The Simple Millionaire Path: ETFs

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Several people hold the desire to accumulate wealth over time and eventually earn the coveted millionaire status. However, in their endeavor to become millionaires, many of these people refrain from utilizing their money to invest in the Stock Market, believing that it is too risky and unpredictable for their liking. Despite all of these concerns, people can still contribute a portion of their income in the Stock Market and practice an uncomplicated, low-risk method to become a millionaire, courtesy the Exchange Traded Fund (ETF) strategy.

What is an Exchange Traded Fund?

An ETF is a type of investment fund or security that, much like a stock, can be bought or sold on stock exchanges at any time of the day with an associated price. An ETF is comparable to that of a basket, holding potentially an assortment of different stocks, bonds, or other different investment types. Since ETFs contain several holdings and a variety of assets, this provides an advantage of diversification for the investor, which typically would hedge risk in a portfolio, especially in market downturns.

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A myriad of ETFs specialize in specific holdings. Some ETFs hold only sector-based assets and track a particular sector, such as healthcare, consumer staples, technology, etc. Other types of ETFs may hold assets or stocks based on company market cap, whether it would be large-cap, mid-cap, or small-cap. ETFs that zone in on holdings with dividend growth or dividend appreciation are available to investors too.

Investors can also buy and hold ETFs that track a market index of stocks. For instance, the following market index tracking ETFs are available: the SPY (tracks the S&P 500 Index), IWM (tracks the small-cap Russell 2000), QQQ (tracks the technology-heavy Nasdaq 100), DIA (tracks the 30 stocks in the Dow Jones Industrial Average), and so on.

Vanguard: A Dependable Starting Point

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For people that harbor ambitions of joining the investing bandwagon but have no prior investing experience or have no idea what to invest in, it is highly recommended that they invest their money in Vanguard ETFs. The Vanguard company offers a variety of ETFs that cover different market caps and sectors. This includes ETFs that are exclusive to holdings based on several characteristics: market cap, dividend yield, dividend growth, high growth companies, sector, etc.

Out of all the ETFs provided by Vanguard, the two most secure ETFs that new investors can invest in over the long term are VOO, tracking the S&P 500 index and holding 500 of the largest US companies, and VTI, tracking the US Total Market Index and holding over 3,500 companies. These two ETFs provide as much diversification that investors can get. This provides the investor the convenience of the diversity without having to go through the strain and ordeal of conducting research of a company, paying attention to fundamentals, and tracking the news and performance of the stock frequently.

A benefit to new investors investing in Vanguard ETFs as opposed to ETFs from other companies is that Vanguard ETFs have comparatively lower expense ratios. The expense ratio is the annual fee that shareholders are changed by the ETF. The average expense ratio for Vanguard ETFs is a meager 0.10%, compared to the industry average of 0.57%. This may appear a subtle difference to many, but in the long run, the expense ratio rates do compound at exponential rates, much like annual inflation and ETF return rates. Therefore, it is imperative to keep expense ratios lower since higher expense ratios can cost potentially hundreds of thousands of dollars of returns.

Primary Factor to Becoming a Millionaire: Time

Believe it or not, the biggest factor to building significant wealth is time. While other factors, such as the ETF or stock, fundamentals, technicals, etc. are essential, investors need to bid as much time as they can to weather through the ups and downs with ease and let the compounding do the work.

To better illustrate the substantial effects of the investor biding time in the market, let’s suppose there are two investors: Person A and Person B. Person A is currently a 20 year old looking to build wealth by investing in ETFs. She plans to annually invest $4,000 into an ETF tracking the S&P 500 from this year until the age of 65. On the other hand, Person B is a 35 year old who also is looking to increase his wealth for retirement. He decides to annually allocate $6,000 of his salary into the same S&P 500 Index ETF that Person A utilizes from now until retirement at 65.

Effects of compounding over 45 years vs 30 years

The average annual return of the S&P 500 is approximately 9.8%. However, factoring in inflation, in the scenario above, the annual compound appreciation of 8% was utilized. This is a more realistic and conservative metric for ETF investors to keep expectations in check when calculating the time and money required to reach the million dollar goal before retirement.

When both investors reach the age of 65, Person A ends up with a significantly higher portfolio value of $1,669,704.27, which surpasses the $1 million goal by a considerable margin. Person A accomplishes this milestone at 59 years of age, 39 years since she started annually investing. Person B, on the other hand, can only grow his portfolio value to $734,075.21. While it should be acknowledged that he invested at a comparatively steeper rate annually at $6,000 than Person A, Person B eventually failed to exceed the $1 million threshold due to him starting to invest with 15 years less until retirement. With the dynamics of annual compounding, missing out on 15 years can make such an immense difference, as depicted in the graph above.

It should be noted that, overall, each person invested $180,000, the same amount of money. However, Person A ultimately ended up having a significantly higher portfolio value to take into retirement since she started investing much earlier than Person B did. The longer you leave your investments to compound, the more the value accelerates later on.

Significance of Investing at a Young Age

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It cannot be highly stressed enough how important it is for people to start preparing for retirement from an early age and as early as possible. It is never too early, as the scenario above demonstrates! Several people make this huge mistake of believing they have enough time to catch up and start investing later. As was the case with Person B, if you leave yourself with a smaller time horizon, you end up having plenty of catchup work to do to approach the million dollar mark, despite annually investing a steeper amount.

For people in their late teens or early twenties, it is pivotal to acknowledge it is never too early to start planning and preparing for retirement, as silly as it may sound. Hence, people that are still young should look to embark on building up their retirement portfolios as soon as they can. As shown in the example above, Person A, who started at 20 years of age, only needed to contribute $4,000 annually in the S&P 500 Index ETF. Given the benchmark was $1 million, it took 39 years for her to reach the goal. To break it down, $333.33 needed to be contributed monthly, by no means a steep amount.

Additionally, with a higher time horizon, young investors can afford to invest in higher risk, higher reward Vanguard ETFs that have regularly outperformed the returns of the S&P 500 over the long term, including the likes of the information technology ETF VGT, consumer discretionary ETF VCR, and mega cap growth ETF MGK. By regularly investing in such ETFs that beat the S&P 500 in the long run from a young age, the $1 million goal becomes surmountable.

As for people approaching retirement but have not started investing yet, the best that can be done is to start ETF investing and prepare for retirement as soon as possible. While it is highly unlikely such people will reach the $1 million mark, it is still possible to generate considerable returns from this strategy and be well settled in retirement. At the end of the day, something is better than nothing!

The beauty with the ETF investing strategy is its simplicity: investors can buy and hold for years without having to frequently keep track or worry. ETFs are an efficient way to accumulate wealth in a retirement portfolio and an effective manner to become a millionaire, with ample time.

Disclaimer: I am NOT a financial advisor! These articles are for educational and inspirational purposes only. In this article, I am only sharing my opinion, with profits or losses on investments not guaranteed! Please do your own research, with due diligence!

Disclosure: I am long MSFT, KO, T, MPW, O, ABBV, and CSCO.

Recent high school graduate and current college freshman passionate about investing, and endeavoring to guide new investors by sharing my investing journey

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Sivanand Birusumanti

Sivanand Birusumanti

Recent high school graduate and current college freshman passionate about investing, and endeavoring to guide new investors by sharing my investing journey

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