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Doing well in the stock market does not necessarily require great skill or vast sums of money.
Clearly, they would help. But fortunately, it is possible to build wealth through a mixture of careful share selection, sensible risk management, patience, and whatever capital is at hand.
For example, if someone had £10k but had never invested before, here is how they could go about it.
Learning is vital to improve the chance of success
It is possible to plunge into the market knowing little and strike it lucky. But that is speculation and, while it can work occasionally, it can also be like setting fire to hard-earned money.
So it definitely makes sense, before investing a single penny (as opposed to speculating), to learn about how the market works. For example, how are shares valued?
Another key thing to understand is the role of risk management.
Spreading £10k evenly over 10 different shares means £1k is the maximum loss an investor could suffer if one share loses all value. Putting the whole £10k into a single share, by contrast, risks it all.
Why a long-term approach helps build wealth
I mentioned patience above. Why does it matter?
Imagine a portfolio that grows at 10% compounded annually. After one year, 10% grows to £1,000. But the following year, 10% (now of £11,000) will grow to £1,100. The following year, 10% (now of £12,100) will be £1,210. And so on.
In short, the growth creates more capital that in turn can lead to further growth. This simple but important concept is known as compounding.
Compound £10k at 10% annually and after 20 years it will be worth £67,275. That is excellent.
But compound it for the same time again and it will be worth not double £67,275, but well over six times as much: £452,593.
Time and patience are the smart investor’s friends.
Finding shares to buy
Some might think that 10% doesn’t sound like much for a compound annual growth rate.
Indeed, FTSE 100 firm Phoenix has a dividend yield of 10.7%.
But no dividend is ever guaranteed. Over five years, Phoenix’s share price has fallen 37%, meaning its compound annual growth rate has not been 10% despite that double-digit dividend.
While 10% is not an easy target over the long run, I think it is possible. Dividends could play a role (maybe a big one) but probably some capital gains would be important too.
One share I think long-term investors could consider with both those things in mind is Guinness brewer Diageo (LSE: DGE).
It has strong brands, a large distribution network, and pricing power thanks to owning unique assets like iconic distilleries. That has helped it fund annual dividend increases for decades. Currently, the share yields 3.8%.
What is less appealing is the five-year stock market record: a share price fall of 32%.
From a positive perspective, that could be seen as potentially offering better value.
But the fall could be seen as reflecting risks including declining alcohol consumption among younger consumers and struggles to maintain sales in a weak economy. This month’s interim results showed lower sales volumes and net sales than in the prior year period.
Still, building wealth is a long-term project.
A short-term first step could be putting the £10k into a share-dealing account or Stocks and Shares ISA.
