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Thursday, April 26, 2007

A Millionaire's Plan

Since today is a public holiday, I had some time to browse other blogs, and came across this topic at Investlah.com titled "Can an average Joe become a millionaire by just investing?". It is interesting that the page was read nearly 300 times, with 2 pages of comments from a wide variety of people. Since this is a serious question, I thought I would share my 2 sen worth on this topic.

I personally believe that it's not difficult for an Average Joe to become a millionaire, provided:
1. He starts early.
2. He has a clear plan with a high degree of certainty.
3. He executes his plan consistently with discipline without fail.

By "Average Joe", I mean just that - just an average bloke, earning an average salary from being an average employee. Start early means starting from the first day of earning a salary, or as soon as possible. The plan is what I will call a "Millionaire's Plan" for easy reference.

You might rightly ask what makes me so confident or qualified to give such advice? As a early retiree, I've "been there and done it". If I didn't, I wouldn't be able to retire. In any case, what's important is not whether I've done it or not, but whether what's written below makes sense to you, and more importantly, whether you are actually able to execute the plan.

So, what exactly does the "Millionaire's Plan" look like? Is it complicated? Actually, no. It's fairly simple. It's simply based on the concept of "unfailingly pay yourself first before anyone else", and "invest that savings". That means to live within your means. A simple plan, but if followed faithfully, will give you that certainty of becoming a millionaire. Don't believe me? Well, take a look at the table below:

In the table, I define "average Joe" to be an average employee. For illustration purposes, he might be age 22 and earn $2,500 per month for uni graduates. As this is a projection, I assume a modest salary inflation of 3% per annum for simplicity, although in real life, I expect most readers to experience higher salary inflation from future promotions, extra savings from bonuses, etc, at least for the initial years. So, I believe this is conservative for most readers.

So, how can Joe become a millionaire? Let's consider for simplicity that Joe saves just 20% of monthly salary unfailingly. I believe 20% is modest. If Joe saves a higher %, he gets there faster. But for simplicity, let's assume 20%. Is this hard to do?

To me, it depends on the individual's mindset and the determination. It's hard, if you are not disciplined or don't believe that it's important, or don't believe that it makes a difference. It's easy, if you truly believe in the Millionaire's plan and make savings an automatic, unconscious habit.

Ok. Let's say Joe agrees to pay himself first, every 20% of his paycheck - without fail. That's $500 per month, or $6,000 per year. Note - without fail. Skip a month or two, and the plan fails and it will take longer.

Now, all Joe has to do is
1. Deduct 20% of his pay check before he spend a dime.
2. Sock away that 20% into a separate F.D. account immediately.
That's it!

Just keep doing this every month, and by the time Joe gets to age 65 (or 43 years later), he should have accumulated over $1 million in F.D.

Note that the actual $ saved is only $513k, and the remainder is compound interest, paid by the bank. Isn't that nice, with the bank making up the other half of your Millionaire's Plan?

So, what do you think about that? Too easy to be true? Just put away 20% of your paycheck, and by age 65, you become a millionaire? Well, the maths said so, so, why wouldn't it work? There are a few reasons why.

1. Joe failed to save at least 20% of his pay check - 90%-99% of the time, I believe this is the most common cause.
2. His salary didn't grow by 3% p.a.
3. The bank decided to lower F.D. rate to below 3.7% in future.
4. His starting salary is lower than $2.5k.
5. He dipped into his F.D. sometime during his savings period (another common reason).
6. He might have lost his job in between, or got married with kids with special needs, etc. in other words, 1. failed.

But if you asked me, there's no reason why 1. should fail if one starts early, and sock that money away and forget about it. After a few months, the action should become an automatic, unconscious habit, and Joe should not even think about it anymore, as he adapts his lifestyle to fit the remaining 80%. If one does not have the discipline to do this simplest act, then, the odds are that person will probably never become and remain a millionaire.

I suspect, even if he suddenly wins a $1 million, without the discipline, he will probably lose it in less than a few years (there are actually many studies done on these sort of very lucky people).

