UK Markets closed

How I’d use compound growth to make a million from £5k

Tom Rodgers
·4-min read
Family with small yellow dog embracing at hill and looking at sunset
Family with small yellow dog embracing at hill and looking at sunset

The stock market is a device for transferring money from the impatient to the patient. So says Warren Buffett. And I think he’s right. If I want to make a million pounds, I’ll need patience.

Yes, it’s less exciting than explosive growth. But most investors just can’t sit on their hands and let their money grow.

The addition of mobile apps into the investing mix is partly to blame. I likely wouldn’t check my portfolio several times a day without them, that’s for sure.

So what are the steps I need to follow to make a million from just a couple of thousand pounds?

Buying options

At The Motley Fool we’re constantly banging on about compound growth. And it could be the key to making a million pounds over time. That’s because this investing method has been proven to grow serious wealth from small beginnings.

To quote finance guru Suze Osman: “You invest money, and your money makes money, and the money you made with the money that you had makes money, and everything compounds.”

To make a million from £5,000 I’d start with a classic FTSE 100 stock like GlaxoSmithKline.

At today’s prices, a one-year investment would yield a dividend return of 5.5%. It’s a rate well above today’s 0.7% UK inflation. So my money isn’t losing value over time as it would sitting in a savings account.

And 5.5% on a £5,000 investment at the end of the first year? That’s £275. The £5,000 has turned into £5,275. Money is making money.

Instead of taking that £275 out to spend, I would reinvest it to buy more stock. This is a key point in the plan to make a million quid. Most ISA providers will allow you to do this automatically with a tick box, so you don’t have to remember to do it manually. Now the next time you get a 5.5% dividend payment? It will be 5.5% of £5,275, not £5,000.

That’s an additional £290.12. It would make your baseline amount £5,565.12 for next year’s 5.5% dividend payment.

So the free money made from dividends is now making its own money. This is compound interest. It’s a simple start for a scheme to make a million in the UK stock market.

Make a million long term

Now I’ll run through the exact calculations required to make a million pounds.

At a return on investment of 5.5% per year, it would take 35 years and an additional £792 per month of regular investing to turn £5,000 into £1m.

While we know that regular, monthly, pound-cost averaging does the hard work for us, £800 a month is a lot of money. So let’s rejig those numbers a little.

I believe with a mix of stable FTSE 100 shares and smaller, more innovative companies, investors can easily bump up their returns to more like 10% per year.

At this rate, it would take three years less and only £315 per month of regular investing to make a million from an initial £5,000 investment.

This is why a diversified portfolio is best. I would mix in some high-margin, high-profit smaller companies like FTSE 250 favourite Games Workshop or 5G devices firm Spirent Communications. I own a couple of rapid-growth AIM stocks like video games publisher Team 17 and human challenge vaccine study specialist Open Orphan too. And along with FTSE 100 dividends investors could add capital gains as share prices rise.

The post How I’d use compound growth to make a million from £5k appeared first on The Motley Fool UK.

More reading

TomRodgers owns shares of Open Orphan plc and Team17 Group. The Motley Fool UK has recommended GlaxoSmithKline. 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.

Motley Fool UK 2020