think that's both right and wrong.
On the one hand, if you're simply shooting for market-average returns, the numbers don't lie: £10,000 invested at 10% for 20 years turns into £67,275. That's a nice return on savings, but it's not huge wealth.
And when I look at the companies that might be considered as "hold forever" shares nowadays, whether newer firms like Admiral Group (LSE: ADM) or ARM Holdings (LSE: ARM) or older companies like British American Tobacco (LSE: BATS) and Pearson (LSE: PSON), I see great established companies. Companies that might well beat that market average of around 10% over time by a considerable margin.
Those are desirable shares to own. But they're not going to build big wealth anytime soon. Without a time machine, you're not going to get rich holding stocks like Pearson.
Risk and Wealth-building Go Hand in Hand
Despite their lukewarm feelings about stock market investing overall, 74% of Stanley's millionaires did say that a "willingness to take financial risk given the right return" was an important factor in their success. Many others talked about the importance of being willing to invest in their own businesses, and of other values related to entrepreneurship.
Entrepreneurship is a potent source of wealth -- maybe the best source. Of course, not all of us are entrepreneurs. But we can all invest in entrepreneurs. Putting £10,000 in a company like Tullow Oil (LSE: TLW) might net you a nice solid return over time.
But if you had put that £10,000 in Tullow Oil 10 years ago, it'd be worth around £160,000 now -- despite the oil price crash and despite last year's market drama.
That's wealth-building.
Now, I'm not suggesting that you buy speculative oil companies in the hope you'll score a huge winner. But I'm also not suggesting that you buy Tullow Oil or any other shares that have already rocketed higher.
Looking For The Next Huge Winner
Instead, look for the next Tullow Oil. A future super-growth story. It may already be public, but tiny and largely overlooked by the market. Or it might be an established company entering a new phase.
Those are the shares that will really "build wealth."
Are those shares risky? Individually they might be, especially when compared with buying a blue chip. And if you buy a dozen of them, even if you choose really well, you might only make significant money on one or two.
But if you've ever read Peter Lynch, you know that those one or two "10-baggers" every now and then can drive huge gains for your overall portfolio.
And that's how you build real wealth with stocks. Please feel free to post specific ideas/suggestions in the comments area below. We're all ears!
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> A version of this article was originally published on Fool.com and on Fool.co.uk on 28 August 2009. It has been updated by Bruce Jackson, who doesn't have an interest in any of the companies mentioned in this article.
