There are several ways of becoming a Millionaire. Some are easier and some are more difficult. The intent of this article is to identify what it really takes to become a Millionaire.
There are several assumptions make in this article while trying to reach one Million. Most of them are reasonable and some inevitable ones. Still, they are documented for reference :
1. We are becoming Millionaire with our own money. There are no shortcuts like inheriting it
2. The means used are legal investments
3. Taxes are not considered while the portfolio is in the growth stage.
4. Calculations are done on average annualized growth rates.
5. The most important one, final amounts are in future value and not in present value
Stash the money under a carpet.
This is the laziest solution to becoming a millionaire with no dependency on anyone else. Just putting 10$ a day under the carpet (or in a locket) would take 100,000 days to become a millionaire. That amounts to 274 years or highly unlikely to happen in your life.
Now, it is a pretty depressing number. If we want to improve the odds of doing it successfully in your lifetime, let’s look at different options that are available.
Putting it in a savings account
For a moment, if we assume that the bank interest rates stay constant and we can do more than 30 transactions a month. The interest rate on online savings accounts these days is 0.5%. Considering an average savings rate of 1.5% , it would take us about 109 years to reach 1 Million.
Again, the odds of reaching that are pretty slim. Even if we get 2%, it is still 95 Years. We may have to go with a more aggressive option than this.
Invest in a market index fund like S&P 500
Investing in a market index fund like S&P should give a much higher growth rate. The key caveat here is to be able to reinvest the dividends. S&P has historically grown at an average rate of 10% per annum. If we reduce the rate by 1% to account for investment costs and other overheads/inefficiencies, we reach 1 Million in 37 years.
Now, 37 years is achievable in one’s lifetime but it is still very long considering that someone who has started working would end up getting a Million only near retirement. Since 1 Million is worth way less than 37 Yrs later than today, we need to figure out a faster way to achieve the goal.
There are a few other interesting things to note here. The first one is that of the 1 Million, only 135,000 is what has been invested by you. The rest of it is the growth. Secondly, the growth accelerates very quickly with the change in rate. Hence, the best way to achieve success is to start early and find the highest growth possible.
Invest in Value and Emerging Markets
Now, S&P has historically grown at an average of 10% per annum. If we want a higher growth rate while maintaining the risk profile, we need to look at asset classes that are historically better than S&P.
Historically, if annualized returns are taken, Emerging markets grow at about 14.6% whereas Small Cap worldwide grows at 13.7% growth rate.
Hence, taking emerging markets as the investment asset class, the time required to reach 1 Million comes down to, about 26 years. Unfortunately, the volatility on Emerging markets is also nearly twice that of the S&P 500, which just implies that you may reach 1 Million a year, and may end up at half a million the very next year. Hence, this approach is good as a supplementary source of investment or a part of a broader portfolio.
There is one other consideration. Looking at it alternatively, if you create a UTMA account for your kid and invest about 3.5K each year for him/her in the account (even only for 10 years), your kid would be a millionaire by the time he/she finishes college and start a job. Secondly, if you can convince him/her to not spend this money on frivolous things and let it grow, it would have grown to 17 Million by the time your kid is 50. Even if we look at it in present value terms, it would be enough for him/her to retire at the age of 50.
Although I am not an expert on the lottery, I did research on how much time it would take to win 1M (or more) in a lottery by using all 10$ to buy lottery tickets daily.
The lottery assumed is Texas Lotto. The odds of hitting a jackpot is 1 in 25,827,165 (or about 1 in 26 Million). Since the minimum Jackpot is 4 Million, and a ticket costs 1$, spending all 10 dollars daily means the probability of winning 4M on a given day is 1 in 2.6 Million.
Using expected value probability, you should hit the Jackpot in a mean of 3,561 years. On a positive note, you are going to make at least 4 Million. So, the Million dollar question is “Do you feel lucky?”
Movie quotes aside, I personally have taken the approach of opening a UTMA for my kid at age of 3 (I am late by 3 years) and invested 5K in Emerging Markets and 5 K in Small-Cap value. As of now, SCV is going ahead of EM by a few percentage points but this may be a good experiment to see over the course of the next 20-30 years.