There’s an investment myth concerning once-outperforming fund manager Peter Lynch and his relationship with 10 baggers.
We achieve a 10 bagger if a share ends up being worth 10 times what we initially paid for it. In other words, we’d achieve a gain of 900%. And Lynch coined the term in his book One Up on Wall Street.
I’d target compound gains from UK growth shares
But the myth is that Lynch made his fund gains of around 29% a year mostly by achieving 10 baggers. But he didn’t. It’s true he wrote about 10 baggers. And he achieved a few. But later he owned up that most of his gains were smaller than 900%. And the growth of the Fidelity Magellan fund he managed was mainly achieved by compounding those smaller gains.
And that’s the principle I’m using to turn a £1,000 investment in growth shares into £5,000. After all, it’s perhaps easier to find a stock with the potential to rise by less than 100% than it is to find one that will go up by 400% over a reasonable time frame.
Meanwhile, the great thing about the process of compounding is it can gain traction fast. The maths are in our favour. For example, if I invest £1,000 in a share that goes up by 71% then sell, I’ll end up with £1,710. If I then repeat the trick and invest the £1,710 for a 71% gain, I’d have £2,924. And doing it a third time would give me around £5,000.
To me, that’s an easier strategy than trying to find a five bagger to achieve that 400% gain. However, I admit that it’s not often a straightforward process to find three 71% gainers in a row. Shares can go down as well as up and sometimes I’ll be likely to lose 20% or more rather than gain almost 100% with a stock investment. Much depends on the performance, growth and prospects of the underlying business.
Potential setbacks along the way
Sometimes, gains approaching 100% will remain elusive. But the principle of compounding smaller gains works well even if I only achieve a 10%, 20%, or 30% gain from an investment. For example, Lynch reckons he made many of his Magellan gains by trading undervalued stalwarts for returns around 20% to 50%.
But stock market investing can involve a two-steps-forward-one-step-back outcome much of the time. Not all the UK growth shares I pick will go up and some will fall and remain down. However, I’d keep the principle of compounding gains in mind as a guiding light. And I’d aim to mitigate the effects of setbacks and reversals by cutting my losses.
In stopping losses from losing shares, I’m in good company. Warren Buffett’s first rule of money management is ‘don’t lose money’. And he is well known for selling some losing investments. Examples include the airlines last year, and Tesco a few years earlier. Meanwhile, ace British investor Lord John Lee reckons he stops his loss if a share falls 20% below his purchase price.
By keeping my winners bigger than my losers, I’d aim to compound my way from £1,000 to £5,000 with UK growth shares. But as with all strategies involving stocks, nothing is guaranteed or certain.
