Monday, March 9, 2009

A Millionaire for the Price of a Donut and Cup of Coffee

© Anant B. Goel

“The difference between a millionaire and poverty lies in a person's determination to succeed, savings habit and power of compounding.”

You see your neighbors always dressed in designer clothes, frequently eat at fancy restaurants, order bottles of top-shelf wines, and have midsummer night's dream party in their manicured backyard. Eyeing their shiny, silver SUV in the driveway and their new kitchen and family room addition, you think, "How can they afford that? What am I doing wrong?"

Anxiety over how our financial lives compare to others' is a well documented natural human reaction and is the subject of a recent book, "Green with Envy: Why Keeping Up with the Joneses is Keeping Us in Debt," by journalist Shira Boss. "How we fit in and how we measure up are such an integral part of our financial well-being," she says. "We construct a fantasy world around those who have more money, and glorify their lives."

However, more and more people around us truly seem to be living the good life -- at least in a material sense -- thanks partly to the democratization of credit and unprecedented levels of consumer debt. This prompts increasing speculation about how they can afford it. The reality is simple: Some of them can't, at least not without going into debt. But on the other hand, many have really become financially wealthy by frugal savings and investing wisely.

In this country of ours, there is no reason why everyone can't retire a millionaire. This is quite a sad thought when one stops to consider that the majority of people that are retired are doing so below poverty levels. It is time to take your future and destiny into your own hands and not be one of those poor souls looking back on life at all the squandered possibilities with a handful of “what ifs?” The time to start is now. Cut back, for example, on that “Donut and a Starbuck Coffee” every morning, and treat yourself to the ultimate gift – a secure future as a millionaire.

The biggest mistake most people make is that they think they have to start with tens of thousands of dollars to make big money. They suffer from the "not enough" mentality; namely that if they aren't making $1,000 or $5,000 investments at a time, they will never become rich. What these people don't realize is that entire armies are built one soldier at a time; so too is their financial portfolios.

Someone once told me, this is a true story, how this 30 year old man who saved about $3.50 dollars a day by foregoing that “Donut and Cup of Coffee” a day and became a multi-millionaire when he retired at age 50. This man saved $3.50 per day despite it never being more than a few dollars at a time. Now, his portfolio is worth millions upon millions of dollars, all of which was built upon small investments. I am not suggesting you become this frugal, but the lesson is still a valuable one. Do not despise the day of small beginnings!

In this article, we're going to touch on three subjects simultaneously: saving, determination, and the power of compounding. Summed up, this is a wake-up call to achieving your goals of financial independence. Hopefully it will serve to assist in regaining your focus on the big picture, should you become distracted.

Having gone through the process myself and practiced the art of saving and investing for over 20 years, I found one primary question kept rising time after time, namely “How much money do I need to get started in trading or investing?” As a matter of fact, it was the belief that the individual may not have enough money to start with that often prevents them from ever getting started. The old adage that “it takes money to make money” is only partially true. More often than not it is throwing fear aside and getting started that is the catalyst to success.

The best way to illustrate how small savings, determination to succeed and the miracle of compounding can make you rich is to recreate the success story of this 30 year old that became a multi-millionaire when he retired at age 50. The story goes, as I recall, this 30 year old started out by saving a few dollars here and there to simply scrape up the $2,500 minimum necessary to open an options margin account, hardly a hefty sum compared to many. He went on to learn stock and derivatives trading and scrimped and saved for 12 months to get that amount of $2,500 going. He quit smoking cigarettes and cut back on his daily Donut and Coffee in order to achieve his goal of saving $2,500 (talk about determination!). He also cut back on lunches at work, opting to pack a lunch rather than go out. But within his allotted time frame he managed to get the money together and accomplish his goal. His mantra was a quote by Mahatma Gandhi: "Every worthwhile accomplishment, big or little, has its stages of drudgery and triumph; a beginning, a struggle and a victory."

He then started trading small. He learned the stock and derivatives trading strategy by which he could make an estimated 3% a month with very little risk compared to most stock trades. He had his share of growing pains and an occasional surprise loss; however, he did not give up and continued to strive for knowledge and education wherever he could find it.

About 10 years after he took off with his maiden trade, he had surpassed the $200,000 mark and kept going strong. You see, this type of success is possible for almost anyone who has the determination, will power, and patience. He certainly sped up his learning curve by years by attending on-line investing courses and learning about trading tools, but he had the drive to succeed that I have found to be more important that brains, genetics, background or luck. After a few bull and bear markets, I last heard he was now up to over $7 million in about 20 years effort. Not bad for someone using $2,500 in savings to open an account and just adding $100 dollars a month [the cost of a Donut and Coffee per day] for the next 20 years!

Another key ingredient to his success was that he did not let the greed factor take over his psyche. You must have a certain amount of greed and desire for success to want to learn trading options. But he never started to get the lottery or Vegas mentality to take over his judgment. As long as you know that the lottery, Vegas or impulsive trades are simply a tax on people who are bad at math, you should stay humble. The key for him, as for Warren Buffet and you, is compounding.

Compounding is just a fancy word for the profits you make on the profits made on the original principal. Albert Einstein once said, "The most powerful force in the universe is compound interest." Compounding is the key to financial success as a conservative trader. Warren Buffet does not sell his stocks, but rather hedges with options, as he does not want to pay capital gains tax that would lower his compounding rate of return.