In my case, I recalled I also found the initial steps hard but not impossible, and stopped noticing it a few short months later. However, I was not perfect, there were occasions (a few years in total, due to absence / forgotten the Millionaire’s Plan) where I got sidetracked (late 20s) before I got back on track. It was only later when I got interested in tracking my daily expenses (after having rediscovered and understood the Millionaire’s Plan), to see where my spending was going to. I would jot down every night what I spend during the day and this would go on for a few months. Later, I would discover patterns to my spending that were not necessary and found new sources of savings. My savings % continue to grow over time. That act (monitoring for a few months) became a turning point for me. I then tracked the figures in my savings passbook closer, to compare the increase in the account balance against salary credited. I would silently give myself a pat at the back when I managed to save an even higher cumulative % than the prior month. In my final year prior to retirement, I was able to save quite easily 85%-90% of my salary, and still live a very comfortable and normal life. I'm sure there are some people who can do even better than I could.

Yes, there were sacrifices, but it really didn't make much difference once I got used to it.

Other thoughts of living simply (and frugally)

Cars. Cars are depreciating items. What that means is if you paid $100,000 for a new car today, it’s worth almost nothing 10 years time. That’s a minimum spending of $10,000 per year, or $200 per week, even when you are not using your car. That assumes you pay cash. If you take a loan, factor in the huge loan interest. So, when my friends bought nice cars and regularly upgraded them, for my very first car, I chose to buy a 2nd hand car (2 years old) that did the job – my depreciation was a lot less, the car was still relatively new with low maintenance, lower insurance, and I drove carefully to save fuel. I almost never brought the car to the car wash, but simply regularly wipe it with clean cloth and water (no detergent).

Car loans. For my first car, I used all my savings to take out the smallest loan possible, and I saved very hard in order to fully pay the car off in the quickest possible time. For my next car, I paid cash. So far, I only owned 3 cars in my entire life. But all the cars are reliable – in fact, I have yet to experience a break-down in the middle of a road (touch wood).

House loans. Whilst my friends bought bigger houses with bigger loans, my first house was small, with the smallest possible loan and a relatively short time to repayment. 7 years later, I paid off my house loans completely. Later in my life, when I got married (late) and have a child, I bought a bigger house with cash.

Daily habits.
- I almost never drank expensive Starbucks coffee (even today, just by force of habit) but just the free coffee at work.
- I almost never ate at McDonalds, just at the work canteen that is subsidized by my employer (which is not bad actually).
- I would eat a balanced diet, and exercise regularly. I don't join a gym (too expensive, unnecessary), but simply played social badminton with colleagues, friends, relatives and we split the costs. Sometimes, free jogging or morning walk at the park (I don't drive there, I walk there).
- I still occasionally go to the movies and do all the regular things with family and friends. At the movies, my wife and I would never buy popcorn and coke (except perhaps initially during courtship, and you cannot imagine my happiness when on our 2nd movie, she told me that she thinks the coke there is expensive and is a waste of money J ).
- I'm not someone who measure myself by the price of the clothes or shoes that I wear, in fact, as a matter of personal preference, I like my old clothes and my old shoes very much, as they are clean, neat, tidy and very comfortable. I don't buy expensive leather shoes - I have 2 pairs of business shoes that I would regularly rotate, and with proper care, would last me years, and they each cost less than $100 bought on a bargain sale (last year’s fashion) - I even wore that when I was working in my final years in senior management ranks of a multinational company.

Electronic gadgets / technology.
- Depreciating item, latest fashion changes too fast to be of lasting value. Definitely don’t own the latest electronic gadgets. In fact, I still own my Nokia phone which is more than 6 years old now, and it still works perfectly. I would choose the cheapest plan, and nowadays, I find pre-paid even cheaper as I rarely use my mobile and more fixed line.

Clothes. I have a couple of nice, moderately priced full 3 piece business suits that I regularly used for work (I rotate them regularly) and they would last me for a decade, and they are still very presentable. My waist size has not changed much, and is still close to where I was in my early 30s. Some of my colleagues have no hesitation buying ties that costs $1,000+, but I can't ever recall spending more than $40-$50 on a tie in my entire life (and I still got promoted at a younger age than they did)

Career. In the initial years, I focused on my career and almost nothing on investing (besides F.D. rates). I got promoted faster than the average colleague, and that helped to increase my savings rate faster.

