You Don't Need a Million to Make a Million

Q: How do you make a million dollars in the stock market?
A: Start with $2 million!

That's a variation on an old joke, but there's a kernel of truth in it. Because if you don't approach your investing sensibly, you could see your nest egg shrink instead of grow.

Losses happen to even the smartest people. Some of the folks behind the famous Long-Term Capital Management multibillion-dollar blowup had Nobel Prizes in economics. And even if you think you're playing it safe by investing in mutual funds, know that they can blow up, too. Imagine investing in the Van Wagoner Emerging Growth fund in 2000, after seeing that it gained an eye-popping 291% in 1999. You might think you're being reasonable if you're just expecting to make 50% or 60%, not 291%, in the years ahead. Well, look at its subsequent returns:

If you'd started with $5,000, you'd be down to around $600. (The fund is still around, by the way, with top holdings that include SAVVIS (NASDAQ:SVVS), Zoltek (NASDAQ:ZOLT), and Internap (NASDAQ:INAP).)

Making a million
Let's back up for a second and think about how to make a million. How quickly you do it will depend on how much money you start with and how quickly it grows, on average, each year. Here are a few scenarios.

That should give you an idea of where you are and where you can get in the next decade or three. Note, though, that some of those numbers represent extremely unlikely investment outcomes. Don't expect to earn an annual average of 26% or 35%. Few achieve even 15% returns. The stock market's average annual gain over the long haul is approximately 10%, and in your particular 10- or 20-year period, it might average 7% or 14% or something else.

Also, those numbers are based on a single lump-sum investment. Odds are that you can regularly keep investing money over the years, meaning that you'll reach your goal more quickly. If so, here's what you can expect from some other possible scenarios:

• Invest $6,000 per year and earn 10% per year on average, and in about 30 years, you'll have amassed a million dollars.
• Invest $10,000 per year and earn 10% per year on average, and in about 25 years, you'll have amassed a million dollars.

Reasonable growth
So what's a good way to go about amassing wealth? Well, I actually do like mutual funds, and lately I've been putting more of my money in them than in individual stocks. With funds, I get experienced investors making the decisions on which stocks to buy or sell and when to do so. I also get instant diversification -- into a variety of emerging-markets companies, for example, or small and promising companies I've never heard of.

I have a sizable chunk of my money in an S&P 500 index fund and another chunk divided between a bunch of outstanding funds. One of my funds, Dodge & Cox Stock, sports a 10-year annualized growth rate of 14.2% (though, darn it, I haven't held its shares for that long), and it focuses on the large-cap universe. Its major holdings include St. Paul Travelers (NYSE:STA), Wachovia (NYSE:WB), Capital One Financial (NYSE:COF), and Electronic Data Systems (NYSE:EDS).

If you're wondering how I found my funds, I was introduced to many of them via our Motley Fool Champion Funds service. Try it for free for a month and you'll have access to all past issues, so you'll get to see which funds our analyst Shannon Zimmerman has recommended -- and why. Together, his picks have gained an average of 28%, vs. 18% for benchmark indexes.

Go for it!
So I hope you see now that you can get to a million dollars, even if you start with modest amounts. With just a few thousand now, and aggressive additions to your nest egg as you invest in carefully selected mutual funds (and maybe a handful of stocks), financial security can fall within your reach.

This article was originally published on Sept. 12, 2006. It has been updated.

Selena Maranjian owns shares of the Dodge & Cox Stock fund. The Fool has a disclosure policy.