Building a million pound ISA or Self-Invested Personal Pension (SIPP) – a goal for many in the UK – isn’t easy. To hit seven figures, you need time, patience, and discipline. The good news is that things tend to get significantly easier once you’ve built the first £100k. Here’s why.
The magic of compounding
The key to building a huge ISA or SIPP portfolio is taking advantage of the power of compounding. This is where you earn a return on your previous returns. Over time, compounding leads to exponential returns, so it can be a really powerful wealth building tool.
Now, the beauty of compounding is that the more wealth you build up, the more powerful it gets. And that brings me back to that £100k.
Let’s say that you were saving £10k a year and generating a 9% return a year on your capital. In this scenario, it would take about seven-and-a-half years to get to £100k.
However, once you got to £100k, it would only take about five-and-a-half years to get to £200k because of the extra returns (a 9% return on £100k is £9k). It would then only take about four years to get to £300k.
Once you got to £900k, it would only take a little over a year to get to £1m at a return of 9%. Can you see how it gets much easier over time?
Note that billionaire investor Warren Buffett’s late business partner Charlie Munger had discussed this ‘first £100k’ concept in the past. He noted that the first £100k is hard but said “you gotta do it”.
Aiming for 9%
Zooming in my hypothetical scenario, is a 9% return achievable? I think so, with the right investment strategy. Global index funds tend to provide the bulk of that return. With a fund, it shouldn’t be too hard to pick up 8% a year (on average, over the long run).
Extra returns could then be targeted by investing a selection of high-quality stocks that have the potential to beat the market. An example here – that could be worth considering – is Amazon (NASDAQ: AMZN). Historically, this stock has beaten the market by a wide margin. Over the last decade, for example, it’s risen about 25% a year.
Now, past performance isn’t a guide to future returns, of course. But looking at Amazon today, I see a company with the potential to deliver market-beating returns in the years ahead.
This is a company that’s a leader in online shopping, cloud computing, artificial intelligence (AI), digital advertising, space technology, and more. With exposure to so many different growth industries, I’d be very surprised if this company didn’t get much bigger over the next five to 10 years (and generate strong returns for investors in the process).
As for the valuation, it’s quite reasonable today. At present, the stock has a forward-looking price-to-earnings (PE) ratio of just 31.
Of course, individual stocks have their risks and can be volatile at times. In this case, a global economic slowdown is a risk to consider – it could slow sales both in online shopping and cloud computing,
But I think this is the perfect type of stock to consider owning alongside a global index fund. It has a great track record, and looking ahead, it has many ways to win.
