How To Make Your First Million

This summary is based on the ideas and learnings from "How To Make Your First Million", 1st Edition, by Warren Ingram in 2016-09. The description of the book mentions: "A simple and easy-to-follow guide which shows various methods of how to make money and reach financial freedom. Sadly, very few people ever get to a stage where they are able to live off the income from their savings and investments. This book provides real examples of ordinary people who have reached their financial goals in their own unique way and offers practical ways of setting goals and keeping motivated to achieve them". Overall, it is a basic attempt with honest intentions, but some content is objectively incorrect.

Summary Disclaimer

It should be emphasized that the summary only includes the content which was found to be relevant. There may have been additional information for many chapters, but it was seen to be unnecessary or incorrect in several cases. In this sense and as a consequence, the information included in the summary may appear different from the information included in the book. Finally, there is every possibility some information was mistakenly missed while reading the book.

Investment Fundamentals

People who do not have clear plan for how they will spend their time once they stop working very often lead miserable and unhealthy lives. It is also worth noting that many high-level executives get divorced in their first year of retirement and a significant proportion die of illness. As an aside from surveys, more than 60% of husbands who are nearing retirement plan to spend more time with their wives, while only 45% of wives plan to spend more time with their husbands. When considering retirement, it is necessary to investigate along the lines of the length of time available to reach the ultimate goal, which factors are the most important priorities, locations to eventually live (cost of living, need to travel, local familiarity, etc), lifestyle to lead (vehicles, medical aid, insurance, food, entertainment, going to restaurants, hobbies, etc), want to travel, and want to help others (family, charities, etc).

To build an interesting and enjoyable career, consider specializing in a certain skill rather than following a generalized path (middle manager); aim to be a primary revenue generator for a company and more important to success; try to leverage skills (engineer, musician, writer, artist, developer, financial planner, etc), rather than selling time (lawyer, accountant, etc), to ultimately be less replaceable while avoiding impact on other parts of life; and find something which is exciting in a way which steadily realizes a personal goal and ensure there is a clear motivation and road map provided by the vision of accomplishing this goal.

Since the 1960s, shares have grown in value more than 3.0 times faster than residential property prices. Considering various asset classes: ABSA House Price Index, 1.9%; All Share Index, 7.6%; SA Listed Property, 6.6%; All Bond Index, 2.0%; STefI Call, 1.0%. It is also important to look at the costs of investments. In the case of residential property, one of the major costs would be a mortgage or home loan. The average mortgage interest rate over certain periods has been higher than the nominal growth on property before inflation. This means that investors in residential property actually paid more in interest than they gained in growth on the value of the property. In addition, mortgage interest is not the only cost of owning a residential property. There are also the initial costs of buying the residential property, which include transfer duties, bond registration, and legal fees and might be as much as 2.5% to 13% of the value of a residential property. Moreover, it will be necessary to pay an estate agent 2.5% to 5.0% to eventually sell a residential property. And there are the maintenance costs which could average as much as 1.0% of the value of a residential property per year.

Those who are still unconvinced that residential property could be a poor-performing asset are probably thinking that at least property is a low-risk investment. But there are some significant risks to consider, including concentration and liquidity risks. Concentration risk means having too much capital exposed to a single investment and liquidity risk means it is not possible to sell an investment quickly.

From a study, the Herengracht Index from 1628 to 1973 recorded the returns of property in the Herengracht district of Amsterdam. The study showed that, over nearly 400 years, real house-price growth averaged only 0.5% per annum over the entire period. The results are fairly consistent over each century as well, with the lowest real growth of -0.2% per annum being in the 18th and 20th centuries and highest real growth of 1.3% per annum being in the 17th century. This study is valuable in that it focuses on a specific area in which the houses have not changed in size and which has always been considered a prime residential area, so performance has not been affected by urban decay or other housing factors. The primary conclusion is that residential property basically tracks inflation over the long term. In other words, someone should not expect an investment in a residential property to beat inflation by a large amount.

The only time a residential property is an investment is when the mortgage is used as leverage to buy income-generating investments. If a residential property is worth R2,000,000 and a R1,500,000 mortgage is taken to buy a rental apartment, then the residential property becomes an investment. If the residential property is only paid off, it is simply a lifestyle asset, as it costs money to live there without producing a return greater than inflation. Like all lifestyle assets, it has value and can be sold, but it cannot generate any further income.

