Looking at the Amazon share price, its 32% fall in the past year is hardly the stuff of dreams. But if I had invested in Amazon at its cheapest point ever and sold at the highest, I would have made a return of over 287,000%. In other words, an investment of £1,000 would have made me a multimillionaire!
There are other well-known companies that have produced some phenomenal returns for investors over the past quarter century or so, such as Apple and Alphabet.
I think that in theory it is still possible a £1,000 investment in a single company in years to come could make me a millionaire. So why am I not focused on using such an approach?
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Risks and rewards
The answer comes down to the balance of risks and rewards I try to consider when I am investing.
Take Amazon as an example. In hindsight, its shares may look like an obvious bargain when they were trading for just a few dollars each. But at that point there was no way for me as an investor to know what the future held for the company, its rivals or indeed the whole business area in which it operated.
That is partly because Amazon was unproven. But even a proven business can suddenly encounter unforeseen challenges.
Five years ago, Amazon’s well-established Chinese rival Alibaba looked like a promising investment. But if I had invested then, I would now be nursing a 37% loss in the value of my stake, even after the shares rallied strongly in recent months.
Diversification
That helps to illustrate a couple of important principles I apply when investing.
One is the principle of diversification. That simply means not putting all my investment eggs in one basket. It is easy to focus on an Amazon or Alphabet and reflect on how lucrative buying into those companies alone might have been for me.
But those firms are outliers that do not reflect anything like the average performance of shares over recent decades. Many of their competitors are now worth nothing – if I had invested £1,000 into such a company I would now have lost it all.
So I always diversify my portfolio across a range of shares.
Trying to pick winners
That explains one way I try to manage my investment downside — but what about the upside?
I could still try to pick winners like Amazon or Alphabet. Indeed, that is exactly what I do. But I would do so only as part of a diversified portfolio.
I also try to be realistic about my investment goals. If I invest half a million pounds in shares, I think it is realistic to try and become a millionaire over time. But, even as a long-term investor, I think trying to turn £1,000 into a million pounds is exceptionally challenging.
Instead, I would try to focus on more realistic — but still motivational — investment goals. Trying to find businesses with great commercial potential trading at an attractive price could lead me to some good opportunities, even if they will not realistically make me a millionaire!
