Becoming a millionaire
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Becoming a Millionaire!. Lecture 12 – Putting it all to work This lecture is part of Chapter 5: Becoming a Millionaire. Today’s Lecture.

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Becoming a millionaire

Becoming a Millionaire!

Lecture 12 – Putting it all to work

This lecture is part of Chapter 5:Becoming a Millionaire


Today s lecture

Today’s Lecture

Basically, there are two simple ways to accumulate wealth that are practical for most of us. Real Estate and Stocks. Let us have a look at both of them before jumping to the last item.

  • Mutual Funds, Index Funds and ETFs

  • Buy or Rent?

  • Making the million … is easy! Or is it???

Compound ….

Compound ….

Compound ….

Compound ….

Buy: 700,000

Rent: 2,000

Compound ….

Compound ….

Compound ….


Investing in stocks

Investing in Stocks

  • There are roughly 5 ways to invest in stocks:

    • Buy and select stocks yourself

    • Buy stocks on advice of an advisor/personal banker

    • Buy a mutual fund (unit trust)

    • Buy an index fund

    • Buy Exchange Traded Funds (ETF)

Note: All the comments are based on the assumption that we are average investors at best…


Investing in stocks1

Investing in Stocks

Buy and select stocks yourself

Nowadays with cheap internet broking readily available, selecting and buying stocks is very easy (especially in countries like the US where you can buy single shares).

However, this is a risky venture! It is very difficult for an individual to beat the market (and in fact most of the professionals as well).


Investing in stocks2

Investing in Stocks

Buy stocks on advice of an advisor/personalbanker

Unless one has very large sums to invest, it is rather unlikely to be assigned a sufficiently qualified personal banker.

Personal banking is very expensive …. and hence not very suitable for the average investor.


Investing in stocks3

Investing in Stocks

Buy a mutual fund (unit trust)

In a mutual fund or unit trust, the money of thousands of individuals is pooled and then invested by the fund manager according to the nature of the fund.

Since ‘shares’ only indicate how much is contributed to the pool, it is not necessary to buy entire shares and one can buy e.g. 0.1234 shares.

In fact, usually one would buy for a round sum e.g. $100 rather than a certain number of shares.

Mutual Funds are pretty good, but!, there are significant costs.


Investing in stocks4

Investing in Stocks

Buy an index fund

Index funds are a special type of Mutual fund that exactly track an index.

Therefore, their performance will almost exactly be that of the market.

A good way to invest with a hands-off approach. The costs are generally low and risks can be much lower as well in the case of broad-based indices.

Well, the marketing asalways moves me to tears..


Investing in stocks5

Investing in Stocks

ETF

Buy Exchange Traded Funds (ETF)

Exchange Traded Funds are shares listed on the stock market that (almost) exactly track an index.

Since they are actual shares, they can be bought and sold any time but only as entire shares.

Pro: Basically all the advantages of Index Funds but easy to trade. Con: For small amounts of money, however, the trading costs may not be worth it. A famous ETF is the so-called Spider which tracks the US SP500 index.


Investing in stocks6

Investing in Stocks

Mutual Funds vs Index Funds:

Investing is a zero sum game as with regards to the overall market performance. If one investor outperforms the market another will underperform it by definition.

The big problem with Mutual Funds is their costs. E.g. most mutual funds in Singapore have a 5% upfront charge plus a 1.5% annual fee.

Index Funds (in the US) usually only charge about 0.27%


Investing in stocks7

Investing in Stocks

=F7*(1+$F$4)*(1-$F$3)+$D8

Mutual Funds vs Index Funds:

Let us see what this means for 20 years IF the mutual funds perform as well as the market.

=E7*(1+$F$4)*(1-$F$2)+$D8*(1-$D$2)

A difference of nearly12,000 dollars! Or morethan 22%!!!

Investments made at end of year.


Investing in stocks8

Investing in Stocks

Mutual Funds vs Index Funds:

Ergo: If the Mutual Funds performs as well as the index, the index funds will do better by more than 22% in this example.

However, on average, Mutual Funds actually underperform the index!!! Hence, on average, the difference is even bigger!

Percentage of Stock Funds Outperformed by Index(Last 10 years, US, Funds investing in large companies)

Ouchhhh!


Investing in stocks9

Investing in Stocks

Mutual Funds vs Index Funds:

In conclusion, historically speaking, the simplest and safest way to invest in stocks is through sufficiently broad based index funds (or for that matter exchange traded funds).

Percentage of Stock Funds Outperformed by Index(Last 10 years, US, Funds investing in large companies)

This hurts.


Buy or rent

Buy or Rent

We all would like to own our own home andthere’s of course nothing wrong with that.

