🤾🏻 🚟 📳 How to become a dollar millionaire in 30 years, lying on the couch 🌎 ⛈️ 🍞

A post ״ Newcomers to the stock market: honest talk about trading ״ recently appeared on Habré . This post, published in one of Habr's most read blogs, misleads people and creates a false impression from them that playing the stock exchange is a good way to earn money. This forced me to write a comment, which gradually grew into an entire article, with a detailed analysis of why trading is not a way to get rich, but a way to lose money, and how to actually make money on investments.

Part 1: why there are no wealthy traders

Who and why advertises trading

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From all sides, streams of advertising are pouring down on us with smiling people holding a bundle of dollars and telling how terribly rich they were sitting at home on the couch, engaged in trading. A single mother with a baby in her arms is not hired anywhere, she learns about trading and now she earns a hundred, no better than two hundred thousand rubles a month, absolutely without straining. Each brokerage firm must have free trading courses that promise the golden mountains after passing them. And I'm not just talking about Forex cuisines like Alpari - normal brokers such as BCS or Interactive Brokers also have these very free trading courses.Why do they need it? Why do even normal brokerages with a good reputation invite you to do such dubious things as trading? To answer this burning question you need to understand one simple rule. When we receive any information from someone, in order to separate the grains from the chaff and the useful content from marketing, we need to ask ourselves: what does the person who informed me of this information earn. So what does the broker make? Any broker earns commissions for every transaction made. That is why it is beneficial for him that you make as many sales transactions as possible and as often as possible. That is, it is beneficial for the broker to engage in trading. And on the contrary, it is absolutely unprofitable for a broker if you make rare long-term investments. And this is about more or less normal brokers.How do Forex kitchens act as counterparties to transactions and “play” with quotes, I don’t even want to say.

Authors of various paid courses and bloggers with a paid subscription, who, according to their own assurances, teach the super-secret technique of earning money on the stock exchange, also call for trading. Why would they sell courses at 5000 rubles, if, according to them, they are cutting money in millions on the stock exchange - the question is absolutely rhetorical.

The unenviable fate of traders

According to statistics, approximately 90% of traders completely or partially drain their initial deposit. Someone does this in a couple of days, someone in a couple of months, and someone in a couple of years, but the result is always the same. This is especially fast done by beginners and those who like to use leverage. Well, what about the remaining 10%? The fact is that among the remaining ones, during active trading, almost no one can bypass the S & P500 market index in terms of profitability for a sufficiently long period of time. That is, even if the trader did not merge all his money, but won on the stock exchange, then in the end he will receive a lower return than if he simply invested all the money in the S & P500 index fund.

This does not mean that no one will receive returns above the market. No, there will always be those who hit the jackpot. Someone invested in bitcoin and became enormously wealthy when the cryptocurrency bubble inflated. Someone successfully bought an apartment in Moscow in 2002 and sold many times more expensive in 2007. That is, there will always be 1% of traders who have earned more than market profitability. The only problem is that this 1% is not the most intelligent or talented. Hitting this percentage is determined by absolute coincidence. And in the future, these same traders with great probability will never again show the same profitability. That is, of course you can win at the casino, but it is impossible to win at the casino stably over a long period of time. That is why trading is called a game on the stock exchange - because it is much closer to the casino than to investment.

Trusting Money to Professionals

Well, suppose that ordinary traders are not good enough to make money on the exchange. But what if we entrust the money to professionals? The very same investment funds managed by people in jackets and ties? Unfortunately, all the same laws of the economy apply to investment funds. According to statistics, most actively managed funds either lose money or receive returns below the market. And those few who received higher than market returns cannot repeat this result in the future. What does not stop these funds from actively advertising and attracting investors, because fund managers make good money on management fees. If they can also earn on a percentage of the profit brought to the client - well, they won’t be able to - well, okay.

Even one of the greatest investment managers of our time, Warren Buffett, who has been earning above the market for more than 40 years, has been losing the S & P500 for the past 17 years. Despite the fact that his methods can hardly be called trading, it is rather a mixture of long-term investments with a very small number of active operations.

