Download Becoming a Millionaire - Frederick H. Willeboordse

Becoming a Millionaire!
Lecture 12 – Putting it all to work
This lecture is part of Chapter 5:
Becoming a Millionaire
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???
Buy: 700,000
Rent: 2,000
Compound
….
Compound
….
Compound
….
Compound
….
Compound
….
Compound
Compound….
….
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 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 Stocks
Buy stocks on advice of an advisor/personal
banker
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 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. $100 rather than a
certain number of shares.
Mutual Funds are pretty good, but!, there are significant
costs.
Investing in Stocks
Buy an index fund
Index funds are a special type of Mutual fund that
exactly track an index.
Therefore, their performance will almost exactly be
that of the market.
A good way to invest with a hands-off approach. The costs
are generally low and risks can be much lower as well in
the case of broad-based indices.
Well, the marketing as
always moves me to tears..
Investing in Stocks
Buy Exchange Traded Funds (ETF)
ETF
Exchange Traded Funds are shares listed on the
stock market that (almost) exactly track an index.
Since they are actual shares, they can be bought
and sold any time but only as entire shares.
Pro: Basically all the advantages of Index Funds but easy to
trade.
Con: For small amounts of money, however, the trading costs
may not be worth it. A famous ETF is the so-called Spider
which tracks the US SP500 index.
Investing in Stocks
Mutual Funds vs Index Funds:
Investing is a zero sum game as with regards to the
overall market performance. If one investor
outperforms the market another will underperform it
by definition.
The big problem with Mutual Funds is their costs.
E.g. most mutual funds in Singapore have a 5%
upfront charge plus a 1.5% annual fee.
Index Funds (in the US) usually only charge about
0.27%
Investing in Stocks
=F7*(1+$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.
A
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
B
Mutual F
Index F
Market
C
Load
Load
Year
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
D
E
5% Annual
0% Annual
New Inv.
1,200.00
1,200.00
1,200.00
1,200.00
1,200.00
1,200.00
1,200.00
1,200.00
1,200.00
1,200.00
1,200.00
1,200.00
1,200.00
1,200.00
1,200.00
1,200.00
1,200.00
1,200.00
1,200.00
1,200.00
Total MF
1,140.00
2,372.94
3,706.41
5,148.59
6,708.36
8,395.29
10,219.76
12,192.98
14,327.07
16,635.16
19,131.42
21,831.20
24,751.10
27,909.06
31,324.49
35,018.37
39,013.42
43,334.18
48,007.22
53,061.25
F
1.50%
0.27%
9.80%
Total IF
1,200.00
2,514.04
3,952.97
5,528.64
7,254.05
9,143.45
11,212.40
13,477.97
15,958.86
18,675.51
21,650.35
24,907.90
28,475.03
32,381.16
36,658.52
41,342.38
46,471.37
52,087.79
58,237.97
64,972.64
=E7*(1+$F$4)*(1-$F$2)+$D8*(1-$D$2)
A difference of nearly
12,000 dollars! Or more
than 22%!!!
Investments made at end of year.
Investing in Stocks
Mutual Funds vs Index Funds:
Ergo: If the Mutual Funds performs as well as the index,
the index funds will do better by more than 22% in this
example.
However, on average, Mutual Funds actually
underperform the index!!! Hence, on average, the
difference is even bigger!
Percentage of Stock Funds Outperformed by Index
(Last 10 years, US, Funds investing in large companies)
Investment Style
Percentage
Value
76%
Blend
91%
Growth
86%
Investing in Stocks
Mutual Funds vs Index Funds:
In conclusion, historically speaking, the simplest and
safest way to invest in stocks is through sufficiently
broad based index funds (or for that matter exchange
traded funds).
Percentage of Stock Funds Outperformed by Index
(Last 10 years, US, Funds investing in large companies)
Investment Style
Percentage
Value
76%
Blend
91%
Growth
86%
Buy or Rent
We all would like to own our own home and
there’s of course nothing wrong with that.
The question being: “Is this the best way to make money?”
Surely paying rent can’t help to make me rich. If I buy a flat,
the mortgage is for my own property. It’s like paying to
myself. And, appreciation of the flat is on the full value not
just on the part I’ve already paid for. Or is it?
Excel to the rescue!
Buy or Rent
This looks like quite a complex problem, hence, as always,
let’s take it step by step and start with a list of things we need
to take into account.
• Rent as a percentage of the Price of the Flat/House
• Mortgage Rate
• Appreciation of Flat/House
• Return on alternative investment (e.g. Stocks)
Do we need the price of the Flat/House?
Do we need inflation?
Buy or Rent
These are fairly reasonable
A
B
C
D
E
percentages.
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
37
38
39
40
=F11*$F$3
Rent %
Mortgage Rate %
Appreciation of Flat %
Return on other investment %
Year
Rent
1
2
3
4
5
6
7
8
9
10
27
28
29
30
3000
3180
3371
3573
3787
4015
4256
4511
4782
5068
13648
14467
15335
16255
=PMT($F$4,$I$4,-$I$3,0)
F
G
3.00%
6.00%
6.00%
10.00%
100000
106000
112360
119102
126248
133823
141852
150363
159385
168948
454938
482235
511169
541839
I
Price
Term
100,000
30
Mortgage
Mortgage Value of Flat Value of Inv.