The question being: “Is this the best way to make money?”

Surely paying rent can’t help to make me rich. If I buy a flat, the mortgage is for my own property. It’s like paying to myself. And, appreciation of the flat is on the full value not just on the part I’ve already paid for. Or is it?

Excel to the rescue!


Buy or rent1

Buy or Rent

  • This looks like quite a complex problem, hence, as always, let’s take it step by step and start with a list of things we need to take into account.

    • Rent as a percentage of the Price of the Flat/House

    • Mortgage Rate

    • Appreciation of Flat/House

    • Return on alternative investment (e.g. Stocks)

Do we need the price of the Flat/House?

Do we need inflation?


Buy or rent2

Buy or Rent

=PMT($F$4,$I$4,-$I$3,0)

These are fairly reasonablepercentages.

Yearly basis!

Value of Investment Account if difference between Mortgage and Rent is saved.

=E12-D12+G11*

(1+$F$6)

=F11*$F$3

=F11*$F$5

Buy.


Buy or rent3

Buy or Rent

All we did is change the appreciation from 6% to 4%.

Don’t Buy.


Buy or rent4

Buy or Rent

All we did is change the appreciation from 6% to 5%.

?

Buy ???

Buy


Buy or rent5

Buy or Rent

All we did is change the appreciation from 6% to 8%.

Buy !!!!

Buy


Buy or rent6

Buy or Rent

So should we buy or rent?

You decide!

I’d say, probably yes unless we either expect appreciation to be very low or stock market gains to be very high. Both not very likely in the long run in an advanced economy.

In any case, whether to buy or rent depends on many factors and is in that sense a very complex decision.


Finale

Finale

  • By now, you might have guessed it. The ‘secret’ to becoming a millionaire is both, a silly AND a serious matter.

  • It’s all about compounding!

    • The silly part: A million in 45 years is worth less thana million today.

    • The serious part: It can actually be done even when compensating for inflation.


Finale1

Finale

First, let’s see how much a million is actually worth in 45 years:

=PV(0.035,45,0,-1000000)

Still, 212,659 dollars is not bad at all! But I want a real million:


Finale2

Finale

How many dollars do we need in 45 years to have the same as 1 million dollars now?

=FV(0.035,45,0,-1000000)

(Same formula with P->F)

We’ll need 4,702,359 million. IMPOSSIBLE!!!!


A better idea

A Better Idea

A letter to Bill Gates!

Dear Bill,

I would like to be a millionaire. Could you kindly please transfer $1,000,000 into my account as soon as possible.

Thank you,

Frederick

P.S. Microsoft is my favorite software. Honestly!


A better idea1

A Better Idea

And he could reply

Dear Frederick,

If you like my software, try using Excel and think of compounding.

Yours,

Bill

P.S. Microsoft is my favorite software too!


Finale3

Finale

Sigh! Ok let’s try …

That’s not so bad!

We’ll need 4,702,359 million….


Finale4

Finale

Getting close …

Wow, but it would be nice if we could push this below 200 dollars.

We’d have more than 4,702,359 million….if only …


Becoming a millionaire1

Becoming a millionaire

Wait a moment! 200 dollars now is a lot more than 200 dollars in 45 years! We should take that into account.

Let’s increase the monthly amount gradually.

Possible, right!

There you go!

~ Avg. return SP500

last 60 years

Inflation plus 1.5%


Becoming a millionaire2

Becoming a millionaire

If $180 is too much, one can of course also start with a smaller amount and increase it a bit quicker.

There you go!

Possible, right!

~ Avg. return SP500

last 60 years

Since the base is low this is quite possible.


Becoming a millionaire3

Becoming a millionaire

Conclusion:

By saving only a small amount every month, it is indeed possible to become a millionaire!

With patience of course…. Probably …


Pitfall

Pitfall

History could be wrong!

True but it’s the best we have, plus even if the average rate will turn out to be less, the power of compounding is still there. In any case it’s going to be a lot of money.


Recommendation

Recommendation

Disclaimer: I’m not taking any responsibility for this!

Don’t put all your eggs in one basket. With your base money, do this:

  • Now:

    • Open an account with a reliable online broker and regularly invest small amounts in Spiders or a similar product until you retire.

  • In a little while:

    • Buy a Flat

Think for yourself!

If you have extra money to save, do this:

Enjoy yourself! Though saving a bit extra can’t hurt of course….


Key points of the day

Key Points of the Day

  • Compound Long and Prosper!

All the best and good luck!

Send me an e-mail in 20years and tell me how your doing!

(If I’m not at NUS, use a search engine to find me!)


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