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What is the best way to aim for a million in the stock market when investing with the relatively modest means of a private investor?
To answer that question, imagine the following scenario.
You have already been investing for 10 years and during that time you have bought 20, 30 or even 40 companies. Some of those shares you have sold and others you still have.
Compile a table that ranks the total return of each investment relative to its time period. Since this is total return, that includes not only the share price gain (or loss), but also any dividends paid, as well as any fees and charges incurred by the holding.
Straw wheat
Then you divide the table into four sections.
The bottom group contains the stocks you would have been better off never touching: those showing a loss. The next section is actions that basically did nothing for you. They didn't lose money but they didn't make much either, although they made a little.
Then come the stocks that did quite well.
The final group are those who did it. brightly.
The 80/20 principle
Knowing what you know now after that exercise, how could you have transformed your investment performance over the last decade?
Simple.
Simply eliminate the first three groups of stocks and put all your money into the ones that performed brilliantly.
By concentrating your funds on the stocks that end up doing the best, it becomes much easier to aim for a million.
For example, if you invest £1,000 each month and achieve a compound annual return of 5%, you would have a portfolio of one million pounds after 34 years. However, if you could achieve a 20% compounded annual return, that term would be cut by more than half, to 16 years.
This is basically what is known as the 80/20 principle: most returns are generated by a fairly small portion of the average portfolio.
Investing the Warren Buffett way
To see this in action, consider Warren Buffett's track record in Berkshire Hathaway (NYSE: BRK.A), (NYSE: BRK.B).
In his 2022 letter to shareholders, Buffett said the following: “In 58 years of running Berkshire, most of my capital allocation decisions have been no better than average… Our satisfactory results have been the product of about a dozen really good decisions – that would be about one every five years – and, sometimes, a forgotten advantage that favors long-term investors like Berkshire.”.
In practice, the simple-sounding idea of focusing on truly big opportunities is much harder to do than it seems in theory. Still, from 1965 to 2022, Berkshire's market value per share compounded by 19.8% annually.
That's very close to the number I used in my previous example of how you could aim for a million.
Few investors will match Buffett's performance, but his success has been largely due to investing in a few well-known and proven blue-chip companies like Apple and Coca Cola. I would gladly diversify my portfolio into less than a dozen brilliant businesses.
It remains to be seen whether that approach will continue to allow Berkshire to perform well in the future. Apple looks expensive to me right now, for example, and Berkshire recently sold a small portion of its stake.
But the principle remains. If I can narrow it down to notable companies with attractive valuations, I think I can more realistically aim for a million.
