When most people think about the stock market and investing, they think of fast-paced trading and get-rich-quick stories. However, as any seasoned investor will know, the key to long-term sustainable wealth creation isn't a get-rich-quick strategy and fast-paced trading can be extremely damaging to returns.
For most investors, slow and steady wealth accumulation using a diversified portfolio is the best way to generate the greatest long-term returns with minimal effort.
A FTSE 100 tracker fund ticks all the boxes here. Over the past few decades, the FTSE 100 (INDEXFTSE: UKX) has generated an average annual return of 5.4% (although the FTSE 100's current dividend yield is 3.6%), excluding fees, dividends and inflation. 5.4% per annum may not seem like a millionaire-making return at first glance, but if you include dividends, the annual return shoots up to around 9%.
The magic of compounding
The power of compounding is a beautiful thing. If you invested £10,000 in a FTSE 100 tracker and the index returned a consistent percentage per annum, it would take 54 years to grow your principle into £1m. If you started off with £10,000 and added an extra £1,000 per annum, it would only take 45 years to reach the £1m mark.
Contributions of £200 a month, or £2,400 per annum would lead to £1m in 38 years and if you added £10,000 a year it would only take 25 years to reach £1m.
If you topped up a stocks and shares ISA every year with the full allowance of £15,000, it would only take 21 years at an average annual growth rate of 9% to hit the £1m mark.
Don't lose money
One of the reasons why such a strategy is best for most investors is the lack of risk. You see, while losing even one or two percentage points of performance per annum can be hugely detrimental to long-term investment performance, a FTSE 100 tracker is so well diversified that there's almost zero risk of permanent capital impairment. With this being case, tracker investors are more likely to see a steady return on their capital with almost no input on their part.
A £10,000 investment in the FTSE 100 30 years ago would be worth just over £48,441 today assuming a basic growth rate of 5.4%. Let's say you're running a portfolio of 30 stocks, which are producing the same returns as the FTSE 100. If in year two, one of the positions goes to zero giving a loss of 3.3%, you only lose £370 at the time but at the end of the three-decade period, the total portfolio value will be only £45,959, an ultimate cost of £2,482. Clearly, this back-of-the-envelope calculation doesn't reflect the whole picture. There are other things to consider here, but it does highlight a key point. Investors should seek to avoid a permanent capital loss at all costs, and a tracker fund is probably the best way to do this.
Overall, the FTSE 100 could make you a millionaire if you buy a low-cost tracker fund and invest with a long-term outlook.
The worst mistake you could make
According to a study conducted by financial research firm DALBAR, the average investor realised an average annual return of only 3.7% a year over the past three decades, underperforming the wider market by around 5.3% annually.
This underperformance can be traced back to several key mistakes that all investors make. To help you realise and understand the most common mis-steps, the Motley Fool has put together this new free report entitled The Worst Mistakes Investors Make.
Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.