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The stock market makes some people rich? Could I be one of them?

Bus waiting in front of the London Stock Exchange on a sunny day.

Whether or not one hopes to be rich, a bit more money in everyday life would rarely go amiss. People try to improve their financial situation in a variety of ways. Some do very well investing in the stock market and many others dream of doing the same.

Could investing in shares make me rich? I think it might, if I go about it in the right way. Here are five key principles I would bear in mind.

1. It takes money to make money

While the stock market can improve my wealth, I need to actively help myself too. Specifically, if I want to own shares then I need to have money I am willing to invest.

I do not need a lot of money, although the more I can invest, the quicker I could see my wealth increase if I make smart choices. But, at a minimum, I need to be willing to invest some money.

2. Investing not speculating

Some share purchases are investments, while others are what I regard as speculation.

What is the difference? If I invest in a company I understand because I think its share price does not fully reflect its long-term business potential, that is investment. That is what I have done recently buying shares in firms like Dunelm.

By contrast, speculation is when someone buys a share without regard to the underlying business fundamentals, because they think the price is about to shoot up. Think about the likes of AMC and Bed Bath & Beyond during the meme stock craze several years ago.

As an investor, I limit my stock market moves to well-researched decisions based on what I see as business fundamentals. I do not speculate.

3. Valuation matters

Many people refer to businesses as having “a license to print money”. In some cases, such as banknote producer De La Rue, that is literally true. For firms like Apple and Alphabet the expression is used metaphorically – but accurately.

But just because a business is massively profitable does not necessarily mean that buying its shares will make me money as a shareholder. In fact, I could lose money. Such a loss can arise because an investor overpays.

To do well in the stock market, it is not enough to spot brilliant businesses. I also need to be disciplined about only buying their shares when I think they are attractively valued.

4. Circle of competence

One of the most common reasons for investors to see the stock market erode rather than build their wealth is going beyond what they know and understand. By contrast, billionaire Warren Buffett is fastidious about sticking to his circle of competence.

According to Buffett: “The size of that circle is not very important; knowing its boundaries, however, is vital.”

If I do not understand a company and cannot assess its prospects, I am likely speculating not investing.

5. Too much of a good thing

One can have too much of a good thing, the saying goes – and that holds in the stock market too.

Even the best company can run into unexpected difficulties, perhaps dramatically altering its fortunes in the blink of an eye. That is why, again like Buffett, I always keep my portfolio diversified across a range of shares.

The post The stock market makes some people rich? Could I be one of them? appeared first on The Motley Fool UK.

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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. C Ruane has positions in Dunelm Group Plc. The Motley Fool UK has recommended Alphabet and Apple. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.