Spouse, friends and family. You could say I chose my wife carefully, as my wife turned out to be an even bigger saver than myself, and we share many of the key life values including savings habits. I am lucky to be born in a family that practices frugality. I am also lucky to have chosen friends who have not diverted me from my financial goals (in fact, many of them don’t realize, noticed or makes an issue about how frugal I am).

These are all not difficult things to do. Once you get used to it, you don't feel it. It's about treating limited resources as precious, not wasting unnecessary resources, consciously developing a good savings habit, and still live life very comfortably. Another Buffett quote: it's not the $1 today that matters, it's what the $1 could become in 20 to 30 years time after compound interest that matters.

Anyway, back to the Millionaire's Plan. If you decide to adopt Plan 1 (earning F.D. rate), then, you are almost guaranteed to become a millionaire if you can stick to the savings plan. If you have a higher salary, or can save a higher %, then, you'll get there sooner. E.g. if you can double the savings, then, you could become a millionaire by age 53.

But the good news is that for the "Average Joe", he doesn't need to stick to Plan 1 all throughout his life.

At some point in future, after his life has settled, and his career taken a stronger foothold, he will have more time in his hands, and could start taking a greater interest in the stock market. Everybody is different, but for me, I found the stock market much easier than the property market. The idea of buying a rental property, dealing with tenants, repairs, etc. seems like hard work, compared to researching under-valued stocks. But I know people who think and feel otherwise, and that's perfectly fine with me - my motto is "whatever works for you best". But the basic idea is to look for returns higher than F.D. rates with almost equal certainty over the long term.

For example, if you could earn double the F.D. rate, suddenly, the goal arrives much sooner. At 7.4%, you could become a millionaire by age 54, or 11 years earlier. Your savings is only $315k, with investment returns forming the majority. Isn’t that nice, with the stock market contributing 70% to your $1M goal?

My own story here is that for a long time (whilst I was working), I had the goal of trying to maximize my returns with lowest possible risk. I would hold nearly half of my portfolio in cash (F.D.) and the other half in stocks. I was lucky, in the sense that my first investment book was on value investing and Buffett, and it made a huge impression and connection to me. I was also lucky, in the sense that my life experience included exposure to a couple of small business experience (when I was working part-time during my student days helping my cousin to manage her coffee shop, including the accounts), and later in my career, to work with and becoming part of senior management in a multinational company, and knowing how the Chairman thinks about constantly growing the business. In my late 20s, I was already thinking like an owner (in terms of how I can add value to my employer's top or bottom line), even though I was an employee, and that got me promoted faster. During the 97 Asian financial crisis, whilst my stock portfolio dropped by nearly 50% of my purchase price, I was fortunate enough to do nothing, kept on saving, and only later (when value becomes extremely compelling), transferred most of my cash to buy a lot more stocks at hugely bargain prices, and doubled my entire cash+stock portfolio a couple of years later - that was a nice 6 figure gain in total, and it forever changed my view about the stock market.

In my opinion, it's not impossible to earn 7.4% p.a. long term even when all you have is just a morning in the weekend to invest. The first rule is never lose money, and here, prevention is better than cure. Don't buy something you don't understand, because if you lose 50%, you will need to find another investment that returns 100% just to break even, and the odds of the former happening is unfortunately much higher than the latter. Also remember to never under-estimate the power of a single bad decision that could put you in negative return territory for years, instead of earning 7.4% p.a. each and every year.

Preparation is important and a careful plan is needed. Bursa might have 1000 listed stocks, but all you need is just 10 excellent stocks that is almost certain be around in 10 years time and is almost certain to be much larger than they are today. A few stocks that come into mind is PBBANK, PBB, TANJONG, etc. Even ICAP fund may also be suitable. If you focus on the long-term, and buy when the price is temporarily depressed and constantly keep the Millionaire's Plan in mind, then, these stocks should return to you 10%+ p.a. over the long term.

With 50% cash returning 3.7%, and the other 50% stocks returning 10%, your average portfolio return should be nearly 7% p.a. But before you even think of putting a single dime in the market, I strongly recommend you read books on Warren Buffett and value investing.

