InvestorsFriend Inc. Newsletter April 6, 2012

Imagine. You. Rich.

Getting rich through investing is simple but, unfortunately, neither quick nor easy.

The mathematical steps to get rich through investing are quite simple and are as follows:

1. Gather and set aside money to be committed to investing for the long term. Repeat this each month or year.

2. As it is accumulated, periodically allocate the money into investments that are expected to earn the highest possible long-term return without taking unacceptable risks. Monitor and reallocate periodically.

Amazingly enough, that is it. Yes it will take a long time to become rich this way. But the time will pass by whether you follow these steps or not.

When it comes to Step 1, setting aside part of your income and dedicating it to be invested for the long term, the percentage of income that could conceivably be saved and the resulting dollars being saved will vary all over the map depending on circumstances and priorities.

A teenager who is really committed to getting rich might be able to invest at least half of every dollar they take home. Similarly a high-income professional who is single and willing to live frugally might be able to save a large percentage of take home pay. (Remember, I said this is not easy).

But what about the average working guy? Well, really almost no one is truly average. The take home pay of families varies enormously as does their living costs. There is really nothing average about the amount that people can save.

What is realistically possible?

I did a comprehensive analysis of what would happen to someone who invested \$500 per month or \$6,000 per year for 30 years. The amount invested was increased for inflation each year. I looked at investing this money at the start of each year into either 100% stocks or a traditional balanced mixture of stocks and bonds. I looked at actual annual returns – after inflation for each possible 30 calendar year period all the way from 1926-1955 to 1981-2010.

This means that in real dollars, adjusted for inflation, a total of \$180,000 was invested over 30 years. (Realistically, someone starting this in 1926 would likely have invested closer to \$600 per year than \$6,000 but in terms of the resulting percentage increase in dollars over time the result is the same.)

Here are the results, in real dollars adjusted for inflation, if all the money was invested in stocks:

Lowest ending portfolio value: \$277,471 (1952-1981), 46 times annual savings of \$6,000 for 30 years.

Average ending portfolio value: \$758,942, 126 times annual savings.

Highest ending portfolio value: \$1,374,265 (1970 – 1999) 229 times annual savings.

If the money was instead invested in a traditional balanced fashion of 60% stocks, 35% bonds and 5% cash then the inflation-adjusted results were as follows:

Lowest ending portfolio value: \$202,559 (1952-1981), 34 times annual savings of \$6,000 for 30 years.

Average ending portfolio value: \$494,252, 82 times annual savings.

Highest ending portfolio value: \$860,218 (1970 – 1999) 143 times annual savings.

The above ending portfolio values are fully adjusted downwards for inflation.

The May 27, 2007 edition of this newsletter also covered some mathematical examples of how much initial money, return and time was required to amass \$3 million. (Why think small?)

Warren Buffett, world champion saver and investor

By the age of 12, Warren Buffett had read every book on investing in the Omaha Library. At age 12 he bought his first ever shares of stock, 3 shares that cost him a total of \$114.75, essentially his life savings at that point. He studied compound interest tables. He announced to a friend that he would be a millionaire by age 35.

By age 12, in 1942, Warren Buffett not only hoped to get rich, but he had a plan of how to do it. He would find every possible way to make some money, he would save that money and invest it in stocks where it would compound and grow. Because he had this clear plan, I believe he not only hoped to get rich, he knew he was going to get rich.

He earned and saved around \$5,000 from delivering a massive amount of newspapers mostly when he lived, with his family, in Washington D.C. for about four years as a teenager. When he finished college he had a net worth of \$9,800 amassed from savings and investment.

Upon graduation from college Warren worked for a time in Omaha at his father’s small brokerage office and then worked for a short period of time with Benjamin Graham in New York. He returned to Omaha in 1956, at age 25 with a net worth of \$174,000. He was married and had at least one child by then. But he had no plans to look for a job. They could live on \$12,000 a year and his net worth would still grow through investing. He then started a partnership, initially with friends and family only, to invest additional money. The rest, as they say, is history.

He ended up earning substantial performance fees from his partnership funds from 1956 through 1969. He lived frugally.

After 1969 his wealth grew almost entirely due to growth in his own investments. He has never taken more that \$100,000 per year in salary from Berkshire Hathaway. He owned roughly one third of Berkshire, and that, after a time, represented over 99% of his net worth. But even the remaining less than 1% of his wealth was invested and eventually amounted to some hundreds of millions. I believe he would have earned some money from sitting on corporate Boards over the years as well. But the vast vast majority of his wealth came from investing and compounding the wealth that he had amassed by 1969. In March 2012, Forbes magazine pegged him the third richest person in the world at \$44 billion. And this is after he gave away approximately \$2 billion per year in each of the last 6 years.

Warren Buffett became one of the world’s richest people by following a simple plan that was well formed in his head by the time he was 12 years old. It consisted of earning and saving up an initial seed capital and investing his capital at the highest returns he could find while not taking undue risks.

Where to Invest?

While Warren Buffett is best known for investing in stocks  he is perfectly willing to invest in bonds but only when they represent the better investment.

In most circumstances stocks are the better investment.

I recently updated two articles that compare the long-term results of investing in stocks versus bonds.

Stocks versus Bonds, Cash and Gold: since 1926 and for selected 20-year periods

Stocks versus Bonds and Cash over all possible 30 calendar year periods since 1926

And for good measure here is a detailed article on investing in stocks versus bonds versus a balanced portfolio for every possible calendar 30-year period from 1926-1955 all the way to 1981-2010.

This shows not only that stocks won in the end but, importantly, it shows the ugly volatility along the way.

100% stocks versus Balanced Approach over all possible 30 calendar year periods since 1926 and including the Volatility along the way.

Is it too late to Invest?

No, it is not too late to invest.

The P/E ratio on the Toronto stock exchange is 15.8, which is close to historic levels.  A P/E of 15.8 is an earnings yield of 6.3%, which compares very well to 10-year government of Canada bonds which yield about 2%.

The P/E ratio of the S&P 500 stock index in New York is 15.3, for an earnings yield of 6.5%, which compares well to 10-year U.S. government bonds that yield 2.1%.

What are some Good Stocks to Buy?

We have some ideas available for those who subscribe to our stock research. The cost is just CAN \$13 per month or \$120 per year. I don’t think even Warren Buffett would consider that to be an extravagant price. As of April 6, our Strong Buys are up by an average of 10.4% each in 2012.

END

Shawn Allen, President
InvestorsFriend Inc.

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