Tag: Millionaire Secrets

Categories
Financial Freedom

In the future, there will be robots: How to Pick Great Stocks

Start with Index Funds

Before getting into picking stocks, it’s worth noting that a good portfolio is largely allocated to low expense index funds. Over the long run, Index funds provide the most consistent returns, a solid dividend to reinvest, and can provide a great foundation to build your portfolio on. If you’re not planning to use the money for 5-10 years, you should be in about 75-80% in an S&P500 Index fund and make sure the dividends get reinvested automatically. This is also an efficient tax strategy for a taxable account. Since you will never sell these funds, they will become long term capital gains, which are taxed at a much lower rate. I recommend using ETF’s such as (VOO; IVV; SPY; RSP). I personally invest in VOO and RSP, the two things to consider when investing in an index fund are: how well does it track to the index it follows, and how expensive is it (expense ratio).

How I Pick Individual Stocks

Lately, I have been adjusting my investing strategy by looking at the long-term potential of the company vs just the valuation fundamentals. You can write a narrative of what you believe the future will look like in say 20 years:

Money In the Future:

  • Physical cash will be obsolete – invest in companies like Visa, Square, AMEX, etc.
  • Cryptocurrencies will weed out the small ones, one or two main leaders will start to go mainstream. Bitcoin is still the leading contender, but has large hurdles to become an actual useful currency:
    • There could be a major shift towards cryptocurrencies if the US monetary policy (in 2020) leads to long term inflation or instability. 
    • Cryptocurrencies will become a larger part of our economy, however, the only value now is based on speculation. Cryptocurrencies are, by their nature deflationary currencies (the supply is limited, so the value goes up the more it is in demand/used). The deflationary currencies aren’t very useful for purchasing things since people think “why would I buy that iPhone today with this Bitcoin? The value of the bitcoin could increase tomorrow and the iPhone would be cheaper!” People aren’t using Bitcoin to actually purchase things in high volumes yet. 
    • Governments cannot control cryptocurrencies, and will likely do everything they can to slow/stop them (the government likely won’t succeed)
    • Normal banks will have to embrace cryptocurrencies. Find the ones that are adapting or the newcomers without corporate baggage slowing them down (SQ)
    • Despite this, I am still not comfortable putting a lot of money into cryptocurrencies right now. I will likely reconsider often, but I don’t think it’s a good primary financial allocation at this point. I don’t understand it well enough to put my money on it…

Technology 

  • Artificial intelligence will grow exponentially. This growth will have an impact on how we learn, manufacture, manage, accounting, etc. There are some big players out there making ‘home-grown’ solutions, but companies like C3.ai (AI) could be huge in the future and disrupt companies like Oracle.
  • Social media will continue to expand its control and AI will replace low-level analytical jobs
  • The majority of retail be from online sales, malls and big-box stores need to adapt or die
  • Ridesharing will expand greatly and become automated (Uber/Lyft). Traditional car ownership may change to looking more like a subscription service.
  • The gig economy will increase and become more global. This may have a negative impact on US wages since it’s easy to outsource on Fiverr
  • The sharing economy is positioned to be bigger than the gig economy because there are so many under-utilized assets being tapped into for the first time. Airbnb will continue to dominate, and the overall scalability can be huge
  • Trucking/logistics industry (Workhorse)
    • The industry will be automated – long haul will go first, local delivery will take much longer to automate
  • Automation will continue to erode US manufacturing jobs… the demand for engineers will be the bottleneck in the near future. AI/Machine learning will need to get much better to remove this bottleneck, but I would bet on AI over traditional manufacturing

Energy/Sustainability – Energy has always been a huge sector of the economy. Just look at the fossil fuel industry over the last 100 years. Their time is over though. We are starting to glimpse at a world without fossil fuel dependence. It’s not political, it’s the technological reality.

