The popular TV show asks, “Who Wants to Be a Millionaire?” The real question is, “Who doesn’t want to become a millionaire?” Aside from billionaires, that is.
Innate in many people is the desire to be wealthy, and to have enough resources to achieve their financial goals. Everyone wants to build enough wealth to retire, gain financial independence, start a business, support worthy philanthropic and charitable organizations, and reach other milestones.
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Whatever the underlying financial goal, wealth is needed to achieve it.
But how do you attain that wealth? Some have become wealthy by mere chance (take the lottery, for example). Others have been fortunate enough to inherit it, and some have built business empires.
Not everyone can win a lottery, inherit wealth or build a successful business. But there is another tried-and-true way for ordinary people to build wealth without depending on luck, inheritance or the ability to build a business empire. It’s called investing.
Investing does not automatically lead to wealth. Putting money in the stock market, for example, will not make you a millionaire, just as randomly tapping your keyboard will not make you a great writer.
Surely, you’ve heard of people (or seen them yourself) who invested in the stock market hoping to be the next Warren Buffett, but who ended up losing money. Many of these people had lofty aims but lacked the principles needed to achieve them via investing.
Consequently, a good place to begin is to identify the four principles of successful investing:
— Start early.
— Stay in the market.
— Invest consistently.
— Diversify your investments.
Principles of Successful Investing
Start Early
To make this point clear, let’s consider the benefits of compounding.
Albert Einstein once called compounding the “eighth wonder of the world.” When you consider the way compound growth helps with building wealth, he is right.
With compounding, all the money you invest earns interest while the resulting interest also continues to earn interest.
For example, if you invest $1,000 at 10% yearly compound interest, then you will earn $100 at the end of year one. At the end of year two, both the original $1,000 and the $100 interest will earn compound interest. A year later, the initial $1,000, the $100 earned at the end of year one, the $100 earned at the end of year two on the initial $1,000, and the $10 earned in year two on the $100 interest earned at the end of year one will all earn compound interest. And this process goes on for as long as you want.
Given the benefits of compounding, it is always better to start investing early rather than later. The earlier you start, the more you can benefit from compounding.
To understand this better, consider two investors: James and Jane. James started investing at the start of 2020, while Jane began in 2022. They both invested $1,000 at 10% compound interest (compounding yearly). At the end of 2023, James would have $1,464, while Jane would have $1,210, a $254 difference.
However, as long as both keep investing at the same compound interest and for the same period, that two-year advantage would persist and even expand going forward. By the end of 2029, James would have $2,594, while Jane would have $2,144, a $450 difference. The difference keeps expanding because the initial two-year advantage continues to compound into the future.
Compounding shows that starting now is better than starting tomorrow.
[READ: Investing for Teens: How to Invest Money as a Teenager]
Stay in the Market
In the same vein, the longer you stay in the market, the more compound growth you can earn.
Many of those who end up losing money in the market are those who are controlled by what Warren Buffett calls the fear-and-greed cycle.
These people invest in the market because they heard that people are making money from one investment (greed). But by the time they enter, the market is already frothy and the values of their investments decline. They then sell out of fear of losing it all. In the end, they have bought high and sold low, thereby losing money.
It is those who stay in the market, through its highs and lows, who can benefit from compound growth. Research has shown that the market rises more than it falls, and that the longer one stays in the market, the higher the probability of making money and the lower the probability of losing it. From 1929 to 2023, bear markets took place in 21.4 of those years, according to Hartford Funds. That means stocks were on the rise 78% of the time.
By the same token, 42% of the S&P 500’s highest-performing days in the 20 years prior to June 2023 happened during a bear market. Another 36% occurred in the first two months of a bull market, before investors even knew for sure it was a bull market, according to Ned Davis Research. Time spent out of the market would have meant opportunity cost.
Invest Consistently
While investing a lump sum in the market and staying in the market can lead to healthy returns, there is an even better way — investing consistently.
Consider two investors who started with $100,000 in the market, earning 10% interest that compounds quarterly. Mike does not add to his investment, while Mary adds $1,000 at the end of every month. At the end of five years, Mike would have $163,862. On the other hand, Mary would have $240,496. Though Mary only invested an additional $60,000 ($1,000 per month for five years), she is $76,634 richer than Mike, making $16,634 from the compound interest generated by that extra $1,000 monthly investment.
The point here is that the fastest way to build wealth is to invest a certain amount regularly. Thus, when creating your budget, you should set aside a percentage of your income to invest consistently.
Diversify Your Investments
Many people have lost significant amounts of money in pursuit of the next big thing in the financial markets.