It should also be noted that buying a rental apartment is not necessarily a good investment and it may be better to consider real estate investment trusts, as a rental property will have higher purchase and sales fees, higher annual fees for maintenance, periods with no tenants, only options for residential property without diversification into offices and shopping centres, and low likelihood for yields more than 5% to 8% per annum for residential property (listed property funds usually yield 6% to 9% per annum). It should be kept in mind that most large properties or developments are valued according to the level of income they generate rather than the actual value of the land or the building. Any factors which hamper rental income are likely to have a direct impact on prices of commercial and industrial properties.

Despite being the cause of some of the biggest investment collapses in South African history (such as Sharemax and Masterbond), property syndications still attract unsuspecting investors who are looking for income. It is usually retirees who are most attracted to syndications and who are therefore the most frequent victims when collapses occur. Some property syndications are massive investment schemes with thousands of investors. The idea behind syndication is that an investor becomes part owner of a property which pays them an income and, hopefully, a capital profit when the property is sold. In essence, a property syndication is a hybrid between a unit trust and a direct property investment. The attraction of these syndications is that an investor can get a high level of income to compensate them for the risk of making a long-term investment that cannot be easily converted into cash. The theory behind these syndications is reasonable, but the way they are implemented is the cause for concern. Syndications are almost always created for individual property developments rather than a collection of different properties. Unfortunately, these syndications are often complex in structure and investors do not actually buy shares in a property business. Most syndications sell shares in a company, which then lends money to another business to buy the physical property. The loan is not secured, meaning the property is not used as surety for the loan, so an investor might get nothing if the syndication fails. It is important to note that an investor has no guarantees with this investment. Their capital and income are always at risk, because they are not actually buying a share in a property business. In reality, this investment is a loan to a property business. The fees are also extremely excessive at as much as 4% to 8%.

Long-term investors aim to buy an investment and to hold it for an extended period until the investment reaches a specific target price at which time it is sold. They will usually aim to hold their investments for at least 3 years to 5 years. Long-term investors are less likely to be influenced by short-term events which could lead them to make irrational decisions. Long-term investors only really start making money after 10 years or 15 years of investing. If they invest wisely, the chances of something going wrong on a long-term investment are much smaller, but traders who participate in short-term events face this risk constantly. Even if the stock market does not perform well over longer periods of time, a long-term investor can still make money from dividend-paying shares over this period. Dividends make up more than 50% of the total returns earned by equity investors over the long term.

Anyone trying to beat inflation will experience losses during an investment career, as investment risk is not a one-way street and there will always be times when the markets will decline. The crucial goal is to ensure that these losses are manageable and fall within the overall investment strategy. However, once an asset allocation has been established for the overall investment strategy, it is not necessary need to monitor investments too often - a focus can be applied to other aspects of life. Instead of worrying about the currency, high stock markets, or interest rate changes, a focus should be applied to income, expenses, assets, and debt - all of which are worked with every day and should be more under direct control to some extent.

Shares and listed property are an ideal combination for long-term capital growth. Bonds can also be included in a portfolio as a stable and inflation-beating asset. If someone is reasonably young and looking to grow their assets without an immediate requirement for income, they could combine an investment in shares with listed property, such as an allocation of 75% in shares and 25% in listed property. If someone is looking for a combination of capital growth and income, they could reduce their allocation to shares, such as an allocation of 50% in shares, 25% in listed property, and 25% in bonds. This combination should ensure that their capital grows more than the inflation rate while generating a good income. If they cannot tolerate the volatility of the stock market, they could reduce their investment in shares to 35%, increase their investment in bonds to 40%, and maintain their investment in listed property at 25%.

For centuries, people have used gold as the ultimate hedge against unforeseen risks. This changed only in the last half of the 20th century, when countries started issuing currency which was not underpinned by gold, eventually causing gold to be replaced by USD as the ultimate hedge against unmanageable risks. This worked very well for more than 30 years, until the early 2000s, when a series of financial shocks around the world culminated in the global financial crisis in 2008. This crisis taught the world that the whole financial system was not as secure as they thought and USD was also vulnerable. This led to a resurgence in the value of gold, which had been in steady decline since the early 1980s. Unfortunately, gold is a complex asset class to analyse, because its price is largely determined by fear. If the world is in financial difficulty and people are very worried about the future, they will buy gold at any price to protect themselves against financial ruin. However, if the economy stabilizes and people regain confidence in their financial well-being, the price of gold will plummet. In times of great uncertainty or financial disaster, gold can be used as currency to buy assets which others are desperate to sell. Unfortunately, this strategy relies on emotions, as the only way to make a return is to sell the gold to someone who is willing to pay more.