  • Ask yourself the following: in 100 years, do you think we will still be using gasoline engines in our cars? Of course not, and if you think we are, go ahead and look at Exxon Mobil stock, they used to be the most profitable and largest market cap company in the world. Invest in them if you think the stock market is wrong… or you can invest in a more sustainable future: so what is that going to take?
  • Renewable energy (solar) will continue to trend cheaper, accelerating fossil fuel obsolescence (TAN)
  • Energy storage solutions will become more critical due to inconsistencies in renewable output. Who are the main players that are best positioned to build market share? (TSLA is making huge strides in both production and storage)
  • Lithium is the new oil. Lithium production into batteries will be heavily demanded. Instead of investing in the commodity, who are the best companies at converting it to a useful product?
  • With more electrified vehicles, it will mean a few things:
    • Our electrical grid needs improvements to support charging EV’s
    • Charging stations will increase in importance, long term replace gas stations
    • Solar energy storage is critical because the grid demand will be at night when people are charging their cars and the sun isn’t shining
  • Clean water will be critical in the future. It’s already scarce now.
  • China is investing heavily in renewables, they understand the opportunity and are trying to win the market.

How to Manage Risk in Stocks

When Stocks fall, they actually get less risky. It’s when valuations are too high that you need to be really worried. Market crashes are a great opportunity to buy great companies at a huge discount. You just need to keep a long-term viewpoint “did the stock market crash that just happened change the fundamentals of the business I want to buy?” if the answer is no, you should buy it. I missed the first Tesla spike of 2020 after groveling for years that I thought it was a good company that was overvalued. When It went close to $1k I thought I had really missed my opportunity. When COVID -19 hit, it cratered the stock down to the mid-300’s where I picked it up a few dollars off the low point. As of writing this, the stock is up around $2,400 pre-split adjusted.

Overvalued Stocks vs. Growth Potential

I bought Tesla even though I thought it was overvalued at $378 (pre-split) – why? After missing out on the Amazon and Netflix growth over the last 10 years. I remember saying “I’m waiting for Amazon and Netflix to drop before getting into them, they are overvalued…”. I have learned is that great high-growth companies trade at higher earnings multiples, and a really good company should be looked at with a 10-year time horizon. I bought Tesla because I said “It’s overvalued at $100M market cap, but I think in 10 years it will be over $2T market cap” I’m pretty sure anyone would be excited about a 2,000% increase in value over 10 years. As of writing this, my shares are up 500% over the last 7 months. I still think it’s overvalued, but I’m not selling since I still think it will be worth at least $1.5T+ in the next 10 years.

The key is patience and understanding the growth story for that company. Especially if you think a company is overvalued, there is a good chance it will have a 30-50% drop at some point of you owning it. The naysayers will say “I told you so” while you add to your position because the business case is still there.

Fundamentals and Company Financials

Before buying the companies in the industries I just highlighted, it is important to have an understanding of how the company makes money and the financial health of the company. Traditional companies are valued using what’s called a discounted cash flow. An analyst makes an assumption of future cash flows, then discounts them to present value. There are a ton of assumptions that go into this, but it ends up with a fair market price. Then you would compare that price with the actual market price to determine if it is overvalued or undervalued in the market. In recent years, we’ve seen a divergence from this method as more tech companies make up a greater weight of the S&P 500. This still applies to more traditional and established companies: banks, manufacturing, retail, etc. 

Speculative/Tech companies require a different kind of financial analysis. Here are the things I focus on:

  • Cash on hand/Cash flow – does the company have enough cash as they grow into profitability? If not, do they have the ability to borrow more? Or will they issue more shares,  which would dilute all current shareholders?
  • How does the company make money? It seems very simple, but you should understand how a company actually makes its revenue. For example, Facebook makes revenue mostly from Ads. So user growth is important, but it’s more important that they are able to monetize that user growth. User growth + online retail growth rates are the indicators for the future revenue growth of Facebook revenue.
  • Disruptive Technology – what are the technologies that are changing industries? Amazon changed retail, Netflix killed blockbuster, Uber is disrupting taxis, Airbnb is disrupting hotels, Bitcoin is disrupting banks, Robinhood is disrupting brokerage firms, Tesla is disrupting the auto industry. Look for the companies that are changing the rules of the game. The ‘old guard’ doesn’t know how to react.