7265
7265
7265
7265
7265
7265
7265
7265
7265
7265
7265
7265
7265
7265
H
4265
8776
13548
18595
23932
29575
35542
41850
48518
55567
258204
276823
296435
317088
Buy.
7265
Yearly basis!
Value of Investment
Account if difference
between Mortgage
and Rent is saved.
=E12-D12+G11*
(1+$F$6)
=F11*$F$5
Buy or Rent
All we did is change the appreciation from 6% to 4%.
A
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
37
38
39
40
B
C
D
E
Rent %
Mortgage Rate %
Appreciation of Flat %
Return on other investment %
Year
Rent
1
2
3
4
5
6
7
8
9
10
27
28
29
30
3000
3120
3245
3375
3510
3650
3796
3948
4106
4270
8317
8650
8996
9356
F
G
3.00%
6.00%
4.00%
10.00%
H
I
Price
Term
100,000
30
Mortgage
7265
Mortgage Value of Flat Value of Inv.
7265
7265
7265
7265
7265
7265
7265
7265
7265
7265
7265
7265
7265
7265
100000
104000
108160
112486
116986
121665
126532
131593
136857
142331
277247
288337
299870
311865
4265
8836
13740
19004
24660
30741
37284
44329
51922
60109
368447
403906
442565
484731
Don’t Buy.
Buy or Rent
All we did is change the appreciation from 6% to 5%.
A
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
37
38
39
40
B
C
D
E
Rent %
Mortgage Rate %
Appreciation of Flat %
Return on other investment %
Year
Rent
1
2
3
4
5
6
7
8
9
10
27
28
29
30
3000
3150
3308
3473
3647
3829
4020
4221
4432
4654
10667
11200
11760
12348
F
G
3.00%
6.00%
5.00%
10.00%
H
I
Price
Term
100,000
30
Mortgage
7265
Mortgage Value of Flat Value of Inv.
7265
7265
7265
7265
7265
7265
7265
7265
7265
7265
7265
7265
7265
7265
100000
105000
110250
115763
121551
127628
134010
140710
147746
155133
355567
373346
392013
411614
4265
8806
13644
18801
24299
30165
36426
43112
50256
57893
317186
344969
374970
407384
Buy ???
?
Buy or Rent
All we did is change the appreciation from 6% to 8%.
A
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
37
38
39
40
B
C
D
E
Rent %
Mortgage Rate %
Appreciation of Flat %
Return on other investment %
Year
Rent
1
2
3
4
5
6
7
8
9
10
27
28
29
30
3000
3240
3499
3779
4081
4408
4761
5141
5553
5997
22189
23964
25881
27952
F
G
3.00%
6.00%
8.00%
10.00%
100000
108000
116640
125971
136049
146933
158687
171382
185093
199900
739635
798806
862711
931727
I
Price
Term
100,000
30
Mortgage
Mortgage Value of Flat Value of Inv.
7195
7195
7195
7195
7195
7195
7195
7195
7195
7195
7195
7195
7195
7195
H
4195
8569
13121
17849
22747
27808
33023
38378
43858
49441
102976
96505
87468
75458
Buy !!!!
7195
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
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 than
a million today.
• The serious part: It can actually be done even when
compensating for inflation.
Finale
First, let’s see how much a million is actually worth in 45
years:
=PV(0.035,45,0,-1000000)
$212,659
Still, 212,659 dollars is not bad at all! But I want a real million:
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)
$4,702,359
(Same formula with P->F)
We’ll need 4,702,359 million. IMPOSSIBLE!!!!
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 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!
Finale
Sigh! Ok let’s try …
Montly savings
Average Return
Number of years
Total Savings
100
12%
45
$2,145,469
That’s not so bad!
We’ll need 4,702,359 million….
Finale
Getting close …
Montly savings
Average Return
Number of years
Total Savings
220
12%
45
$4,720,032
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 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!
Montly savings
Average Return
Number of years
Yearly increase
180
12%
45
5.00%
Year
1
2
3
4
5
6
7
8
9
Total
2160
4687
7631
11047
14998
19555
24796
30811
37700
~ Avg. return SP500
last 60 years
Inflation plus 1.5%
Savings
2160
2268
2381
2500
2625
2757
2895
3039
3191
Total at end:
4,782,937
There you go!
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!
Montly savings
Average Return
Number of years
Yearly increase
100
12%
45
9.20%
Year
1
2
3
4
5
6
7
8
9
Total
1200
2654
4404
6495
8981
11922
15387
19456
24217
~ Avg. return SP500
last 60 years
Since the base is low
this is quite possible.
Savings
1200
1310
1431
1563
1706
1863
2035
2222
2426
Total at end:
4,778,768
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
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
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
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
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!)