So you want to know how to become a stock market millionaire? It’s much easier than you think. Let me rephrase that – it takes a lot less work to become a stock market millionaire than you think. In fact, the most work you do is at the beginning of the process. Once you have your foundation laid, you can pretty much put things on auto-pilot. How great is that?
In fact, if you just take about an hour or two of your time now, you are 95% of the way to becoming a stock market millionaire.
What do I mean when I say laying your foundation? I am talking about creating your investing strategy. You can’t be jumping in and out of the market, chasing returns and trying to pick the best time to buy or sell. You have to have a strategy and stick to it, in both good and bad times.
So what exactly are the steps you need to do in order to become a stock market millionaire? I’ve outlined all of the steps below to help you build your wealth in the stock market.
Becoming A Stock Market Millionaire: Your How-To Guide
Step #1: Create A Plan
If you don’t have a plan, how do you know where you are going? Better yet, how do you know you even succeeded? You don’t. When it comes to investing, having a plan is crucial. Most investors jump around from investment to investment. They never see any real increase in their portfolio values so they give up investing because they think the stock market is rigged against them. What most of these investors fail to have is a plan. If they had a plan to follow (and they followed it) they would be successful.
By having a plan, you can assess if you are on track to meet your investment goals and if not, where to make changes along the way.
Here are the questions you should ask yourself when putting together your investment plan. Don’t worry, creating your plan isn’t very difficult to do.
Why Are You Investing? The first question you need to ask is why you are investing in the first place. Is it for a house, a vacation, wedding, early retirement, child’s college education, etc.? If you plan on investing for more than one goal, this is OK. Write down the various goals but keep them separate and answer the following questions for each of your goals.
What Is Your Time Horizon? In other words, how long will it be until you need the money you are planning to invest? For retirement, you would tend to have a very long time horizon, up to 40 years depending on your age. But for a house or vacation, your time frame is going to be much less.
The general rule of thumb is to invest in stocks for any goal that is more than 5 years away. Any goal shorter than this should have money invested in bonds or in cash instruments like certificates of deposit or savings accounts. Below is a chart for you to follow so you know where you should invest your money, based on when you will need to money you are saving:
What Is Your Risk Tolerance? We have our goal and we know when we need the money. Now we have to figure out how to invest it. I mentioned above how if your time frame is greater than 5 years, you should invest in stocks. But just how much of your portfolio should be in stocks? This is where you have to be honest with yourself.
You want to find an allocation that helps you reach your goal, but one that you are comfortable with so that you can sleep at night. If you aren’t sure what your allocation should be, I suggest you read my post on understanding risk tolerance. In that post, you will find a link to a risk tolerance questionnaire from Vanguard that will help you determine your risk tolerance.
One note about taking a risk tolerance questionnaire: make sure you focus more on the amount of money you could potentially lose as opposed to the amount you can gain. We all will take more risk to earn that extra money. But we discount how we will feel if we lose any money. When the stock market drops, we freak out because we didn’t assess our risk tolerance correctly for losses. This is why you need to be totally honest with yourself. There are no wrong answers when it comes to your risk tolerance.
If you chose not to take the questionnaire, note that most of you should be investing in a 60% stocks/40%bond portfolio if you are saving for retirement. This allocation will allow for you to earn a good rate of return on your investments and also allow you to sleep at night.
Should you find that 60% of your money in stocks is too risky, then reduce that to a 40% stocks/60% bonds portfolio. You really don’t want to go much lower than this if you are young because over the long term, bonds will not offer the return that you need to reach your goals.
How Much Do You Need? Of course, we need to know how much money we need to save if we ever want to reach our goal. For a house or a vacation, the amount we need to save is easy to determine. We know how much a vacation will cost us or how much of a down payment we need for a house.
For retirement, it’s a little bit harder. Here is a rough calculation for you to perform that will give you an idea of how much money you need to save:
- Figure out how much you spend on a monthly basis now
- Subtract out an obvious costs that you won’t have when you are retired, such as supporting young children or life insurance premiums
- Multiply the leftover amount by 12 to annualize the number
- Multiply the annual number by how long you will be retired for (95 minus your retirement age)
- Add an additional 10%
It’s not an exact number and some may argue their expenses will be lower in retirement, but I would rather have too much money than be broke at age 75.
How Much Can You Save? Once you know how much you need to save, you need to figure out how much you can save each month. Don’t give up or become frustrated if you realize you can’t save as much as you need to save to meet your goal. You have time on your side.
