Transcription
The vast majority of people should never be investing in anything but an index fund until they hit $100,000. I'm going to show you why this is true both in the statistics, why this is true mathematically, and show you why you will come out with much more wealth and get there faster if you follow this plan instead of trying to pick stocks and actively trade at the beginning.
When I first started trading, I thought I was a genius because I was making money hand over fist. I was making more money from trading than I was at my job and it only took a couple of months before I completely blew myself up and I lost 95% of my net worth in one single trade. I spent the next couple of years learning how to trade better, blowing myself up a couple more times, and pouring a significant amount of effort and time and attention into learning how to invest and trade more effectively.
But the truth is, beating the market is very hard. It took me years to figure out how to do it. And starting over from zero or starting over after a 50% loss or a 60% loss sets you back really, really far. I mean, just look at the math. If you've gotten to a point where you've saved up $20,000, and then you blow yourself up and you have a 60% loss, now you're only sitting at $8,000. But the problem is, if you only have a 60% gain from there, you'll only be back up to $12,800. So, a 60% loss needs way more than a 60% gain to get back to break even. In fact, it requires a 150% gain just to get back up to break even. And that's just break even. That's not even making money. That's just getting back to where you were. You needed a 150% gain, and now you're at zero, back to square one.
It is far more likely in the beginning of your investing journey that you will have a learning curve, that you're not going to be naturally good at it from the start, which means you are going to have losses. And those losses are going to need exponentially larger gains in order to make up for that. Again, beating the market is hard. It's not impossible. At this point my five-year compound annual growth rate is 39%, but it is very difficult and it will take you a long time to get there.
But matching the market is extremely easy. If you want to achieve average market returns, the only thing you have to do is invest in the market. >> [laughter] >> Extremely easy. Now you can do this by investing in SPY, which is an ETF that tracks the S&P 500. You could choose QQQ, which is an index fund that tracks the Nasdaq. You could do this with VOO, which is a Vanguard index fund that tracks the S&P 500. You could do this with VT, which is a Vanguard index fund that tracks the entire world stock market. But at the end of the day, especially in the beginning, it really doesn't matter which one of these you choose. All of these.
The reason why is because in the beginning, the only thing you should be focused on is increasing your income. This is a scatter plot chart that shows the relationship or the correlation between income and wealth. You can see there's a positive correlation here. Which makes sense intuitively. The more income somebody makes, the higher chances they have of having a larger net worth. We can break this down by level of wealth and median US household income, and we can see that for people who have a net worth of less than $10,000, the median income for that group is only $32,000 for the household for the year. That people who have net worths in between $10,000 and $100,000 have a much higher median household income at $47,000. And this relationship holds true all the way. The people between $1 million and $10 million net worth make about $200,000 per year. The people who have net worths between 10 and 100 million make about $720,000 a year. And the people with net worths over 100 million have incomes above $4 million every single year.
Income is the best predictor of wealth. And the reason why is very intuitive. The more money you make, the more ability you'll have to sock away a bunch of that income into assets and build your net worth. Now, even if you say, "Yes, but this is just statistical probability. This is not guaranteed." Of course, you could make $200,000 a year, $300,000 a year, and spend everything, live paycheck to paycheck. In fact, that is exactly what Goldman Sachs just found in a recent survey they did of households. Then they found that 41% of households who earn $300,000 to $500,000 a year say that they're living paycheck to paycheck. So, having a high income is not sufficient for having a high net worth, but it is necessary.
And we can just look at the math to show this. Let's say you make $50,000 per year. After taxes and expenses, it's going to be pretty difficult for you to save and invest more than probably $5,000 per year. It's going to be 10% of your income. Again, after taxes and expenses, this is going to only be able to be done by the people who are extremely disciplined. So, if you make 50 grand a year and you're able to save five of that every single year for 40 years, religiously, and you're able to turn out a growth of 10% per year, you will have $2.4 million in 40 years. Now, that's nothing to scoff at, but it's enough to where you'd be able to live on about $120,000 to $150,000 per year from that without touching the principal. And by the time 40 years arrives, you can kind of imagine what inflation is going to be doing to the dollar over that time. You're not rich. You're surviving, but you've saved up just enough to be able to not be poor and dependent by the time you need to retire. And again, keep in mind this was with you saving and investing pretty much the maximum you'd been able to. And that's because there is a floor underneath your expenses.
