Integrity Competence Prudence
You want to be a billionaire?
Many people look at investing in stocks as a way to amass a large fortune. Some may even think that after depositing a one time sum of money and without ever adding to it they can become multi millionaires or even billionaires ! Mark Hulbert had a very good piece on Marketwatch website related to this subject after the Forbes 400 list came out last month. Here are some excerpts from his column:
A careful study of the Forbes 400 list provides a reality check on the dreams of avarice that motivate many investors. With few, if any, exceptions, the billionaires on the list didn’t make it by engaging in some particularly shrewd trading strategy on Wall Street.
On the contrary, the most well-worn path on to the list is through starting a company that eventually gets bought or goes public. Another popular pathway is to be born to rich parents who leave you with a hefty inheritance.
Since you don’t have control over the latter, the best way to get on the list is to focus your entrepreneurial energies on producing something that the world needs. The stock market will be there after you make your fortune.
This isn’t to say that the billionaires on the list don’t have sizable investments in stocks. But most of them go to the stock market after they already have made their fortunes. Their attitude toward the stock market is not so much that it’s a place where great wealth is built, but instead where you go to preserve the purchasing power of your previously acquired fortune.
What is realistically attainable in the stock market?
Warren Buffett is widely regarded to have the best long-term performance of any investor alive today, and over the past 30 years the book value of his company, Berkshire Hathaway which makes direct investments in stocks of other companies has grown at a 17.7% annualized rate.
The threshold to make it on to this year’s list, for example, is $1.7 billion. Let’s say your net worth by the age of 30 is $1 million. A 17.7% annualized return from then until age 65 would produce “only” $300 million.
And note carefully that the chances of actually realizing a 17.7% annualized return over the next three decades are vanishingly small. If you were merely to equal to the market’s return, and its future return is as good as it was over the past 30 years, your $1 million from age 30 would become $41 million by age 65.
The picture becomes even more bleak if we assume you do no better than the average equity fund (which has produced a 7.93% annualized return over the past 30 years, according to Lipper). On those assumptions, your $1 million from age 30 becomes no more than $15 million by age 65.
Developing realistic expectations is crucial. With unrealistic expectations, you take on unreasonable levels of risk, and then even more risk when those expectations don’t pan out, as they inevitably won’t.