Conclusion

Paul Graham said about how to get startup business ideas: “Live in the Future, then build what’s missing”. This follows the same advice but applied to an investing strategy. 

Please leave any specific questions or thoughts in the comment section. I’ll be adding to this post as I continue to evolve. Let me know what you think!

Categories
Journal

The Secret to Becoming a Millionaire – Guaranteed

Secret to becoming a Millionaire

Yes, I know that is a clickbait headline, but a modified version would probably be “The least exciting and sexy way to become a Multi-Millionaire – Guaranteed”. Becoming a millionaire is actually quite simple. It’s nothing more than a basic math problem that requires two things: time and discipline. You don’t need to earn a ton of money to get started. Building wealth is like planting a tree – “The best time to plant a tree was 20 years ago, the next best time is now” – Chinese Proverb. The combination of time and discipline is the secret to becoming a millionaire.

If you are under 30 (or even 20!), this is one of the most important things you will ever read. The sooner you start investing, the more the magic of compounding interest will work in your favor. 

Compounding Interest

Compounding Interest, The secret to becoming a millionaire

What is compounding interest? It’s what creates the exponential growth chart above and really the special sauce when talking about growing wealth. It is basically the concept of earning interest on your interest. For example, if you earn 5% interest on a 5 year bond worth $1,000 that is compounding annually that means you will be granted the interest after the first year of $50, but you don’t get the money out – it adds to your investment. The good news is that it’s the new basis for next years’ interest, so your next interest payment will be ($1,050*0.05=52.5) which brings your new balance to $1,102.5, and over the course of the five years you will end up with $1,276 vs. $1,250 with just simple interest (just getting an annual $50 interest payment and your principal back at the end)

This example may seem small, but as you start to use longer time horizons you see it really have an impact. In the chart below, you will notice that over 30 years of the same example, you would have $1,822 more using compounding interest than simple interest. It is a snowball effect known as exponential growth!

YearsCompounding InterestSimple InterestDifference
5$1,276$1,250$26
10$1,629$1,500$129
15$2,079$1,750$329
20$2,653$2,000$653
25$3,386$2,250$1,136
30$4,322$2,500$1,822

The Rule of 70 (or 72)

You don’t want to get me started talking about how beautiful powerful exponential growth is. But what you need to know is that it allows us to take modest contributions and turn them into a fortune! One tool you can use to let your imagine start running wild is what we call the rule of 70 (some people use 72 – its an approximation so use either one). The rule of 70 is basically that you can divide 70 by your anticipated (compounding) rate of return, which will tell you how many years it will take your investment to double!

If we used the above example of $1,000 at 5%, you can take 70/5=14 years. You can see in the table above at 15 years we had over doubled the initial $1k investment. The best part is that you just added a layer to the snowball, which will double again in another 14 year (from $2k to $4k). 

So to recap that – your investment is accelerating in value over time. It takes you 14 years to get $1k in interest, then just over 7 years past that you get another $1k of interest. What happens is that over time your initial investment is dwarfed by the compounded interest – which is why you don’t need a huge $ investment if time is on your side.

How to apply it to your ‘wealth accumulation’ plan

Side note- I don’t like the term ‘retirement’ because it sounds like an exit strategy. Financial independence and wealth accumulation are worthy goals whether you want to work a traditional job and have a traditional lifestyle or want to support a long term alternative lifestyle like sailing the world.

