It’s a common aim for investors, to want to build a portfolio that is worth £1m. But reaching that point can seem daunting for most people with more modest incomes and small portfolio starting points. My belief however, which is backed up by the maths, is that investing in shares makes it possible to become a millionaire.
So instead of piling my money into the latest fad such as Bitcoin, or into the ever more expensive buy-to-let market, I’m instead going to look for those companies I think can grow for many years to come.
Power of compounding
Dividends play a crucial role in creating a portfolio that will reach the £1m level. This is because of the big difference that compounding makes. It boils down to using the dividends you receive to then buy more shares which means the next year you get an even bigger dividend. Compounding creates a virtuous circle of building ever more income, which can then be used to buy more shares.
Showing the power of compounding is this example. £10,000 invested in the UK stock market before the 2008 financial crisis would today be worth nearly £15,000. If you had reinvested the dividends as you went along, it would be worth in excess of £21,000.
Now, if you reinvest your dividends into good companies that also have a share price that over time heads up, then you’ve got yourself a great combination of share price growth and income. This great combination could, over time, get you to the £1m mark.
Helpfully for investors, dividends paid out within an ISA are tax-free so the whole amount can be reinvested in more shares. This is a great way to help build up the level of an ISA year-on-year.
Staying disciplined and consistent is another key aspect of reaching investment goals generally. It’s accepted by many that keeping faith with shares and not selling up when the markets get choppy is the best course of action. Illustrating this is a striking example where it has been calculated that missing only the best five days in the market in the past 20 years would have led to a 23% lower overall return. Missing the best 10 days would have reduced returns by a staggering 40%.
Conversely, missing the 20 worst days would have led to double the returns of staying invested all along. With that in mind the point is, by all means, manage your portfolio, but don’t try to outwit the market too much. Keep plugging away at building up dividends and don’t hold too much of your ISA(s) as cash.
Rules of Warren Buffett
What’s also important is not to take massive risks with your money. Legendary investor Warren Buffett famously has two major rules: “Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1.” Look for shares that have sustainable growth potential, growing dividends and operating profits rather than gambling on tiny unprofitable companies.
So there you have it. Follow this plan for investing in the stock market and I think you’ll be far more likely to have investments worth a million than if you try to chase that dream by investing in Bitcoin or property.
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Andy Ross has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.