Efficient market

Why is this happening? Why no one can consistently receive returns above market. In response to this question, the American economist Eugene Fama received the Nobel Prize in Economics. And this answer sounds like this - the market is efficient. If in an effective market someone finds out some way to beat the market, then soon all other participants will also learn about it, and with the spread of this knowledge, prices in the market will change, reflecting new information. Thus, the market is self-regulating. This is the same invisible hand of the market, about which Adam Smith wrote.

But what is market efficiency? Market efficiency is the speed of dissemination of information. That is why in ancient times it was still possible to show excellent profitability by investing in small companies with great growth potential - then the speed of dissemination of information was not so high. But in the last couple of decades, with the total penetration of the Internet into the most remote corners of the planet and the acceleration of the dissemination of information, our global stock market has become almost absolutely effective and no one has been able to exceed its average yield.

Part 2: passive investments

So how do we still make money in the stock market? Let’s think - if it’s impossible to consistently receive returns higher than market returns, then it means you can consistently receive market returns! So stop it. First, let's figure out what kind of beast this is - market profitability. Let's start from afar:

Profitability and risk

What is profitability and how to calculate it, I think, is clear to everyone. What risk exists when investing is also pretty obvious, but far from everyone knows how it is measured.

In the world of finance, risk is a synonym for volatility. And the word volatility itself is a synonym for the mathematical concept of standard deviation. That is, if you have a stock that yesterday cost $ 100, today costs $ 95, and tomorrow costs $ 105, then it is much less volatile, and therefore less risky, than a stock that cost $ 100 yesterday, costs $ 20 today, and tomorrow costs $ 180.

The main axiom of finance is that a higher income is always accompanied by a greater risk, and low-risk investments produce a small income. For example, in any Russian bank, deposits in dollars have a very low percentage, while in ruble deposits the percentage is quite high. This is because the likelihood of a strong devaluation of the dollar is very low, and the likelihood of a strong devaluation of the ruble is much higher.

It is also worthwhile to understand that the expected return and expected risk are calculated based on historical data. But historical data do not fully guarantee that future profitability and volatility will be the same as in the past. For example, a Coca-Cola company that has existed for more than a hundred years and regularly pays good dividends, can suddenly suffer enormous losses, lose market share or even close completely.

Asset classes

And what kind of assets can bring us income?
There are a great many exchange-traded assets. But to form an investment portfolio, usually only three asset classes are used.

Stocks - stocks - you buy a piece of the company. Income is derived from dividends and an increase in the price of the stock itself. For example, stock A was worth $ 25. A year later, it began to cost $ 27 and brought $ 1 dividends. Your income is $ 3. Stocks are highly profitable, but also risky assets. A year later, a stock may not cost $ 27, but $ 20. Or it may be that the company goes bankrupt and the stock price becomes equal to $ 0.
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Why are these three classes of assets used to form the portfolio? It's all about correlating their value.

Stocks - the value of different stocks correlates quite well with each other. When the economy grows, all companies make good money. When the economy falls, all companies lose
Corporate bonds - the value of corporate bonds has a weak correlation with the value of shares. When the economy falls, the risk of defaults rises slightly and corporate bonds become cheaper and vice versa. This correlation is very weak, but still exists.
Government bonds - the value of government bonds has a negative correlation with the value of shares. That is, when stocks get cheaper, government bonds go up, and vice versa
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, ETF

About once every ten years, crises occur during which the economy deteriorates sharply and the value of all shares drops sharply. But in the long run (if we take intervals of tens of years), the total value of stocks always grows - after all, the economy is growing on the whole planet and labor productivity is increasing, and the dollar is gradually devaluing. And although individual companies may go bankrupt or cheaper, the value of the shares of all companies combined, for a sufficiently long period of time always tends to rise. That is, having invested in the shares of one or two companies, we can easily burn out, but if we invest in the shares of all companies at once, then everything will be fine. Even if some of these companies go bankrupt or their shares become cheaper, the shares of other companies will rise in price and compensate for our losses with interest.But how do we invest in all companies at once?