Regardless if you can save enough each month or not, you should make it a point to create and follow a budget. I know, but hear me out.
By creating a budget, you can see where all of your money is going. This can be a real eye-opener for some people. You might not have realized just how much your eating out was costing you. After you create and follow your budget, you can better assess your spending and saving and who knows, you might be able to save more money! More on this below.
Now, how do you get started with a budget? You can go the manual route or the automated route. For the manual route, you can check out this post which highlights some great excel spreadsheet templates for you to use.
For the automated route, you can go with Power Wallet (whom I like more than Mint for the reasons outlined in this post) or you can go with You Need A Budget. There is a learning curve to YNAB but many swear by it. And if you want to buy it (it does cost money), by clicking on the link above, you save 10%. And just so you know, Power Wallet is 100% free.
Getting back to saving more money, once your budget is set up and you see where your money is going, you can start looking for ways to save more. Can you cut your monthly expenses? Can you turn a hobby into an income stream?
When it comes to cutting expenses, I recommend starting with the big expenses first: insurance, mortgage, etc. and then focusing on the smaller expenses.
As for income, work hard so that you become invaluable at work and can earner higher raises. At the end of the day, you can earn a lot more money than you can cut out of your budget.
Creating An Investment Plan: Real Life Example
To make sure everyone is still following along, here is a step by step example of how creating an investment plan would work. The information in the parenthesis are the steps in creating an investment plan.
Bob wants to save for retirement (why he is investing). He will need the money in 30 years (what his time horizon is). He is a middle of the road type of guy. He doesn’t like a lot of risk. As such, he is investing in a portfolio of 60% stocks and 40% bonds (what his risk tolerance is).
Next, Bob estimates his monthly expenses are $3,000. Multiplied by 12, his annual expenses are $36,000. He plans to retire at 65 and live to 95 (this should be your ending age as well). He takes his $36,000 and multiplies that by 30 years to get $1,080,000. He then adds 10% to get a final number of $1,188,000 (how much he needs).
Finally, Bob has to determine how much he should save. He backs into this number by using this calculator.
He enters in the following values into the calculator:
Starting Balance: $1 (or how much you already have saved for your goal)
Interest Rate: 8% (assuming a 60/40 portfolio; if you have a lower percentage of stocks, drop this to 5%; don’t use a number higher than 8% to be safe)
The above numbers will stay the same as he runs his calculations. For the “Number of Years” field, he enters how long he has until he needs the money. Finally, he enters an estimated amount for the “Monthly Deposit”field and clicks on the calculate button.
He guesses at the “Monthly Deposit” number and recalculates until he gets a result that meets his needs. In his case, he needs to save $800 per month. (Don’t get scared by this number. We’ll see in Step #3 that this amount isn’t that much.)
Notes When Creating Your Investment Plan
The example I gave above is simplified so you can easily follow along. When you sit down to figure out your plan, many won’t know where to start. Ask yourself, “why is money important to me?” and write down your answers. If your answers are “freedom” or “flexibility”, you need to keep digging because you are only at the tip of the iceberg.
For example, you might say money offers you freedom, but what does that mean? Maybe it means quitting your job. But why do you want to quit your job? Is it because you want to start your own business? Or maybe it is so you can start a family? These are the real answers as to why money offers you freedom.
Be sure to take the time to really dig down to get to these answers. The more concrete you are with your plan, the greater the success you will achieve.
Also, when it comes to picking investments, you can’t jump right into figuring out what you should invest in without first asking yourself the above questions. For whatever reason, when it comes to investing and money, we want an answer without ever taking into account the question.
Would you be OK with walking into the dentist and having them just start pulling your teeth? No! You want to tell them why you are there in the first place so they can make your teeth feel better.
The same holds true with investing. You can’t just start picking investments and think all will be fine without first figuring out your goals. Take the time to figure out your goals so you can put your money where it makes the most sense.
Step #2: Open Your Account
I know, it’s basic, but hey, it has to be done. You have all sorts of options when it comes to investment accounts. You can choose a place like Vanguard, which I love, but you need to have a decent amount of money at the start ($3,000 to open a new mutual fund), which many don’t have. Because of this, I recommend a handful of online brokers here.
I personally use Vanguard, Betterment and Schwab. I love Schwab for its large selection of no load/no fee mutual funds that I can invest in with much less money than Vanguard ($500 for most funds to start investing in except Schwab funds which are $100 to start and then $1 after that). Schwab also offers a handful of exchange traded funds (ETFs) that you can trade without paying a commission. What’s not to love about that?
