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How I’d make £1m: gold, Warren Buffett or an index fund?

What’s your magic number? Many people would say £1m would be enough for them to give up work and live comfortably. But building this kind of lump sum isn’t easy while dealing with the costs and challenges of everyday life.

Investing your money skillfully can give you a big advantage over cash savers. But what’s the best way to maximise your chances of long-term gains? Here, I’ll look at gold, index funds and Warren Buffett-style stock picking and give my verdict on the best way to make £1m.

Gold: the oldest investment?

Gold is one of the oldest investments known to man. But is it really a good investment? If you ask a financial adviser, they might tell you gold tends to perform well when inflation is high. They’d probably also suggest it’s a good safe haven asset — when the world’s in trouble, gold usually rises.

However, there are some problems with gold. It doesn’t generate income, industrial demand is minimal and it doesn’t increase in size. One kilo of gold today will be one kilo of gold in 20 years. And you’ll have paid for storage costs.

The only way to make money from gold is to buy low and sell high. I always think that’s a bit risky, as timing the market is difficult. On balance, I don’t think gold is a good way to make a million.

The Warren Buffett method

It’s no secret US billionaire Warren Buffett avoids investing in gold. He once pointed out we pay money to dig it out of the ground, and then we pay money to store it in another hole in the ground.

Buffett prefers to invest in good quality businesses. These have two advantages over gold. They usually get bigger over time and, most of the time, they also produce shareholder returns, such as dividends.

Identifying winning businesses isn’t always easy, but you don’t need to be a hedge fund wizard with a PhD. I think one of the secrets of Buffett’s technique is his patience. He doesn’t speculate on racy small-cap stocks. Instead, he buys mature, proven businesses and lets time work for him.

For investors like us, with smaller pots of cash, I think the best way to replicate this approach is to buy good quality FTSE 100 dividend stocks, and then use your dividends to buy more shares each year.  This approach can deliver surprising gains, thanks to the magic of compounding.

My £1m tip

If you don’t want to pick stocks, then I think a FTSE 100 index tracker fund is a good, safe alternative. The FTSE 100 has a dividend yield of 4.5% at the moment and doesn’t look particularly expensive to me.

However, my £1m tip would be to buy index funds when the stock market crashes. Unless you think the world’s going to end, then history suggests the market will bounce back strongly. If you bought the FTSE 100 at an average of 4,500 in 2009, you’d have made a 30% profit by early 2011.

If you’d bought into the 2016 dip, when the FTSE 100 dropped below 6,000, you could have made an easy 20% in one year, plus dividends. My tip is to be brave and buy when everyone else is selling. It’s not easy — but the rewards can be impressive.

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Roland Head 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.