However, let's take a look at the person with a high income. Let's say a US household makes $250,000 per year. This would be one very high income earner, or this would be two decently high income earners. For the person who's making 250 grand a year, it's going to be extremely easy to save 10% of their income. In fact, so easy you probably would not even notice it, which means that it'd be really easy to save more than 10%. Maybe you could put away 20%, 30%. But let's just say for sake of argument here that you're putting away even less than 10%. Let's say the $250,000 earner is only putting away 5%, which is half, percentage-wise, of the person making $50,000. That means that the person making $250,000 a year is putting away $12,500 every single year, which is over double what the low-income earner is putting away. So even though the high-income earner is putting away a smaller percentage of their income, such a small amount they would not even notice, the dollar amount is over double. And you can see that after 40 years, the high-income earner retires with $6 million, which is almost triple.
Now let's say the high-income earner matches the percentage and puts away 10% of their income every single year, just like the low-income earner. That means they're putting away $25,000 every single year, and they're going to retire in 40 years with $12 million, almost six times as much. And again, they probably wouldn't even feel it. They wouldn't even notice 10% of their income is going to investing. Not only do the statistics show that it is true, but the math shows it is true as well. Income is the most powerful wealth-building tool you have.
Okay, so why am I harping on income so much? It's because it makes zero sense to focus on increasing your investment returns by actively investing or actively trading until you have a decent amount saved up. And guess what? It's going to take you a lot longer to get there if you have a low income. So the number one priority for everybody should be increase your income first. All of your time, all of your attention should be focused on gaining new skills, gaining new experience, trying things, taking risk in order to increase your income drastically. It will be very difficult, if not impossible, for you if you stay a low-income earner to ever build significant wealth. But it will be very easy for you to build significant wealth if you can increase your income significantly.
Consider for a moment the amount of time, the amount of energy, the amount of attention that it takes for you to learn how to invest and trade well. You have to spend time doing research, looking up stocks, filtering through the news. You have to spend time learning from your mistakes, researching strategies, learning fundamental analysis, technical analysis, how to trade options, risk mitigation strategies like stops, hedging with puts. There's a reason why there are professionals in this space is because it can take all of your time and attention. And if you are spending all that time and attention on trying to increase your investment returns when you're only able to put away $5,000 a year, $10,000 a year, that juice is not worth the squeeze. If you're able to increase, if you are able to beat the market and increase your returns to 11%, 12%, 13% a year, you're doing that on a very small amount of money. An extra 1% on $10,000 only translates to $100. If you translate that into how much you're paying yourself per hour for all the amount of time and energy you spent trying to increase your returns, you're getting paid literally pennies per hour for your labor.
Now, imagine you had spent all of that time focusing on ways to increase your skills, learn new things that are valuable to people who will pay you more for your time, your products, your services. Within a short number of years, you can increase your income from $50,000 to $100,000 to $250,000 or more. In the beginning, the highest ROI for your time and for your attention is to focus on increasing your income.
Now, here's the most exciting part. Capital scales extremely well, which means the same time and attention that it took you to increase your returns by in the beginning, you can do that once you already have $100 grand or $200 grand saved up. But instead of it only earning you an extra $100 a year, now it's earning you an extra $1,000 or $10,000 per year. It's the same percentage difference, but it's on a way larger dollar amount. So, once you do have a significant amount of money saved up and built up, suddenly it does become more and more worth it to focus on increasing your investment returns.
So, in my opinion, the path you take should look like this. Number one, focus all of your time, attention, energy on increasing your income, your earning capacity. Keep your expenses locked so that every extra dollar you make is not going to increasing your lifestyle, you are investing the difference. But instead of actively choosing stocks or trading, you're just starting it in an index fund like SPY, VT, or QQQ. Once you're making six figures and you have six figures, suddenly it starts to make more sense to focus some of your time and attention on increasing your returns. Don't do this with the entire account, your entire portfolio. Take a portion, 10%, maybe up to 20%, and start actively investing, picking stocks, or trading with that. The reason why you don't want to do it with everything at first is because, like I said at the beginning, losses are more powerful than gains. Beating the market is hard. You will make mistakes. You will lose money. There's probably a multi-year learning curve here. At least there was for me. So, you want to minimize the cost of that learning curve so that doesn't take you years to gain back what you lost. But, if you learn from others' mistakes and you keep on going, eventually you will get better. And that boost to your overall performance of your overall portfolio will start to become more and more worth it for you because you're increasing the returns on a larger and larger portfolio. And that snowball effect will really start to kick into gear.
As always, thank you so much for watching. Have a great day.