Investing in shares is one of my favourite methods of building wealth, mainly because I don’t actually need to do anything beyond finding a great business to buy shares in.
There are two main approaches to investing in the stock market — growth and income. Growth investors seek to generate exceptionally high returns by investing in younger companies. By comparison, income investors tend to target more mature corporations that pay out reliable and consistent dividends.
Personally, I like to blend the two investing styles together, enjoying the benefits of both worlds while on the path to becoming a millionaire.
Using growth stocks to grow wealth
Typically a growth investing style carries a higher risk level. But it also offers higher potential returns.
In my opinion, investors need to find companies with unique competitive advantages. Preferably one that most people have either not noticed or ignored.
Fortunately, there is a large segment of the UK market called AIM, which is the most successful growth market in the world. It is home to over 850 companies that most institutional investors ignore. Why? Because regulatory restrictions prevent them from investing in such small businesses.
Of course, not all stocks listed on AIM are gems. I’ve found plenty of rotten eggs when searching for growth opportunities. However, as most investment banks aren’t getting involved, when I do find a stock with multiple competitive advantages, it is often undervalued. Needless to say, investing in undervalued shares will accelerate the journey to becoming a millionaire.
Dividends growing dividends
When a company pays out dividends, investors can re-invest the cash into the same business, thus buying more shares. In fact, most brokers will offer a way to do this automatically.
Utilising dividend re-investments unlocks a mighty wealth-building weapon: compounding. If you are unfamiliar with the term, compounding is when an individual receives an interest payment on an initial sum of money as well as any interest payments before it.
In the case of dividends, investors receive a cash sum linked to the number of shares they own. As the income is being reinvested, the number of shares increases with every payment. Therefore each time dividends sent out, the cheque gets bigger and bigger. And after several years, compounding transforms into a snowball effect that can lead to millionaire status.
Investing in shares of high-quality businesses
Buying shares in terrible companies will destroy wealth, regardless of investing style. That’s why I believe the key to becoming a successful stock picker is to take an ownership mentality.
That means understanding exactly how a business works, the growth opportunities, and whether the management team has a smart business strategy.
All three aspects are critical for success in my mind. After all, a firm that generates enormous profits but doesn’t innovate or adapt with the times won’t generate profits for long. Likewise, a company that innovates but doesn’t have a robust business model won’t reach its full potential.
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Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.