If you are just starting to trade, undecided about trading or are already well off but want more, take this simple example as a motivational tool by which to visualize your future, and make it happen. No matter how strapped for money you are, if you have $2,500 in starting capital and can save $3.50 a day, you too can become a multi-millionaire in a few years time. Depending on what statistic one uses, the average return for a passive investor sitting on stocks is 12% a year. However, with a little knowledge about trading, covered calls, and other option strategies you should have little trouble bumping this number up conservatively to 3% a month. You would be surprised at what this comes to. A mere $3.50 a day is more than $100 a month saved. I know people who somehow manage to fritter away more than $100 a day some days, and regularly spend over $100 a month on beer and cigarettes. But saving $1,200 a year (that’s less than $3.50 a day) it is possible by everyone if you want your goal of becoming a multi-millionaire bad enough.

Save $3.57 a day x 7 days a week = $100 a month
+ additional $100 saved a month
= $200 per month
x 12 months in a year
= $2,500 approximate

Do the Math:
With your yield of 3% per month and with a monthly deposit of $100 and with an initial savings amount of $ $2,500, you are looking for a Final Amount of $7 million in about 20 years. Keep reading and you will see how?

Time Value of Money:
One of the fundamental principles of finance is the concept that $1 today is more valuable than $1 a year from now. The reason for this is two-fold. First, a dollar will probably buy less goods and services in the future due to the destructive force of inflation. Second, if I have the dollar in my hand today, I can invest it and earn a return in the form of dividends, interest or capital gains.

I have used the above example to help illustrate this point. Let’s assume that you are determined to become a multi-millionaire in the next 20 years, have a starting capital of $2,500, you found a way to save $3.50 a day and have taken some time out to learn how to invest in stock derivatives to conservatively make 3% a month on a consistent basis, then you truly are on your way.

Using one of the time values of money formulas, you can calculate the real economic cost of not investing the small amount of cash on regular basis.

Here’s the formula…

FV = PV * (1 + i )N + PMT * [ ( ( 1 + i )N - 1 ) / i ]

FV = future value (maturity value)
PV = present value
PMT = payment per period
i = interest rate in percent per period
N = number of periods

To perform the calculation, you have to make a few assumptions. First, let’s assume that you are 30 years old (and hence 20 years away from becoming a multi-millionaire at age 50). It also means that the initial investment of $2,500 and a monthly saving of $100 per month will compound for 20 years. Therefore, we will substitute 240 months [20 years] for “n” in the equation.

Next, we must establish your expected rate of return. Historically, the stock market has returned 12%. If you want to invest in bonds, your return will be lower. Assume that you invest in a combination of conservative stock derivatives strategy and expect to earn a 3% rate of return per month. This will be substituted for the “i” variable in our equation as 0.03.

The “PV”, or present value, is the value of the single amount you want to invest (in this case $2,500). The “PMT”, or payment per period, is the monthly investment [in this case $100] that you have managed to save from cutting out your morning Donut and cup of Coffee.

Now that we’ve figured out the variables, the formula looks like this: FV = $2,500 (1+.03)240 + $100 [((1+.03)240 -1)/.03].

This is how you do it on your calculator…

Enter 1.03 into your calculator (this is the sum of 1+.03). Raise this to the 240th power. The result is 1,204.85. Multiply the 1,204.85 by the “PV” of $2,500. The result ($3,012,130 and change) is the true value of investing wisely the $2,500 today.

Now, let’s calculate the future value of saving and investing $100 per month for the next 20 years. Enter 1.03 into your calculator (this is the sum of 1+.03). Raise this to the 240th power. The result is 1,204.85. Subtract 1 from 1,204.85 to get 1,203.85. Divide 1,203.85 by 0.03 to get 40,128.34. Multiply the 40,128.34 by the “PMT” of $100. The result ($4,012,840 and change) is the true value of investing wisely the $100 per month for the next 20 years.

Now add the two figures [$3,012,130 plus $4,012,840] to get a total of $7,024,970. Even if you adjust for inflation, it would probably work out to be over $3 million in today’s dollars.

Clearly, this $7 million dollars in 20 years may not be enough to retire but armed with this knowledge, you are free to make an economic decision; namely, would you prefer to have your “Donut and Starbuck Coffee’ every morning or have over $7 million in the bank in the future. The answer is entirely personal. Once you understand this concept, however, it becomes painfully obvious that the small luxury items you think nothing of are really costing you millions and millions of dollars in future wealth.

I hope this article served its purpose by helping you to appreciate the value of small savings, determination to succeed, the miracle of compounding, and firmly establish this time value of money concept in your head. The key to financial prosperity is realizing the potential value of every dollar that comes into your hands. In fact, I think of cash as a seed – you can either eat it (spend it) or invest it (sow it).

It is time to take your future and destiny into your own hands. The time to start is now. Cut back on some of the Christmas spending, give-up smoking, or cut back on those Donuts and Starbuck Coffee and treat your-self to the ultimate gift – a secure future. Get some education on investing, learn a few trading tools and forget the excuses for not starting now.

“Human beings, by changing the inner attitudes of their minds, can change the outer aspects of their lives.” By William James

Anant B. Goel
www.wealthbyoptions.com

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