If the best possible investment growth above inflation is considered, the Johannesburg Stock Exchange (JSE) is a good place to invest. Since 1900, the JSE has beaten inflation by a larger amount than the United States, European, and global stock markets. In fact, only Australia has proved more rewarding for investors and this was by only a very small margin. As shown, South African shares have grown by an average of 12.5% per year since 1900. If the effect of inflation is removed, then South African shares have grown by 7.2% per year above inflation since 1900. Since 1900, South Africa, 12.5% nominal, 7.2% real; US, 9.3% nominal, 6.2% real; Europe, 7.7% nominal, 4.6% real; and world, 8.5% nominal, 5.4% real.

The common characteristic between clients who have retired early include a fear about dying young, getting married and staying married as a team, contentment with what they have as enough, parents who showed the way through prudence with money (not necessarily wealthy), and stable predictable life where money is not a source of trouble due to planning of major expenses and avoidance of debt.

According to research, women save 8.3% and men save 7.9% of their salaries every year. In addition to being slightly better savers, women are also better investors than men, as it was found that women tended to outperform men with their investment portfolios by 0.94% per year. This amount might seem small, but over a 30-year period, a woman who invests R1,000,000 is likely to have R7,600,000 more than a man who starts with the same amount. A broker in the United States also found that women checked their online investment portfolios 45% less than men and changed their portfolios 20% less than men - women tend to be more patient and hands-off, which is a better strategy over the long term.

A bond is a debt investment in which an investor loans money to an entity, which borrows the funds for a defined period of time at a fixed interest rate. Bonds are used by companies, municipalities, states and governments to finance a variety of projects and activities. The interest rate on bonds is normally determined by the credit quality of the entity which issues the bond and lifespan of the bond which can extend to 30 years. It should be noted that this interest is taxed as income.

When a company makes a profit, it might decide to pay some of that profit to the owners who hold shares in the company. This payment to shareholders is a dividend. The amount paid to each shareholder will be determined by the number of shares which each owner holds. Dividends are usually paid in cash, but sometimes shareholders are offered shares to the same value as the cash instead. Dividends do attract tax, but they are much more tax efficient than interest. Over time, dividends can increase in value if the company does well and profits increase. Every investor should have a portion of their capital in shares with at least 35% to a maximum of 100% if they are very young. Keep in mind that, over the long term, more than 50% of the return generated by shares is the reinvestment of dividends. If an investor does not reinvest their dividends, they will severely limit their potential capital growth.

In an endowment, money is invested via a lump sum or monthly debit order for a minimum of 5 years. Endowments have a fixed contract from the start of the investment, so there are specific rules which regulate changes to monthly payments or lump-sum additions. The money which can then be taken out of the endowment when it matures is tax free for the investor. This is because the endowment itself pays income tax and capital gains tax. Capital gains tax is paid when a profit is made on an investment, where a portion of the profit will be added to income for the year and taxed accordingly. Endowments are often marketed as education funds, but essentially they are an enforced way of saving a certain amount of money every month for a fixed period. It is important to remember that endowments can hold a range of different investments, including shares, bonds, unit trusts, and property. For trusts and income earners who are at the maximum-income tax rate, endowments can be a tax-efficient way of saving. The income tax and capital gains tax inside the endowment are lower than the maximum rates which individuals pay and lower than the rate which trusts pay - for people who are at an income tax rate of 30% or more, investing in an endowment might make sense. Endowments can be expensive when sold by a life assurance company or bank, because they will typically charge an upfront fee and high annual fee. Instead, endowments which are offered by unit trust companies are usually preferable, because there is usually no cost associated with them.

Exchange-traded funds (ETF) trade on the stock market like an ordinary share, but they consist of a basket of investments, such as shares, bonds, or property. ETFs generally charge very low annual fees and no upfront fees, which makes them ideal for private investors who want to invest in shares either with a lump sum or debit order. Most ETFs are based on an index or a portfolio of securities representing a particular market as a whole or a particular market sector. A low-cost ETF which owns a diversified selection of shares is the best option for anyone with limited resources but who can afford to put a regular amount of money each month into an investment. An ETF can be bought directly or via a stockbroker. ETFs are usually much cheaper than life-assurance company investments and are often cheaper than unit trusts too.

A fixed deposit is a kind of savings account which usually pays a fixed rate of interest for a fixed time period. As the name suggests, a deposit is made of a fixed amount and then the funds are left to mature and gather interest until the maturity date arrives. Funds placed in a fixed deposit usually cannot be withdrawn prior to maturity, although there are some banks which have slight variations on this rule (sometimes funds can be withdrawn if an advance notice is given, but there might be a penalty for doing this). Fixed deposits are relatively safe investments when provided by financial institutions, such as banks, savings and loan corporations, or credit unions which are properly registered and regulated. However, in most cases, the yields offered are fairly low and rarely do better than inflation, so they should only be used if money needs to be in cash for a specific purpose.