When it comes to Betterment, I can’t say enough good things. You can basically skip half of the work in the investment plan creation step when investing with Betterment because they do it for you. In 10 minutes you can open an account, select a goal and set up an automatic transfer and you are done.
Just as awesome, you’re diversified from the start (more on why this is good below in Step #5) and the fees are super low. In other words, if you take 10 minutes out of your day, Betterment will do all of the work to make you a stock market millionaire. It’s exactly like the commercial below, if Carbonite were Betterment:
Of course, there are other options as well. If you are more hands on than Betterment allows and want to invest mainly in stocks, then TradeKing, Motif Investing, or Scottrade are for you. You can read my detailed reviews for all of these by checking out my online broker chart I mentioned above.
Step #3: Set Up Automatic Transfers
Once you have your account open, you need to set up a re-occurring transfer into your account each month. All of the investment options I listed above allow for ongoing transfers. If you are going to become a stock market millionaire, you are going to need to invest in the stock market regularly. You can’t just invest $1 and wait for it to become $1 million.
I say that because if you invest $1 and it grows at 8% annually, it will take 173 years until you become a stock market millionaire. I hope you see the problem with that.
But, if you invest $100 monthly and earn 8% annually, it will take you just 53 years to become a stock market millionaire. Now we are talking!
The great thing is that I can show you how to reduce that time even more. Do you want to know how to become a stock market millionaire in just 30 years? Here’s how: Simply save $667 per month in the stock market. Before you get choked up on that number, hear me out.
The average U.S. income is $40,000 per year (here is the median U.S. household income). If you contribute 10% of your salary into your 401k, you are saving $333 each month. That leaves you with just $334 to invest after tax. (I didn’t include employer matches in this since some people don’t get employer matches. If you do, then you’ll be a stock market millionaire in less than 30 years.) Simply set up an automatic transfer to your investment account monthly for $334.
Let’s say you want to know how to become a stock market millionaire in less than 30 years. Here is a chart that I created. It shows you how much you need to save per month based on your current age to reach millionaire status at a given age.
Note the figures highlighted in green. I feel that these are easily attainable numbers if you invest 15-20% of your income. The great thing about investing is that if you are still young, as long as you invest a few hundred dollars, you are essentially guaranteed to become a stock market millionaire!
The key takeaway from Step #3 is to invest as much as you can on a regular basis. The more you invest, the quicker you will become a stock market millionaire.
Step #4: Pick Low Cost Investments
Unfortunately, many people don’t realize that they pay fees annually on their investments. Every mutual fund and ETF that you invest in, you pay a fee on. You never see the bill for it because the fee is taken out of the return of the fund itself. Therefore, if your mutual fund charges a 1% management fee and it returned 5% this year, it really returned in the neighborhood of 6%. You only earned 5% of that return. You might be thinking, “big deal, I’ll take that 5% because I’m going to be a stock market millionaire based on Step #3 alone!”
While this is true, you can get to millionaire status quicker (and have more money in the long run) by picking low fee investments. Here is an example of how costly investment fees are.
Let’s say you have $1,000 invested in a mutual fund that has a management fee of 1.25% which is about the average for a stock mutual fund. In 30 years after earning 8% annually, you will have paid just shy of $1,200 in fees. In contrast, if everything stays the same, but instead of paying 1.25% annually you pay just 0.30% in management fees, you will have paid about $350 in fees.
Some may be looking at the difference of $850 and not bat an eye. If this is you, you need to read my post on compound interest and then come back. While $850 on the surface might not seem like much, it really is. That $850 is taken from your investment account, which if left alone, would be able to compound upon itself and your balance would grow even faster.
Put another way, by investing in a higher fee mutual fund, you cost yourself a grand total of close to $3,200 ($1,200 in fees and $2,000 in opportunity cost).
As your investment balance grows, so do the fees you pay. If you have $50,000 invested, you are paying almost $60,000 in fees over the course of 30 years by investing in a mutual fund that charges 1.25%. If you instead invest with a fund that charges 0.30% over the course of 30 years you will have paid just $17,000 in fees. By simply choosing an investment with a lower fee, you would have $43,000 more! Fees matter. Let me say it again: Fees Matter.
On last point about fees: don’t fall for the idea that the higher fee you pay means a higher return. Investing doesn’t work this way. If I were to ask you, would you rather have a man wash your car for $10 or $5, assuming there was no guarantee that your car would be cleaner in either case, what would you say? Many would still choose the $10 wash. Why? Because they perceive an added value out of the $10 car wash.
