In earlier topics we looked at the magic of compounding and how to select suitable investments.

The magic plan for achieving financial freedom can be summarized quite simply:

Put away as much as you can as early as you can. And having done that, do whatever you can to increase the rate of return.

By following and adapting the methods of the great investors (as we will cover in Investing Approach), the vast majority of people are quite capable of amassing well over a million over a lifetime. There is a simple and effective plan:

• Don’t get into debt – especially credit card debt.
• Follow Buffett’s advice, ‘do not save what is left after spending but spend what is left after saving’.
• Build an investment pot by creating a portfolio of index based funds – preferably in a tax-sheltered account.
• Once your portfolio reaches a reasonable size – look to increase the percentage of your returns by investing in individual companies.

The first few steps are self-explanatory, but the last merits further comment.

How do you know when the savings pot reaches a ‘reasonable size’ and how should you approach investing in individual companies?

Firstly – before starting to invest in individual companies you should have enough capital to provide adequate diversity.

Secondly – buying stock in a single company may incur dealing fees that are higher than you may be charged for investing in a regular savings plan. A good rule of thumb is not to purchase stock if the dealing fees amount to more than 2 percent. (For example, If your broker charges $10 per trade, then a single trade should be a minimum of $500).

Thirdly – you will be on a learning curve when you first start to invest in individual companies, and you may wish to curtail your exposure until you have become more adept at investing.

How you go about this will depend, to a large extent, upon your circumstances and personality.

A young, adventurous investor with a pot of $5,000, may wish to start a portfolio of ten positions at $500 each. A keen, but somewhat more cautious investor, may wait until there is $10,000 in the pot, keep $5,000 in index-based securities and start a ‘learning portfolio’ of $5,000. A very cautious investor may wait until there is $20,000 in the index-based pot, learn for a few years with a $5,000 portfolio and then gradually start transitioning into a stock-based portfolio.

At this point, you may be wondering if it is all worthwhile – and shouldn’t you just stick to the index-based plan?

OK – if that’s how you feel. But remember (as we covered in Understanding Compound Returns) that where the index-based plan returns $45,259 – the investor making just five percent more gets $267,864. Is that worth the effort?

You may also be wondering if it is really feasible that you can beat the professionals and beat the market. The answer is an emphatic, Yes. Lynch says that the average investor should be able to beat the market by two to five percent through investing in individual stocks. And, as Guy Thomas’ book, Free Capital testifies, many individual investors do considerably better than that.

With a little discipline and application there is no reason why you shouldn’t achieve a fifteen percent return over the long-term. At this rate, even if you didn’t start saving until the age of forty, by saving $5,000 per year, you would achieve returns of over $1M by age sixty five.

Now that we have a plan, it is time to move on to the next stage in our investing journey: Investing Approach.