Becoming a millionaire has never been easy. However, there are three steps you can take to make it a lot easier.
Think long term
The first is to think long term. Many investors try to buy low and sell high. This is a sound strategy in theory and if you’re able to execute it consistently over a long period then it will work out well. However, the reality is that predicting short-term price movements of any share is incredibly challenging. That’s why it makes sense for investors to think long term and focus on the compounding of returns rather than seeking to trade their way to millionaire status.
In fact, the FTSE 100 has returned over 9% per annum since its inception in 1984. This is a stunning return and shows that even if you’re only able to match the total return of the index, doing so over a long period can turn even a modest amount of cash into a sizeable nest egg.
Buy the best
All investors are tempted by cheap stocks. Likewise, they’re all tempted by companies that offer high potential growth rates. The reality, though, is that both types of company come with high risk. For cheap stocks, they’re often cheap for a reason. Their profitability may be about to come under pressure or their financial standing may be dubious, for example. Growth stocks sometimes deliver on their potential, but are often let down by rich valuations or inconsistent results.
Due to this, it makes sense to invest in stocks that offer a broader appeal. In other words, invest in stocks with a mix of a sound balance sheet, strong cash flow, a competitive advantage over rivals and a valuation that’s fair rather than dirt cheap.
By investing in the best quality companies, an investors’ risk/reward ratio is likely to be maximised. And while they may cost more than the cheapest stocks around or be forecast to grow at a slower pace than a small tech stock, in the long run the best quality stocks are likely to offer the best overall returns and improve your chances of becoming a millionaire.
While all investors would like to think that they’re the next Warren Buffett, the reality is that we all make mistakes. Certainly, it’s possible for anyone to beat the market on a consistent basis as Buffett has done. However, any company can have a profit warning at any time and it’s therefore imperative that diversification is a central theme of all portfolios.
That’s because it reduces company-specific risk. This means that if a stock in a diversified portfolio halves, it will have a smaller impact on the overall portfolio and won’t put an investor back to square one on the journey towards becoming a millionaire. Diversification also means that it’s possible to invest in a wide range of sectors and geographies, thereby allowing you to access growth rates and value opportunities that wouldn’t have been possible through holding only a small number of stocks.