£100 a week doesn’t seem like a large amount of money and £1m sounds like a lot. But it’s possible to get from one to the other surprisingly quickly if you invest in shares and share-backed investments.
For example, several sources cite the long-term annualised return of the UK’s stock market as being around 8%. And if you can compound your investment at an average 8% per year, my calculations show you could end up with a pot worth just over £1m after around 36 years.
That may seem like a long time, but if you start when you are 20, you may have enough to retire from work forever at around the age of 56 – nice!
What about inflation?
One fair criticism of illustrations like this is that in several decade’s time, £1m will not seem as impressive as it does today because of the eroding effect of inflation on prices. That’s a good point, but when inflation goes up, wages tend to follow. So, if you can find £100 a week to invest today, you may be able to find twice or three times that much to invest each week 20 or 30 years from now. And the higher the sum you compound, the higher the end figure will likely be. So you could end up with rather a lot more than a million after 36 years.
But compounding can be accelerated in other ways too. For example, small increases in the annualised return you achieve on your investments add up to big differences in the sum of money you eventually end up with. And compounding delivers the biggest absolute annual returns in the later years. Therefore, if you extend the period of compounding by five years, say, your pot of money could grow very much larger in a relatively short amount of extra time.
Do the work
However, investing in shares and share-backed investments isn’t a get-rich-quick scheme or a way of accumulating wealth without putting in some effort. One of the biggest dangers is that compounding is interrupted because of poor annual returns or even negative annual returns. And I reckon the best way to try to avoid that happening is by focusing on risk before you look at the potential for gains.
I’d be careful about downside risk by avoiding speculative, high-risk investments altogether. So, for me, it’s out the window with profitless, speculative stocks such as Sirius Minerals. Such shares have the potential to multiply your money many-fold, but they also have the potential to wipe it out altogether.
Instead, I’d focus on the shares of companies with a good record of trading and a financial record that reveals generally rising revenues, earnings and cash flow. Quality is key, for me. And I’d look at individual company shares as well as managed funds and index tracker funds.
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Kevin Godbold has no position in any share 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.