I’m certain it’s possible to invest £500 a month into UK shares and compound gains to achieve the sum of £1m. And it’s something achievable well within a person’s working lifetime.
Although such outcomes are never certain because all shares carry risks as well as positive potential.
Wealth-growing power
However, I crunched the numbers based on compounding an average annual gain of 7% from UK shares. And the calculation revealed my investment portfolio would edge over the £1m mark in 38 years.
I admit that sounds like a long time to me because I don’t have that much working lifetime left. But discovering this possibility in my early 20s would potentially have had me laughing with joy now.
The calculation also revealed my £500 monthly investments over 38 years would have totalled £228,000. And the rest of the gain making up the £1m would have come from compounding those average 7% annual increases. I’m always amazed by the wealth-growing power of the process of compounding.
But I need to heed the words of billionaire investor Charlie Munger who is Warren Buffett’s sidekick. He once said the first rule of compounding is to“never interrupt it unnecessarily”. But putting such advice into practice may not be as easy as it sounds.
Handling market volatility
One of the main challenges that any long-term investor faces is the frequent occurrence of stock market setbacks. Just recently, we’ve endured the coronavirus crash and a bear market from its bounce-back highs. And it can be discouraging when annual returns turn negative. It’s even possible to succumb to the temptation to stop investing regularly.
But in my example, it would be folly to miss one of the £500 monthly investments. The thing about the stock market is that it regularly moves up and down. And the 7% annualised returns in the illustration are just an average. In reality, I might gain 1% one year, lose 2% the next year and gain 10% the following year, and so on. But if I stop my monthly investments, I’d be interrupting my programme of compounding and committing the ‘sin’ that Munger also warned against.
But is the 7% figure realistic in the first place? I believe so because the UK’s FTSE 100 index has delivered an annualised return with dividends included of around 7.8% over the past few decades. And America’s S&P 500 index has returned about 10.5% on average each year.
Eating my own cooking
Meanwhile, I’ve been eating my own cooking and kept up my monthly investments through all the market volatility of the past few years. I put my money in low-cost index tracker funds and in various Investment trusts such as Finsbury Growth and Income Trust and others.
But on top of that, I’m a dedicated long-term investor and choose to research and invest in individual company shares. And I do so with the aim of beating that annualised 7% rate of return. It’s a good goal to have because small increases in the annualised rate of return can lead to big increases in the eventual sum achieved.
However, that’s not a certain outcome with shares. And it will only happen as long as I keep compounding positive overall returns and never interrupt the process.