Jun 18, 2021
Can One Become a Millionaire Through Investing Alone?
Debunking the myth of ‘passive investing’
Warren Buffett has gone on record multiple times and stated that if he were to advise his family members or anyone else for that matter about investing, he would very simply tell them to put 90 percent of their savings in a low-cost index fund and the remaining 10 percent in short term US government bonds.
If you happen to think of it a 90 percent allocation in any particular asset class is a risky one. The realm of passive investment vehicles has surpassed a lot of actively managed funds. This is partly because of the high-fee structure most asset managers charge on top of underdelivering on returns.
With the rise of algorithmic reading and AI, floor traders are being replaced by increasingly efficient machines which can execute a trade in a microsecond. The amount of time a human being would need to make a particular decision with regards to a particular trade can sometimes destroy the trading opportunity since market swings have somewhat become super volatile.
Index funds eliminate all the hassle of actively managing one’s portfolio. Most index funds track a particular benchmark such as the S&P500 or other index funds, in which case we call such instruments, funds of funds.
They replicate the indices and other portfolio holdings encompassing those benchmarks and readjust every time those benchmarks readjust themselves.
But what would happen if stock prices begin to exhibit lower lows and the market goes past a correction. If you happen to be an individual buying/selling any financial instrument you do have the liberty to short stocks or any financial instrument for that matter. Most mutual funds and index funds also have that option, but the problem arises when the entire market starts collapsing.
If the fund is not careful enough it wouldn’t take long before it wipes out a hefty chunk of the fund’s overall NAV (Net Asset Value) simply because the financial instruments, in particular stocks, would have reduced in market capitalization significantly.
For the most part, the holding period for the average investor has come down drastically. Warren Buffett may have indeed “bought and held” certain stocks forever, but the average holding period today can range from anywhere between a few seconds to a few years. People have become more prone to the idea of booking profits and not simply holding strong businesses in their portfolios.
If and when a market crash does happen, be rest assured that the markets will rebound. The question is how much longer can an individual hold onto those “losing positions”. Corporations and big banks can afford to use the adage, “time is money”, simply because they have an infinite holding period. They can afford to finance working capital requirements from other external sources and in most cases are backed by government funding during certain times.
But the state won’t bail you out, nor will it help you in becoming a millionaire!
But despite that why do so many “experts” claim that investing is the way to a “lifetime’s worth of riches”? The answer is simple. The statement is partially true, and promoted for the masses, but what they don’t talk about are the detrimental effects of inflation, diminishing purchasing power, and planning the timing of depositing/withdrawing funds for emergency purposes. Let us explore the idea in detail.
Your money’s worth depreciates the older you become — When you’re in your early 20’s the capital you produce is more valuable than at any other point in your lifetime. Understanding compound interest is absolutely essential to building serious value over the long term. The scenario below illustrates compounding interest and the difference between saving/investing when you’re young compared to when you’re older:
$10,000.00 invested at 20 with standard 10% annual growth = $452,592.55 by the time you’re 60.
$10,000.00 invested at 40 with standard 10% annual growth = $67,274.99 by the time you’re 60.
Investing from a young age is helpful but only if you have the leverage beforehand. This kind of leverage comes from having capital in your hands, the only ways to earn such substantial sums are either selling your stakes in a profitable business or through inheritance. If you want to build substantial wealth there is no other way. Depositing small sums from your savings will eventually help you accumulate a million dollars at some point in the future, but by that point a million dollars might only buy you one bottle of Coca-Cola!
This is all because of the fact that inflation will keep on going up no matter what most federal governments do. They will keep on printing excess money with regards to supporting the economy, but in reality, if the supply surges at one point the value of any particular commodity continues to decline. The idea that a million dollars can buy you a bottle of Coke in say 50 years' time, describes the notion of purchasing power.
The phenomenon that states that “ is a measurement of prices in different countries that uses the prices of specific goods to compare the absolute purchasing power of the countries’ currencies”.
But even if a loss of purchasing power isn’t a primary concern central banks will keep on printing more and more paper currency, simply because it technically helps the IRS and the big banks to stay afloat. The cost to print a “$10” bill is roughly “$0.03” or 3 cents. This leaves $9.97 on the table of central banks which is accounted for as profits within the IRS’ book of accounts. This profit is known as ‘seigniorage’.
The money is then supplied by the FED to major banks in exchange for government bonds or other collateral through QE, depending on whether the FED plans to expand the economy or contract it. This money is also used to boost liquidity in the stock market as we have seen recently in addition to supporting large corporations with regards to working capital.
But if and when the excess funds does run out, the markets will plummet and so will the funds that track the market indices.
Those funds be it index or otherwise can afford to sit back and operate simply from management fee and other annual charges it will continue to charge its clients but the average client might not have that high a holding period. They might not liquidate a few positions based on their needs, which in turn will further hamper their returns.
Thus, index funds or a passive investment approach might look good on paper but the pitfalls surrounding the investment environment is something no one talks about until they have become victims themselves. Passive investing definitely isn’t a bad thing, especially when you have a limited idea about the financial markets. But expecting to have a time horizon similar to “The Oracle of Omaha” whilst starting out with a capital of $10,000 will come to haunt you sooner rather than later.
Read. Learn. Invest. Stay consistent. But do not simply believe you next door neighbour the next time he says, he’s going to “buy and hold Tesla shares forever”!