Successful investing requires diversification. This means, for example, investing in multiple stocks in different industries instead of just one or two stocks in the same industry. It can also mean investing in stocks as well as bonds.
Since diversification can be hard to achieve for retail investors, many investment professionals, including Buffett, have advised that they stick to investing in the S&P 500 index. By investing in this index, investors have exposure to 500 solid companies.
Some retail investors have also sought to diversify by buying index funds or exchange-traded funds, or ETFs, that cover emerging markets and small-cap stocks, among others. Many investors also include a certain percentage of bonds in their portfolios to minimize risk.
Whatever the method used, the key point is that diversification can help reduce risk and prevent huge losses in the market.
Can You Become a Millionaire by Investing?
Now that we have considered the four key principles of investing needed to build wealth, let’s consider how you can become a millionaire by investing. We will look at two test cases — how to become a millionaire in five years and how to make it happen in 10 years.
How to Become a Millionaire in Five Years
In these examples, we will assume that you are investing in the S&P 500 with an average annual rate of return of 10.7%. It’s important to remember when setting savings goals that past performance, especially short-term performance, does not guarantee future results, but we’ll go with this annual rate of return for our analysis.
Finally, we will assume that you are compounding your returns on this investment every quarter. That is, once you earn a dividend at the end of every quarter, you are reinvesting it into the market.
So, what do you need to do to have $1 million after five years?
If you have never invested before (you have zero balance in your investment account), you need to invest approximately $12,821 at the end of every month for the next five years.
Suppose you already have $100,000 in your savings account and you decided to transfer that to your investment account. In this case, you will need to invest approximately $10,648 at the end of every month for the next five years.
How to Become a Millionaire in 10 Years
Now, let’s consider how our calculations change if the time horizon is 10 years.
If you are starting from scratch, you will need to invest about $4,757 at the end of every month for 10 years. Suppose you already have $100,000. Then you will only need $3,390 at the end of every month to become a millionaire in 10 years.
Note that the amount you need to become a millionaire in 10 years is not simply half of what you need to do it in five years. In this example, $3,390 is much less than $5,324 (half of $10,648). This again shows the power of compounding, especially when you stay in the market for a long time.
More Examples of How to Become a Millionaire
If you already know how much you can save every month, given your monthly income, you can use that to calculate how long it will take you to make it to $1 million, given the assumptions we have made (investing in the S&P 500, a 10.7% annual rate of return and quarterly compounding).
What is more, you can also change any of the assumptions we made. For example, you might think the 10.7% return on the S&P 500 is unrealistic going forward, or you might prefer to invest in several funds that will yield an annual rate of return higher than the S&P 500.
Let’s consider some examples:
— Investor A can only invest $1,000 every month and has nothing in savings. If he earns a 10% annual rate of return (compounded quarterly) in a portfolio created by a robo advisor, Investor A will need 22 years and seven months to become a millionaire.
— Investor B is also investing $1,000 but has $50,000. She has the same assumptions as Investor A. It will take her a little over 19 years to become a millionaire.
— Investor C can invest $2,000 every month and she has $50,000. She is sticking with the S&P 500 but is revising the annual rate of return to 7%. She will need 17 years and seven months to become a millionaire.
— Investor D can invest $2,000 every month but has no lump sum. He is also sticking with the S&P 500 but assuming a rate of return of 9%. He will need 17 years and six months to become a millionaire.
We can go on and on with examples. The main point is that instead of determining how much you need to invest to reach your goal, you can start from what you are capable of investing and then find the number of years it will take you to be a millionaire given the other assumptions.
Bottom Line
Investing in the stock market remains one of the most tangible ways to become a millionaire. It is available to everyone, and it does not require luck, a rich family background or entrepreneurial genius. The only differentiating factor is the number of years it takes every individual to get to those million dollars.
Nevertheless, as we have seen, there are principles that you must embrace. Following them is not a matter of intellect but emotional discipline, as Buffett has always emphasized.
Consequently, becoming a millionaire is only hard because of the fear-and-greed cycle and the lack of emotional discipline that subject investors to the short-term whims of the market.
If you can start as early as possible, stay in the market through the highs and lows, invest monthly and diversify, you can be on your way to becoming a millionaire. Forget the lottery, forget inheritance, forget business genius, forget “Who wants to be a millionaire?” Investing, when done right, is a sure path to wealth.
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How to Become a Millionaire by Investing originally appeared on usnews.com
Update 06/07/24: This story was published at an earlier date and has been updated with new information.