Holding cash is important for "insurance reasons" (cf. my experience from the Asian Financial Crisis). Whilst the long term expected return from stocks might be higher, the day-to-day returns can be volatile. But if the stock that you choose is sound, solid, with good long-term growth prospects and if it’s also one where you would trust the management to grow shareholder value in the long-term, then, there is no need to panic when the stock price goes down. Often, it's an opportunity to buy more at cheaper prices. That's when the cash will come in useful.

In the Millionaire's Plan, I also tabulated what would happen if your investment earnings grew faster than 2 x F.D. rates, such as 3x and 4x. This is just for information, to highlight the importance of investing as the "average Joe" gets older with larger savings $. As you get more experience in investing, you may choose to learn the more advanced investment techniques that provides you with even higher expected return, and still retaining a lower probability of loss. Yes, this is against conventional wisdom that says that higher returns can only be obtained from higher risk, but my limited investing experience has shown me that I do not need to take higher risks to get higher returns. As a wise person once said – Opportunities are everywhere, we just have to learn to see them. The sooner you learn about investing, the longer you can apply it for the rest of your life. We might all have similar life expectancy, but the one who learns good sound investment habits first can expect to benefit more than possibly his wildest dreams.

As usual, use your own judgement and invests at your own risk.


Bryan said...

Hello there. Got directed to your blog when checking out some posts on the investssmart blog. Interesting post about the millionaire's plan, found myself agreeing with most of what you shared. I have recently started to invest in Bursa and I was wondering if you have any specific stock investing books that you would recommend? Cheers

KLSE Investor said...

Hello Seng! Thanks for featuring one of our topics on your blog! :) Your analysis is so much more detailed than what we had. It would be great if you could join us in the forum when you have the time. I would like to propose a bit of a link exchange between Investlah and yourblog, please contact me at ong@investlah.com if you are interested.

Seng said...

Hello bryan,

Welcome. I wish I could recommend you just a single book on value investing in Bursa Malaysia, but I haven't come across one yet.

My advice will be to visit a reputable bookstore such as Borders, and try taking a look at the Investment section. There will be many books written about Warren Buffett and Value Investing ... spend some time browsing and see whether you find yourself agreeing with what's written. Borders allow you to browse for free :-)

Whilst reading books is necessary, it is probably insufficient. You may find the road long and arduous. Happy reading!

Seng said...

Hello Ong,

Thanks for visiting my blog. Unfortunately, I'm not much of a blogger, and I tend to chat more at investssmart chatbox on certain mutual stocks. I hope you find this and the various comments there useful.


Dennis said...

Seng, thanks for this meaningful article. You managed to clearly state the key points of a straight forward plan to making a million within the local context. To know of someone local who successfully practices this plan is rare. To have someone share his actual experience & knowledge in following such a plan, is a privilege indeed. Thanks for sharing.

grahamsmun said...

I think to save 20% of your pay is an easy task your EPF alone is saving us more than that!
The return of 7% is not difficult as most of real property appreciate around this level over 10 years.
But the average Joe want to get rich and his reasonable timeframe of 10 to 15 years.
This joe is looking into the mkt as an avenue.
Joe is also influence by his neighbour and relatives good lifestyle and his son in school look into his friends spending habit.
How can Joe make ends meet and achieve his goals to have a million in 15 years time ?

Seng said...

Hi dennis,

You're welcome. I'm glad to hear that you find the article meaningful. I hope all the readers here who genuinely seeks to improve their financial net worth will find something useful. Cheers.

Hi grahamsmun,

As making a million is easy for you, may I suggest that you create your own blog, and tell the readers at Investlah.com how you have successfully accumulated $1 million over the last 15 years. I am sure there will be many readers who would be most interested to read about your success. I would count myself amongst them. Please do so and create your own blog. Regards,

grahamsmun said...

I see your investment is quite good currently and conservative i am wondering if u had started from beginning (employing) basing on the pay u have mentioned would u be able to achieve that target(assume u save 20% Epf)plus ur savings from investment would u be able to make it.
As for me i find that have yet to perfect my technique not qualify to came up with my own blog

Von Siong said...


This is a good article.
I think lecturer in uni should share this infront of their students.

Well Done , Seng !