The famous financier Charles Dow thought in the 19th century that adding up the share prices of 11 of America's largest companies of his time, he would get a number that shows how the entire stock market behaves as a whole for a given period of time - is it growing or falling. So the first stock market index appeared - the Dow Jones index. And since 1957, another well-known financial company Standard & Poors has published its stock index of the 500 largest companies in America. It is the S & P500 that is now considered the main indicator of the state of the US stock market. That is, buying shares of all these 500 largest companies in equal proportions, we just get market profitability. Sumptuously!

But how to buy shares of 500 companies at once, if we have $ 1000, and the average share price of one company is $ 100? To do this, you need to unite with other investors, throw all the money into one fund, buy the shares of these 500 companies for this lot of money, and then give each investor a share in the fund, proportional to its investment. That's what the big-headed guy John Bogle did, who founded Vanguard in 1976 and came up with the first index fund.

But the management of such a fund takes up a lot of resources, because of this the commission of the fund manager is too high. And to buy or sell a share of such a fund is not very simple. Therefore, in 1993, the first ETF (Exchange Traded Fund) on the S & P500 index was born. The idea of the ETF is that this index fund does not give shares to its investors, but rather registers a company whose shares it distributes to investors in proportion to their share. And these shares can also be traded on the stock exchange. That is, having bought ETF shares on the stock exchange, we invest our money in an index fund that buys shares of the 500 largest companies in America in equal proportions. The main advantages of ETFs are that the fees for managing such a fund are extremely low, and that we can buy or sell our share on the exchange in seconds. Wonderful, isn't it?

Moreover, later, in addition to ETFs on stocks, ETFs for various types of bonds appeared, and even for gold. For example, in my portfolio I use ETFs such as VOO (S & P500), VCLT (long-term corporate bonds), VGLT (long-term US government bonds) and IAU (gold). They have the smallest management fees in their class. Why is it important?

Because the most important expenses of any investor are taxes, broker commissions and fund management fees. And one of the primary tasks for us is to minimize these three expenses. Therefore, choosing ETF funds, be sure to see what commission they charge for management. Even seeming insignificant differences in a couple of tenths of a percent over a long period of time can turn into very, very significant expenses.

Diversification

Well, it would seem that we bought a stake in the index fund and get market profitability. It seems that everything is fine and we are in chocolate? But not so simple.

There is one problem. Our investment horizon (that is, the time when we want to use our investments) may not be so far that we can calmly survive the loss of half the value of our portfolio during the crisis. For example, after a couple of years it’s time for us to retire and start spending our fund, and then the crisis began, and the value of our portfolio fell by half. And as we remember, stocks are a high-risk asset, and this happens periodically. In this case, we need to reduce the volatility of our portfolio. Of course, in this case, our income will decrease, but we’d better not get the extra profit than lose half of our honestly earned income. Here gold comes to our aid and also corporate and government bonds, the value of which, as we recall, is correspondingly zero,weak and negative correlation with stock value. Therefore, adding bonds and gold to the portfolio, we will sharply reduce its volatility, which is what we need.

Portfolio Theory of Harry Markowitz

How can we find the ideal ratio of various assets in our portfolio to get the best return at the most acceptable risk to us? Here the portfolio theory comes to our aid, for the development of which Harry Markowitz received the Nobel Prize in economics. Its essence is that if you take all possible combinations of the proportions of the assets used in the portfolio and calculate the expected risk and expected return for them, it turns out that there can be several portfolios that have different returns with the same risk indicator. For example, a combination of 70% of asset A and 30% of asset B gives us a 5% return with a risk of 7%, and a combination of 80% of asset A and 20% of an asset B gives us a yield of 8% with a risk of 5%. The second portfolio is clearly better.

In the following profitability and risk chart for all possible combinations of VOO fund shares and VGLT fund shares, it is clearly seen that there are portfolios that, with the same risk level, have completely different returns.

