Three rules for becoming an Isa millionaire

There is no easy way to build serious wealth through investing. It takes an enormous amount of research. And in my experience, a great deal of time on the road. There are very few short cuts.

But recently The Sunday Times tracked down a group of people whohave managed to build an Isa portfolio worth over £1m. And they had some very sharp insights into the best way to build your wealth.

Be self-reliant

The maximum that you could have subscribed to an Isa since they were first introducedin 1987 (thenknown as PEPs)is about £200,000. So, as Isa millionaires, they must have achieved an investment return of at least 20% per annum for over two decades. That is on a par with the greatest investor of them all, Warren Buffett.

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So how have they done it?

These investors are pretty sure of themselves. They do not rely upon the opinion of others. As one puts it a consensus of expert opinion is often not valuable in investment, because it is already reflected in market prices. Successful investors tend to have a predilection for figuring things out for themselves.'

Back your best ideas

Having done the spade work of research, they are confident in their share selections. And they're happy to hold concentrated portfolios. Were they to go to a professional adviser they would no doubt be told to hold 20-30 shares. But as one investor says, 'diversifying risk also means diversifying away profit.' And I'd agree.

I look at it this way. The stock market is the place where you can find good companies that grow and multiply your investment. If you can find thirty that truly measure up to your demanding criteria then by all means invest in every one. But too many investors are at heart afraid of putting too many eggs in one basket. So they fill out their portfolios with shares in which they do not have maximum confidence, and their returnscan suffer as a result.

This conviction investing' contradicts one of the other messages of the article, which is to top-slice'. If, for example, you buy a share at £1 and it doubles to £2 then some investors like to sell perhaps half of their holding, banking at least part of their profit.

The key here is to determine why the share has gone from £1 to £2. If it has simply appreciated along with the underlying business, then it is no more expensive at £2 than it was at £1, so I see no reason to sell. But, if the share price has run up ahead of the progress of the business due to that flaky thing, investor sentiment', then I think there is a good case to sell some shares, maybe with a view to buying them back if the price subsides.

These millionaire investors pay attention to value. That implies an understanding of valuation measures such asprice/earnings (p/e) ratios and yields, and a basic grasp of profit and loss accounts and balance sheets. This is not too hard to acquire and really distinguishes the true investor from the speculator.

John Lee, a notable private investor, warns investors to look out for danger signals delayed company results, auditors or directors resigning, a change of accounting year-end or too many acquisitions. And many of the Isa millionaires look at the chat on the bulletin boards, confident that they can sift the well-informed commenters from the ignorant and nefarious.

For the biggest returns, think small

But the biggest message from the millionaires is this. If you want to make big money, you must buy small companies and be prepared to hold them for the long term. Far too many investors think that entering the stock market is like entering the casino. They think that if you are smart and have a good nerve you can swing the odds in your favour, but basically it is a matter of luck.

These novices fancy themselves as smart traders, but nine times out of ten, the market is smarter than they are. The best investors do all they can to remove luck from the equation. They do so by identifying good businesses, analysing them thoroughly and repeatedly, and then staying with them through the inevitable gyrations of investor sentiment.

Now of course penny shares carry higher risk than blue chip stocks. And when the market collapses, penny shares can suffer badly.

But consider this

All but one of the twelve millionaire investors in the article ignored the top 90% of companies by stock market value. They like the fact that small companies are under researched to which I would add the simple observation that while it is hard for a £20bn giant company to double in size, a £20m company can grow ten-fold and still be considered small.

As I said in this column on 14 February, small companies on the UK stock market have returned 15.1% per year since 1955 compared with 12.4% from the market as a whole. So my recommendation is this.

Find some of these successful small companies, put them in your Isa (if they are eligible).

If you are having trouble finding the best companies yourself, then keep reading Penny Sleuth and Red Hot Penny Shares.

This article is taken from Tom Bulford's free twice-weekly small-cap investment email The Penny Sleuth. Sign up to The Penny Sleuth here.

Information in Penny Sleuth is for general information only and is not intended to be relied upon by individual readers in making (or not making) specific investment decisions. Penny Sleuth is an unregulated product published by Fleet Street Publications Ltd.