Thursday, July 16, 2020

How to Become a Millionaire

Charlie Munger taught me that in order to reach a certain goal, I need to invert. In other words, once I identify my end goal, I would have to work backwards in order to get the right parameters in action, and reach it.

“It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.”

“Invert, always invert: Turn a situation or problem upside down. Look at it backward. What happens if all our plans go wrong? Where don’t we want to go, and how do you get there? Instead of looking for success, make a list of how to fail instead–through sloth, envy, resentment, self-pity, entitlement, all the mental habits of self-defeat. Avoid these qualities and you will succeed. Tell me where I’m going to die so I don’t go there.”

One such goal I have had over the years was to become a millionaire. Now you may say that a million is not what is used to be. Naysayers may also state that $1 million will have a lower purchasing power in 20 – 30 years. And they may be right. Or they may just be looking for excuses as to why they are no millionaires, which is why they pretend like it is not a big deal.

Actually, becoming a millionaire is a big deal in the United States. That’s because there seem to be only 12 million millionaires in the country. That’s compared to a population of 330 million. It means that roughly 4% of the population are millionaires.

For example, if you started 40 years ago, and saved and invested $160/month in the S&P 500, you would be a millionaire today. I believe that $160/month was within reach for a large portion of the population of the United States. Yet, less than 4% of the US population is comprised by millionaires.

And to make it even more interesting, a large portion of the millionaires reached this status by starting or owning a business, rather than investing in stocks. By starting a business, you can capitalize your earnings stream. However, a large portion of businesses fail within the first five years.

The second way to get rich is through wise investing. This is really the way I focus on my site, because I believe that you don’t need special skills to become a millionaire. You need time, patience, dedication and ability to soak up money in stocks for years. I believe that becoming a millionaire through regular savings and long-term stock market investing is easier for the large majority of people in the US than starting a business, striking it rich with real estate or through any other way possible. It is within reach for most folks that put this goal to mind, and act accordingly.

If you listen to naysayers however, it sounds as if becoming a millionaire is out of reach for a large portion of the population. But I am not sure why that is the case.

Becoming a millionaire is a function of your savings, your investments and your holding period. The result for your individual situation will vary, because the inputs for every unique individual will vary. We all live in different environments as well. If you graduated from college in 1980, you would have had different job prospects and investing returns than the person who graduated from college in 1930 or 2020.

That’s why I will present you with a simple formula, and a range of options for ponder through.

If you save $1,000/month, and you invest it at 7%/year, you will be able to reach $1 million in 28 years.

If you double that savings rate to $2,000/month, and invest at a 7% annualized returns, you will be able to become a millionaire in 20 years.

If you are able to save and invest $4,000/month at 7% annualized returns, you will be able to become a millionaire in 12 years.

If you are the next Warren Buffett and you generate 17%/year, and saving $4,000/month, you will become a millionaire in 9 years ( versus 12 years at $4,000/month at 7%/year)

A high savings rate brings you closer to the goal than a high return in the accumulation phase.

I used a 7% annualized return in my assumptions, in order to be conservative. Historically, US stocks have returned 10%/year, annualized over long periods of time. While year over year returns fluctuate, they have held through for longer periods of time. If you subtract the 3% annualized inflation rate, you end up with a real return of 7%/year, which is very good. While it doesn't account for taxes and investment fees, I am going to assume that the person who invests for their future is smart enough that they would minimize investment fees to the bone and that they would also invest their money in a tax efficient way ( Roth IRA's are a good start).

It is possible that future returns are much lower than the historical average. Or it is possible that they get closer to the average. You cannot control future returns, but you can control your savings rate, your investment costs, your holding period and what you invest in. If you give yourself every edge possible, you are setting yourself up for success, even if returns disappoint in the future.

I am not sure why more people in the US are not millionaires through investing. The past 40 – 50 years have witnessed a few major bull markets, which have delivered amazing returns to shareholders. anyone who started investing $160/month in US Stocks over the past 40 years could have become a millionaire today. This is a small amount, within reach for most investors. Yet, so many missed out on the great bull run since 1980.

Of course, this million dollar exercise is just a guideline. Instead of looking at dollars and cents, it is better to look at it as a percentage of income. If you spend everything that you earn, you will never have the savings to invest for your retirement. A high savings rate is more important than a higher absolute dollars savings amount.

For example, a person who earns $50,000/year and spends $25,000/year is better off than someone who earns $200,000/year and only saves $40,000/year. That’s because the first person saves 50% of their income, while the second person saves 20% of their income. In addition to that, it is easier to survive on a lower income, in case life throws unexpected surprises your way, such as a job loss and having to accept a position that pays much less. In this case, having a low cost of living is an edge.

Early retirement is easier to achieve through a high savings rate, not by generating high investment returns. That’s the truth in the accumulation phase.

For example, by saving 20% of your income, you can retire in 34 years

If you manage to save 50% of your income, you can retire in 17 years

By becoming a super saver and saving 70% of income, you can retire in a decade

Today, Investing has never been easier, and cheaper and more accessible to the masses. You can choose from thousands of securities from the comfort of your home, You can choose low cost funds holding thousands of securities. Yet, the share of the US population that holds stock is down from its peak in 2000. You just need to take the first step to start your journey towards financial independence.

There are multiple ways to invest money. Some do it through dividend paying stocks, others do index funds, a third group invests in real estate and a fourth group starts businesses. While a large portion of businesses fail, plenty of small business owners can build their net worth over time. One of the best ways to get rich in America is by starting a business. This is how most of the self-made billionaires on Forbes made their fortunes. A business capitalizes your earnings stream and creates wealth that way.

The second best way is to sell your time for money, and invest the difference in businesses. This is what a highly skilled professional, such as a doctor, lawyer, engineer, IT specialist, accountant would do. You have to pay a multiple for that earnings stream however, but you are also a passive owner, with less worries about day-to-day business operations.

- How to retire in 10 years with dividend stocks
Use these tools within your control to get rich
The Dividend Crossover Point
Simple Investing Principles to Follow
What drives future investment returns?

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