A mortgage or home loan is simply a loan from a bank or other financial institution which assists people in buying their own home. The bank will lend money to buy a house conditional on a credit record, ability to afford the repayments, and finding sufficient value in the home in question to secure the loan. The amount is usually loaned over a set period, such as 15 years to 30 years. It will be required to pay an instalment on the loan every month for the full period of the loan. For people who are very financially disciplined, a mortgage can also be a source of low-cost finance for other assets. Some people use their mortgage as a credit facility to buy cars or purchase growth assets like shares. This can be an efficient way of using debt at good interest rates, however this is also a very easy way to fall into an even bigger debt trap.

Unit trusts, also known as collective investment schemes or mutual funds, are open-ended investments without a set limit, either in time or amount invested. Each investor in the unit trust is a unit holder and the investors are the only owners of the unit trust. There is a wide range of unit trusts available representing a variety of assets from shares, listed property, bonds, cash, gold, to indexed investments. In South Africa, unit trusts are highly regulated and very transparent investments and a much better alternative to life-assurance investments. If something happens to the company managing the unit trust, it will not affect the assets of the investors. Because unit trusts are transparent, an investor can see how the unit trust is invested every day. There are some very low-cost unit trusts which are ideal for most individual investors, although some unit trusts are ridiculously expensive and should be avoided - some unscrupulous managers charge unfair performance fees which enrich them at the cost of their clients. In addition, some unit trusts invest in other unit trusts to form a fund of funds and their costs can also be exorbitant. It is usually best to invest in unit trusts which are operated by specialist investment companies, as there are very few quality unit trusts offered by life-assurance companies.

Index investors try to get the same return as generated by a specific index. Most of these indices are based on shares, listed property, or bonds. To invest in the index, an investor would normally make use of a unit trust or ETF which follows the specific index. The index is normally quoted as a number, but this is simply a value of all the shares on the stock market and is meaningful only in that it explains whether the stock market as a whole has gone up or down over a specific period (over one day, week, month, year, etc). History has proven that it is very difficult for most investors to beat the index over long periods of time. When an investor invests in a fund or other product which aims to beat an index, there is a management cost, transaction cost, and other charges which have to be recouped regularly. This means that more than 8 out of every 10 unit trusts in South Africa have not been able to beat their index over 10-year periods. There are a handful of managers who have beaten the index over the long term, such as Warren Buffett, but there are many more who do not and investors tend to find out about those who do only after they have reached their peak. By far, the best decision which most investors can make is to invest in indexed and low-cost investments. Over the long term, they will be better off than most managers more than 80% of the time. There is little need for someone to do anything or manage anything, as the investment is very passive in nature. An investor should be prepared to leave their money in the index for 7 years to 10 years at least without making changes.

Some Quotes

"If you ask a skinny woman what her diet is, she will probably tell you she does not really have a diet - just works out a bit and eats whatever she wants, but makes some effort to avoid junk food. Ask entrepreneurs how they became so successful, and they will say they just got an idea, started a business, and it took off somehow. And they will all be lying. People would rather hear that success comes from luck than from hard work. The next time you hear a successful person say that they did not have to work very hard for their success, do not believe them. They are lying - not because they are jerks, but because other people are jerks and will punish them for being honest".

"You are the average of the 5 people with which you spend most of your time. The fastest way to change yourself is to hang out with people who are already the way you want to be. It is very possible that the people with whom you are spending the most time are part of the reason you cannot recover from a slump and, unless you start spending time with different people, you are probably going to remain bogged down".

"Know what you own and know why you own it. Do not look for the needle in the haystack, just buy the haystack. Investing should be more like watching paint dry or watching grass grow. If investing is entertaining, if you are having fun, you are probably not making any money. Good investing is boring. If you want excitement, take $800 and go to Las Vegas".

"The stock market is filled with individuals who know the price of everything, but the value of nothing. Buy when everyone else is selling and hold until everyone else is buying. That is not just a catchy slogan - it is the very essence of successful investing".

Conclusion

The key to financial freedom will always be the ability of an investor to consistently maintain financial discipline, as much as the whole investment industry would like to convince them otherwise. The ability to spend less than what is earned every month of every year and to save for investments consistently is the real secret to financial freedom. If a number had to be given, this is 80% of the reason why someone will achieve their financial goals. The other 20% is about actually being smart with savings and investments, as even the best investors in the world cannot achieve any success unless they have money to invest. It would be wonderful to write a follow-up book based on new people who have reached their goals.