This holds true even though I told you that you weren’t going to get a better car wash. With investing, many investors make this same mistake. They think a fund that charges a higher fee does so because it has a secret formula to earn a higher return. It doesn’t.There is absolutely zero in common with high fees and high returns. None. Zip. Zilch. Zero. Save your hard earned money and pick investments with the lowest fees possible.
You have to pay attention to the management fees of what you are investing in. You should not be paying over 1% in any circumstance for an investment. There are many low cost mutual funds and ETFs that you can invest in that will not cost you and arm and a leg. Vanguard and Betterment are excellent when it comes to low fees. Schwab is good too if you pick the right investments. That is your money. Don’t give it up so easily.
If you need help constructing a portfolio, read my post on model portfolios that will help with picking mutual funds and ETFs to invest your money in.
Step #5: Diversification
Risk and reward are tied together when it comes to investing. The higher return you want to achieve, the more risk you are going to have to assume. It’s the nature of the beast. By diversifying your investments, you take away some of the risk with investing in the stock market and this allows you to earn a little bit higher of a return.
Here is how diversification works. Stocks tend to earn a higher annual return than bonds and are also more volatile. What this means is that stock prices tend to rise and fall quicker and in larger amounts than bond prices do.
If you invested in just stocks, you could earn as much as 51% in one year or lose as much as 37% in one year. With bonds, you could earn as much as 17% in one year or lose as much as 11% in one year. Most investors wouldn’t like it if they had to choose between these two.
This is where diversification comes into play. If you were to create a portfolio of 50% stocks and 50% bonds, your potential one year gain drops to 32% while your potential loss drops to -17%. The numbers get even better when we extend the time horizon out to 20 years.
Of course, diversification doesn’t stop there. There are all sorts of stocks you can invest in – small cap, large cap, growth or value stocks, domestic or international, etc. For bonds, you can invest in long-term or short-term bonds, government or corporate bonds, or even junk bonds.
All of this diversification has an impact on your returns. At the end of the day, the goal with diversification is to allow you to earn the highest return with the least amount of risk.
Realize that there are limits to diversification – you can get to a point where you are too diversified. Plus, you can’t diversify away 100% of the risk in the stock market. There will always be risk present.
When it comes to being diversified, I go into great detail showing you the importance of diversification in this post. I encourage you to read it (plus it has some really cool charts!)
But the bigger question is, how do you know if you are diversified right now and how do you go about making some changes to help you get to an ideal mix?
You have two options: a manual one and an automated one. Let’s look at the automated one first.
- Automated Option #1: It is called Personal Capital. You create your free account, link up your investment accounts and you will get a chart that shows your current asset allocation. In just a few minutes you will know what moves you have to make to become better diversified.
- Automated Option #2: Another somewhat automated option for you is to use Quicken. I personally have not used Quicken in years. I have read some good and bad things recently about Quicken. As of this writing, they do allow for you to try it out for free before spending any money.
- Manual Option #1: When it comes to a manual approach, your best option is an excel spreadsheet. You can create your own from scratch or use this one that I created. You could even just use mine as a template and edit it to make it your own as well. The benefit of going this route is having complete control over it, so you can make it exactly how you want it. The downside of course is it requires you time to update it.
Step #6: Don’t Chase Returns/Stay Invested
This may be Step #6 but it is extremely important. Chasing returns doesn’t work. When you try to chase returns, you cost yourself money through commissions and trading fees. At the end of the day, you end up in a worse position than you would be in had you just stayed invested. This is why the average investor only earns a 2% return.
Chasing returns is akin to Wile E Coyote chasing down the Road Runner. He does every possible thing to catch the Road Runner and every time he comes up empty. Same idea applies here. If you want to be a stock market millionaire, you can’t chase returns. Don’t be Wile E Coyote.
Another reason why chasing returns doesn’t work is because many times, we base our investment decisions off of past performance (even though investments tell us not to). Back during the dot-com boom, I made this fatal mistake.
I invested heavily in a tech mutual fund that earned over 60% in the prior year. The year I invested in it, the bubble burst and I lost close to 60% of my investment. I never chased returns again. For me, slow and steady always wins the race when it comes to investing.
After the stock market collapse of 2008 many investors fled the stock market. Some investors have come back into the market; many investors have not come back at all. Those that didn’t come back have missed out on one of the greatest bull markets ever. The market is up over 130% as of this writing from the lows in 2008. You would have made all of your money back, plus some had you just stayed invested.
