Most of us suffer from illusory superiority in our early investing years. No matter how many investors are scammed in land deals and gold investing schemes, we believe that we have superior investment smarts. The telephone call from the pump-and-dump stock operator offering a 200% return on your money in two weeks was too attractive to resist. The mining stock in a part of the world so remote that no one has pictures to show you was the investment tip of a lifetime, you thought at the time.
Many investors get beat up many times before they concede that they are not a superior investment being. So you lose some more money in a few high growth stocks and, finally, concede that three decades of financial market performance cannot be wrong. Passive investing beats out active investing over the long term.
Making your first million dollars does not have to be about making high-risk investments and putting your life savings at risk. To make $1 million, you only need discipline.
Make Your First Million #1: Delay Immediate Gratification
Young children understand the secret to making a million dollars. In the famous Stanford University marshmallow experiment, children were given the choice of eating a marshmallow now, or waiting 15 minutes and getting two marshmallows. The children who had discipline and waited for the two marshmallows were more successful in life than the children who wanted immediate gratification.
You, too, can be more successful if you are willing to put off consumption today in exchange for more money in the future.
Make Your First Million #2: Place 15% of Each Paycheck Into Savings
The secret to making a lot of money is not consuming everything you want today. Instead, put more money into savings. Investment advisors recommend putting 15% of every paycheck into savings. Those without a budget seldom meet this savings goal. If you take your paycheck, cover your expenses and then spend the rest, how much do you have left on average to allocate to savings?
To make sure you do not miss the 15% savings goal, write up a budget and itemise your income and expenses. If you want a new coat and new smartphone in the same month, be disciplined and delay buying one item until the following month. Now you have met your savings goal.
Make Your First Million #3: Retirement Account Matching funds
Recent US studies have shown that less than half of Americans were taking advantage of employer matching funds placed in their retirement savings plans. Be sure to understand how your employer retirement investment plans work. Attend seminars and ask questions. If you do have employee matching funds, it is potentially a huge pot of money that could be sitting waiting for you when you retire.
Make Your First Million #4: Develop a Diversified Portfolio
A diversified investment portfolio is your best defence against the ups and downs of the stock market – a mix of equities, fixed income, alternative investments and cash. The market has become more volatile, and some investment analysts believe the volatility is here to stay. If you were invested in the market during the 2001 or 2008 market downturns, you will understand the importance of diversification.
Market crashes always have an object of speculative excess. In 2001, many portfolios were weighed down by technology stocks. When prices in the technology sector crashed, some portfolios fell in half while others were wiped out.
In 2008, many investment funds, including conservative bond funds, had high exposure to subprime mortgage-backed securities. The underlying mortgage borrowers had lower credit quality so investors were attracted to the higher returns. When the high risk borrowers could no longer pay their mortgages, the massive defaults caused the mortgage-backed securities market to collapse.
So whether it is gold in 1929, technology stocks in 2001, or mortgage-backed securities in 2008, if you jump in when an asset is appreciating, you need to know that eventually all asset bubbles burst.
Investors with diversified portfolios lost some upside when technology stock prices were soaring, but were not destroyed when technology stocks fell. Over the long term, they realized higher returns than the Internet bubble followers, without the high risk and stress.
Make Your First Million #5: Buy Undervalued Stocks
Passive investing does not mean that you should never re-evaluate your portfolio holdings. Periodic reviews and re-adjustments can significantly increase your returns. When the market does decline, it is a good time to go bargain hunting and buy undervalued stocks with strong, long-term fundamentals. As the market slowly rebounds, the value of these stocks will also grow.
Buying undervalued assets is a good strategy to use in all areas of investment. If the housing market is in a rut, it may be a good time to buy the second home you want to purchase for rental income. Timing is everything. Buying at the top of the market can cost you money, and timing the top of the market has proven to be an illusory goal for most investors. Market troughs are easier to react to.
Make Your First Million #6: Reinvest Dividends
Rather than spend your gains, reinvest dividends and invest in future growth. With the benefit of compound interest, the dividends will add a large dollop to your retirement nest egg in 30 or 40 years. Reinvesting dividends is also a form of dollar cost averaging – investing a set amount in the market at consistent intervals. Those who invest with such discipline realize higher investment returns than investors who try to time the market. Impulsivity is removed from your buying decisions, so you can avoid the traps of buying at market peaks and selling at market lows. Some brokerages are waiving the fees on dividend reinvestment in stocks and exchange-traded funds.
What if you need some of the money today? If, for example, dividends are the only way to fund your yearly vacation, there is no need to deny yourself. Balance out the dividends between the vacation and reinvestment. Alternatively, you may choose to not touch the dividends or a set percentage and let them accrue in a savings or higher yielding account. If you are not using the dividend income for more than a year, then chose an investment vehicle with a higher return than a savings account. You may even choose to reinvest this money when you rebalance your portfolio once a year.
More young investors today have the philosophy of living their lives to the fullest today. With willingness and creativity, even these life adventurers can find ways to save 15% of their paychecks. Do you really need the highest end tennis racket for beginner tennis lessons? Many of us are a slave to brands. When it is time to retire and your consumption has been reduced to a $1300 a month retirement pension, those brands will no longer seem important.
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