I’m not the first person to suggest you should be setting aside at least 10% of your gross earnings toward ‘retirement’. I created a super simple interactive spreadsheet you can use to see what your specific scenario would look like. The point of this spreadsheet is to illustrate the long-term view of how these variables impact the future. A few notes to get you started:

  • Rate of return – I recommend sticking to market index funds (like the Vanguard S&P 500). They have extremely low expense ratios and consistently beat the so called ‘pro stock pickers’ over the long run. I have it set at 9% to start with. Why? over the last 90 years the S&P 500 has averaged 9.8%. Averages aren’t perfect predictors of the future, but it’s the best we have.
  • In the spreadsheet, you can fill in the yellow boxes, everything else will automatically populate
  • Be aware of your time horizon. If you are 40 years old you have a different time horizon (years left until retirement) than a 20 year old
  • If you’ve played around with the tool for a bit, try deleting all contributions after year 15. Did you notice anything? Your ending balance really doesn’t drop that much. That is because at this point, your snowball is already greatly outpacing your annual contributions. You planted the tree 15 years ago, and it’s got its own roots now so it can grow without watering it.
    • You can also do the opposite, and ‘delay’ saving for the first ten years. How much does your balance drop then?
    • These are examples the of time value of money – we’ll get into that in a different post though

Below is the Excel spreadsheet I made to illustrate this. It’s a simple, but powerful calculator to estimate wealth accumulation over a long term:

Download Simple Investment Calculator

Setting Goals & Milestones

There are two more profound milestones I want to point out. This is because even though I intellectually understood them, it took me to actually achieve them to realize their power. There is a point where your annual growth from capital gains is greater than the contributions you made that year. This is a big psychological win as you will realize your account really has legs of its own now. The second is when your annual capital gains exceeds your annual salary – I am not there yet, but I see that as another profound milestone. If you look at the spreadsheet, you should be able to see both of those points.

You will find that, if you have time, it doesn’t take any crazy assumptions to end up with a multi-million dollar net worth. I get it – this is not the sexy get rich quick scheme you may have been hoping for. It’s really the “build wealth slow method”. Remember that wealth that is acquired quickly is often disposed of just as quickly. Just read the statistics on lottery winners and recipients of large inheritances. 

Time is much more valuable than money. I’ll let that sink in for you to digest as a much more philosophical statement than just wealth accumulation. How are you planning your life around the time you have left?  Whether it’s 100 years of 20 years, we all have a finite amount of time-wealth left, and even less of it in our ‘youth’. 

Wealth accumulation isn’t a goal in itself, financial freedom is what that wealth buys you. You will need to make sacrifices in the short term so you can earn your freedom in the long term. It’s incredibly simple, but not always easy. Otherwise everyone would be a millionaire.

Getting Started

I learned in High School that the sooner you get the ball rolling (investing early), the more times you will ‘double up’ your net worth. When I started investing at the age of 16, I needed to first convince my parents to help me open a custodial account since I was under 18. I also started investing in 2007 right before the great recession hit (a good time for a lesson, not the best time to go all-in on a REIT…) I always looked at my early investing as a way to guarantee myself a modest, comfortable retirement. Over the years, my goals have changed, but the strategy has been steady. I no longer consider it a ‘retirement’ plan, but a ‘wealth accumulation’ plan.

The point is you need to get started – right now. Open a brokerage account if you don’t have one already. I use E*Trade, but there are a lot of newer brokerage firms like Robinhood, Cashapp, etc. that you can easily get started.

**Before you go too far on brokerage accounts, you need a tax strategy. There are tax-advantaged accounts like a 401(k), 403( b), Roth IRA, Traditional IRA. Or if you want to be able to touch it before retirement age you can get a normal brokerage account. I think a good strategy involves both. I’ll go into the options in another post, but you should understand your tax goals and strategy for this account.

Step by Step

  1. Open a brokerage account (or increase contribution of your tax-advantaged account)
  2. Fund the account with money you have available – whether it’s $100 or $50k
  3. Start with index funds like the Vanguard S&P 500 ETF (VOO). Don’t get distracted by individual stocks or cryptocurrency until you have a diversified base to start from
  4. Set up automatic deposits and automatic investing in the fund you choose, have it automatically invest
  5. Reinvest dividends
  6. Continue for 30-50 years

Recommended Books & Resources

Books and Resources to cultivate your financial mindset:

What do you think about the secret to becoming a millionaire? It’s simple but powerful. Do you have the discipline it takes to gain your freedom? Leave a comment below!