Some investors are deterred from investing in the share market because of the high level of perceived risks, together with the perception that it requires a lot of money to get started.
Neither of those beliefs are necessarily true.
First, let's address the issue involving risk. Investing in the share market does involve risk. Shares can – and do – rise and fall on a daily basis, with some stocks experiencing significantly greater volatility than others. Investors can mitigate this risk by focusing on well-established businesses with strong fundamentals, but that doesn't stop even the best of the best falling on some days.
By comparison, cash in the bank accrues interest on a regular basis, with virtually no risk of losing money in the process. But it is this lack of risk that means cash will generate poor returns in the long run, while the higher level of risk associated with the share market has historically allowed it to generate significant returns for investors.
The second issue some investors have is the idea that the share market is only suitable for wealthy individuals with loads of spare cash. Again, not true.
In Australia, the minimum order size for the first trade in any company on the ASX is often $500 (you wouldn't want to spend any less than that anyway, because the brokerage costs as a percentage of your order would be excessive). But that doesn't mean you have to put in $500 at a time! After all, there are no rules stopping you from making regular contributions to your brokerage account.
Here's what it would take to make a difference…
Monthly contributions make a whole lot of sense when you consider the power of compounding. Compounded returns (the concept of interest earning interest) start off small, but get bigger and bigger until they are impossible to ignore.
Between the years of 1900 and 2014, Shane Oliver, chief economist for AMP Capital, found that shares grew at a rate of 11.9% per annum. While 114 years' worth of data is hard to argue with, let's play somewhat conservatively and assume you achieve 8% returns each year going forward.
Let's also say you were to add $100 to your brokerage account each month. It might sound like a bit at first, but a bit of budgeting and spending awareness is often enough to make that work.
Over the course of 12 months, you would have added a total of $1,200 to your brokerage account, buying shares in quality businesses when the opportunities present themselves (note that I am excluding the impact of any brokerage costs here). Over the course of 20 years, you would add a total of $24,000 of your own cash, whilst generating more than $31,000 in returns – be it capital gains or dividends.
Notably, after 30 years, you could have generated more than $100,000 in gains compared to $36,000 in regular deposits. You can see from the chart below how the gains grow larger and larger as the years go on and as compounding works its magic.
A commitment of $100 per month may seem like a reach, and it will be more difficult for some to commit to than others. But if there is room in your budget to start investing regularly, a small-ish contribution each month can make a world of difference. Even $50, invested each month for 30 years, could yield a total result of more than $68,000.
What companies should you buy?
Buying shares isn't as easy as selecting a three-letter ticker symbol at random from the newspaper. Nor should it be as simple as buying the biggest and most widely followed businesses, such as Commonwealth Bank of Australia (ASX: CBA) or BHP Billiton Limited (ASX: BHP).
To achieve great results in the long-run, investors should be on the lookout for businesses that are in good financial health and have reasonable growth prospects. Commonwealth Bank and BHP are unlikely to disappear anytime soon, but it's difficult to see them growing at a rapid rate, either.
One company I do like is Retail Food Group Limited (ASX: RFG). The owner of food brands such as Gloria Jean's and Crust Pizza, this company has a strong history for earnings and dividend growth.
Washington H. Soul Pattinson and Co. Ltd (ASX: SOL) is also worth mentioning. Although it is the second-oldest surviving business on the ASX, the company still has plenty of ways to reward shareholders in the long run.
Foolish Takeaway
Don't let common misconceptions about the share market stop you from investing. Even a small amount set aside each month could make a real difference in helping you grow your wealth in the long run.
