The key to making a million from the stock market is to compound your gains. However, doing so over an investing career can be fraught with difficulties, setbacks and challenges.
But it’s possible. And the UK has an impressive and growing list of ISA millionaires who’ve invested their way to the ‘magic’ seven-figure sum.
Here are five simple steps you can take to improve your chances of making a million from shares.
The first step towards making a million from shares
I reckon the first step towards making a million from shares is to heed Warren Buffett’s advice to never lose money. Don’t take it literally, because shares will move up and down and occasionally you’ll be underwater with a holding. But do endeavour to avoid situations where you irretrievably lose your capital.
Losing money is worse than you might think. If you do so when you’re young, you’ve also lost all the multiples of that money that you would otherwise have compounded over your investing lifetime. Losing what seems like a little in your 20s, say, could take a big chunk out of your investment income in retirement.
One way of aiming to avoid the permanent loss of capital is to invest in defensive businesses with recurring revenue models. And to do that, I’d look for companies with customers locked in by contracts. Or a firm supplying goods that people tend to buy no matter what, such as medicines, cigarettes, alcoholic beverages, food and cleaning products.
Look for shares with more upside potential than downside risk
The best long-term investments tend to have more upside potential if things go right than there is downside risk if things go wrong.
One way of limiting downside risk is to look for firms with strong balance sheets featuring plenty of cash and liquid assets. I’d also want to see borrowings at sensible levels so that if anything happens, such as the current coronavirus crisis, the business will have a good chance of surviving and thriving afterwards.
Quality is king
Right now, there’s a lot of talk about the cheap stocks on offer after the recent market crash. But ‘cheap’ is only one half of the equation that makes good value.
Buffett, for example, is well known for hunting out good value. But as well as looking for cheap, he has a strong focus on quality.
I reckon quality is king for all stocks. If the underlying business has a strong showing on quality metrics, there’s a good chance that further research will reveal an enterprise operating in a strong and defendable trading niche of the market.
And a good-quality, expanding business can help investors to guard against downside risks as well as powering the upside potential of a shareholder’s portfolio. If you pick a basket of high-quality stocks and buy them at good-value prices, I reckon you’ll have a decent shot at compounding your returns to a million.
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.