Thus, the main application of this theory is to find the most effective portfolio, that is, to find such a combination of the proportions of the assets we have chosen that will give us the best return at the desired risk level.

It is also very important to understand that the composition of the portfolio strongly depends on the totality of all life circumstances and investment goals of a person, such as his investment horizon and risk appetite. For example, a person of pre-retirement age is most likely to reduce portfolio volatility so as not to lose too much in the crisis before retiring. But if the crisis in the stock market has ended recently and you are young, then perhaps you should think about a more volatile, but also more profitable portfolio.

Portfolio rebalancing

Every Wall Street shoe cleaner knows that to make a lot of money you have to buy low and sell high. But how to guess the right moment to buy? Let us turn this question to the same hypothesis of an effective market. If someone knew how to predict a good moment to buy or sell assets, then he could beat the market. But this is impossible! So what do we do? The correct answer: use rebalance.

Let's imagine that we have a portfolio of two shares A and B. Share A costs $ 10 and Share B costs $ 10. We decide that our portfolio of these shares should be equally divided. And so we invest our initial $ 100 and buy 5 shares of A and 5 shares of B. After some time, the price of share A drops to $ 5, and the price of share B rises to $ 15. That is, now we have 5 shares of A with a total value of $ 25 and 5 shares of B with a total value of $ 75. With the next paycheck, we have another 100 dollars that we want to add to our portfolio. What is the best way to do this?

In this case, it is best to rebalance the portfolio and return the ratio of shares to the initial ratio of 50% to 50%. We buy 14 shares of A at $ 5 and 2 shares of B at $ 15. Thus, we now have 19 shares of A with a total value of $ 95 and 7 shares of B with a total value of $ 105. We brought the portfolio to a ratio of 47.5% to 52.5% - that is, almost equally. Suppose that now stock A has risen in price again and has become worth $ 10 again, and stock B has become cheaper and has also become worth $ 10. That is, the prices of both shares returned to their original prices. How much will our entire portfolio cost now? Let's count: we have 19 shares of A with a total value of $ 190 and 7 shares of B with a total value of $ 70, which in total gives $ 260. So stop, we only invested $ 100 in this portfolio twice, why now it costs $ 260? Because we bought more shares of A,when they were cheap, and then they went up. And we didn’t invest heavily in B shares when they were expensive, and then they fell in price.

Dividend reinvestment and compound interest

Even if we apply rebalancing, the profitability of our portfolio will still be small and amount to only 4-8% per annum in dollars. How can we get rich getting such a small profitability? Very easy! A complex percentage will help us with this.

If we reinvest all dividends received from stocks and all coupons received from bonds back into the portfolio, buying additional securities with this money, then the value of our portfolio will increase not linearly, but exponentially.

For example, if we have a certain portfolio with a yield of 5% per year, then upon reinvesting the income received back into the portfolio, our capital will double not in 20 years, but in only 14.5 years.
Over 30 years, our capital will increase by 4.3 times. This is the magic of compound interest. And if we also add monthly additional funds to our portfolio on a monthly basis, then our capital will grow at a much faster pace.

Now, finally, let's move on to the main issue of the post!

How to become a programmer dollar millionaire

Suppose we have Vasya. Vasya lives in Kiev and he works there as a senior programmer for $ 4000 per month. With this money, Vasya is quite free to save $ 1,500 per month on investments. Vasya has a portfolio that, over a long period of time, has an expected return of 4% per annum. All dividends paid to Vasya, he reinvests back into his portfolio. Thus, for 30 years, Vasya becomes the owner of a fortune of more than a million dollars. Simple math and no magic.

Conclusion

In my article, I was not able to tell all about passive investments. If you want to know more, I advise you to read an excellent series of training articles by Sergey Spirin, in which all aspects of investment are very well described, as well as his magnum opus “Bedriddle Portfolio” . If you are fluent in English, I advise you to read the beautiful book Simple Path to Wealth . Good luck and financial prosperity!

How to become a dollar millionaire in 30 years, lying on the couch