Do you want to become a millionaire?
That’s obviously a rhetorical question; the majority of us would love it. But what’s your plan for achieving that goal?
If your plan is to make that sort of wealth in the stock market, then what’s your strategy? Blue-chip stocks? Index funds? Or do you want to watch your dividend “paychecks” roll in by the truckload?
All of these strategies are great. There’s nothing wrong with them, and they’ll probably make you money in the long run.
But I doubt they’ll make you a millionaire — at least not in time for you to enjoy it.
They’re not going to give you those knocked-out-of-the-park returns that you’ve heard about since you first learned about the stock market.
No, I’m convinced that if your goal is to reach a seven-figure bank account, you need to follow something I like to call the “10 percent solution.”
The idea behind it is simple. If your goal is to become a millionaire in the market, then you need to dedicate a portion of your portfolio to swing for the fences.
Let me explain.
My daughter is in private school. She will eventually go to college and will need cars, trips and — someday — perhaps a wedding.
For her and for the rest of my family, I’ve allocated 90 percent of my portfolio to safe and reliable assets — the kind of assets I know will allow me to meet my comfort level and feel confident knowing I can adequately provide for my family.
But the other 10 percent? That’s different.
This portion is dedicated to the “game changers.” These are the types of stocks that have the potential to move the needle not only on the balance of my account, but on the life I live.
You see, most investors are stuck in the slow lane, passively accepting the market’s returns and failing to use equities as the supercharging force they can be.
While it’s important to have the bulk (90 percent) of your portfolio tied to dependable assets, I think a portion (the other 10 percent) needs to go toward investments with the potential to knock the cover off the ball.
Here’s How The 10 Percent Solution Works
I’ll start this example with a modest amount to show you how it works. Assume you start with a $25,000 portfolio that tracks the broader market. The average annual return from 2002 through 2012 for Standard & Poor’s 500 index was a measly 3.5 percent (with dividends). That means $25,000 turns into $36,499.24 in 11 years.
But things can change dramatically when you add in the potential for just a few big winners.
Let’s say you invest 90 percent of your $25,000 portfolio, or $22,500, in the broader market to achieve that 3 percent return. Then you allocate the remaining 10 percent, or $2,500, to a collection of game-changing picks — stocks with the potential to snag major gains.
If that part of the portfolio averages 30 percent a year, then the initial $2,500 grows into $44,804.01 after 11 years.
Add in the $22,500 and its market return, which has grown to $32,849.32, and you’ve got a pretty nice nest egg of $97,552.06 — nearly double the other portfolio, all thanks to where you put just 10 percent of your money.
(Note: You’ll notice that this return isn’t $1 million, but the results are fully scalable. You can simply start with more capital to reach your goal.)
I’ve made the comparison in the chart to the right. Would you rather have Column A, or would you rather end up with Column B, which uses the 10 percent solution?
I think the answer is obvious.
Now you may be asking, if the 10 percent solution seems to work so well, why not dedicate 50 percent or 100 percent of your portfolio to it?
Simple answer: It’s always important to be diversified, so putting all of one’s eggs into a single basket is never a good idea, no matter how spectacular the potential for returns.
I can sleep at night knowing that most of my money (the majority of my equity portfolio) is invested so as to expose it only to general broad-market risk. Only a small percentage is allocated to game-changing plays with return potential that could move the needle on the overall portfolio.
The fact is, if you pick a few winners over time with a small subset of your portfolio, then it can make an enormous difference. And 10 percent can do the trick nicely. It’s enough to make a difference, but not enough to keep you up at night.
Don’t get me wrong, though. I’m not guaranteeing my system will make you a millionaire. There are no guarantees when it comes to investing.
Action to Take: But what I’m saying is this: The results of a portfolio with room for big winners can be dramatically different from those that stick to cash, fixed-income or even the returns available in the broad market.
And if your goal is to eventually become a millionaire from the market, then I can’t think of any better route.
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