When I was working for a financial advisory firm, most of our clients had their portfolios back to pre-crash levels mid-way through 2011. They were scared during the crash, but they knew they were better off staying in the market.
You have to stay invested in the market, in both good times and bad. The market will drop. But it will also rise. Over the short-term, the market can be very volatile. Just look back to the summer of 2011. I’ve never seen anything like that in my life. But over the long-term, the general trend of the market is positive. Look at any chart for proof. The market pushes higher over time.
With that said, I know it can be hard to stay invested when it seems as though the sky is falling. Especially when the media over-blows the situation and makes it seem as though the world is coming to an end. You have to do your best to keep your emotions in check and tune out the “noise” as I call it – turn off the television, don’t read the stories in the newspapers, magazines or online. Remember that Wall Street makes money by making you trade. The more you trade, the more money they make.
Fear and greed are the two most dangerous things to an investor. You have to learn how to manage these if you want to be a stock market millionaire.
When you are feeling most worried, refer back to your plan you created in Step #1 and review why you are invested the way you are and what your goal is. For most, it is a long-term goal, so don’t get upset over things happening in the short-term.
Finally, always remember we make things out worse in our head than they turn out to be. The worst case scenario rarely becomes reality.
Step #8: Track Your Progress
Unless you track your progress, you will never know if you are on track for meeting the long-term goals you outlined in your investment plan in Step #1.
Based on how the market moves, over time, you might see that you are investing in more stocks than bonds, which means you are taking on more risk than you are comfortable with. By tracking your investments, you can correct this so that you stay on track.
Likewise, maybe you now have more bonds than you planned on holding. This too can be a problem since bonds tend to have a lower rate of return than stocks. If you are invested too heavily in bonds, you run the risk of not earning the return you need to meet your goal.
In order to get your holdings allocated correctly, you will need to rebalance. This means selling off the holdings that have grown in value and buying those that have decreased in value. On the surface this might sound counter-intuitive. After all, why sell the holdings that are making you money?
By rebalancing, you are guaranteeing that you buy low and sell high. You take the emotion out of investing and this is a major factor in your success with investing.
Here is a quick example of rebalancing: Let’s say your ideal portfolio is 60% stocks and 40% bonds. At the end of the year you see you have 70% stocks and 30% bonds. You would sell off 10% of your stock holdings and use the proceeds to buy more bonds.
Now, when it comes to your retirement accounts, you can buy and sell without worry as there are no tax consequences from placing trades within these accounts. But things get tricky in taxable accounts since you have to pay taxes on any gains you realize when you sell.
Here are the guidelines I use to rebalance:
- I review my holdings twice a year – usually at the end of June and the end of December
- I look for holdings out of balance by 5% or more (meaning if my 60/40 portfolio is 62/38, I don’t bother rebalancing)
- For my retirement accounts, I buy and sell without question as taxes don’t factor in
- For my taxable accounts I skip the buying and selling and simply add new money to the assets that I need a higher proportion of. So, if my 60/40 portfolio was 70% stocks, 30% bonds, all new money I invest would go towards bonds until I got my portfolio back to 60/40.
Finally, as time goes on, you may realize that you need more or less money that you originally calculated. As a result of tracking your investments, you can make any necessary changes to your investment plan.
The easiest way to track your investments is through Personal Capital. Just link your accounts and you’ll get detailed analysis from Personal Capital. Another option is using personal finance software like Quicken. You could even use an excel spreadsheet and do the tracking manually.
So there you have it, your step-by-step guide for how to become a stock market millionaire. I told you that it was easier than you thought. If you follow these steps, you will be well on your way to investing success.
I know that there was a lot of information here, but don’t feel like you need to cover everything at once. I know that investing can be overwhelming for many people. Everyone is telling you something different.
What I can tell you is that all of these tips, when used together, work. It’s the same philosophy we used at an investment firm that I worked for that dealt with people who had millions to invest. I use all of these tips personally and it has allowed my wife and me to have great success when it comes to investing.
If you feel overwhelmed, but want to start investing, I highly encourage you to start out with Betterment. It is the easiest way to get started in the stock market and we all know getting started is the key. As I mentioned earlier in this post, just take 10 minutes, pick a goal and monthly savings amount and you are done. They will do everything else for you.
For the rest of you that want a little more detail on these steps, along with a few additional points, be sure to check out my eBook, 7 Investing Steps That Will Make You Wealthy. By taking the time to understand how to invest, you will find success and reach your goals. You aren’t going to get anywhere without taking action. Start investing today and become a stock market millionaire.
[Photo Credit: Maklay62]