Of the proven methods to make a million, two include either creating a revolutionary new product/service, or investing in a company to do it for you. The latter is significantly easier and requires far less effort.
However, there is a caveat. You need money to invest in a company. This often discourages people from considering the stock market as a viable means of building wealth out of fear of losing their initial capital. There is no doubt that buying shares has its risks, but due to the magic of compounding those risks might be worth it.
How compounding can turn £500 a month into a million
Compounding is a pretty simple concept. Whenever you receive an interest payment, the amount being paid to you is based on the initial investment, plus the interest that has been paid previously.
For example, an initial investment of £100 paying 10% interest annually means that the interest payment in year one is £10. But in year two, the interest is now paid on £110 and therefore is now £11. The interest payment has grown by 10% since the previous year. In year three, the interest payment grows once again to £12.10, and this quickly creates a snowball effect.
Let me demonstrate how powerful this snowball effect can be. On average, the FTSE 100 has yielded an 8% annual return. Using this interest rate, the table below demonstrates how long it would take to transform various monthly investment into £1m.
|
Monthly Investment |
5 Years |
10 Years |
20 Years |
30 Years |
40 Years |
|
£250 |
£17,600 |
£43,460 |
£137,290 |
£339,850 |
£777,170 |
|
£500 |
£35,200 |
£86,920 |
£274,570 |
£679,700 |
£1.55m |
|
£1,000 |
£70,400 |
£173,840 |
£549,140 |
£1.36m |
£3.11m |
Making a million over the long term
Matching the market performance is not difficult. Investing in a FTSE 100 tracker fund will almost guarantee the same returns as the general market over the long term.
However, while the prospect of turning a £500 monthly investment into a million is exciting, at an 8% annual return, the process will take 35 years!
A shortcut to millionaire status would be to increase the monthly investment. By comparison, a £1,000 monthly investment would only take 27 years. But that’s quite a financial commitment when there is a less expensive alternative.
Instead of matching the market performance, you could just beat it. Suppose you managed to double the performance of the market average. In that case, reaching a million would only take 23 years instead of 35 with £500 per month.
Invest in high-quality businesses run by experts
Achieving a 16% annual return is much easier said than done. Even professionals struggle to achieve such returns, but it is not impossible.
I have found that the best way to achieve such returns is to invest in high-quality businesses with an ownership mentality. Before I invest in any stock, I ask myself “Why is this company special?” And “Who’s going to run things while I’m enjoying my life?”
These two questions are very simple but can eliminate most stocks from consideration. Whenever I find a business run by a team of talented managers, with a product/service that has multiple distinct advantages over the competition, I get rather excited.
This approach to investing has led me to some of my best investments — including Shopify which has yielded a 1,720% return in just four years!
