Editor’s note: Today, we continue our special holiday series with one of Chief Analyst Stephen McBride’s most important essays. If you have kids or grandkids, you’ll want to pass this one along to them…
My wife and I recently welcomed our first son into the world.
We named him Rí (ree), which means “king” in Irish. He’s doing great, settling into home life with his big sister. Right now, his only job is drinking bottles of milk and sleeping.
But one day, he’ll start asking grown-up questions like, “What’s the stock market, and how do I invest?”
When I was little, nobody ever sat me down and taught me about stocks. Now that I have two kids, I’ve been thinking about what a dad should teach his children about money and investing.
I’m not talking about specific tips or tactics or even what types of investments to buy. But the truly big stuff. The two or three money principles that really move the needle.
If I can ingrain these principles in my kids, I’ll know I’ve done all I could to set them up for a wealthy life. As I’ll show you, there is a Big 3. Nail the Big 3, and everything else in your financial life slots into place.
Teaching your kids the Big 3 while you’re still around will help them build on your achievements. So if you have kids and grandkids, please share this letter with them too.
Step #1: Save, save, save
Saving money is the foundation of wealth and a prerequisite to investing.
Before you even think about investing, you first have to save a lot. If you don’t put money aside, you’ll never be able to buy stocks.
This is hardly groundbreaking advice. Telling someone to “save money” is like a fitness guru advising you to eat healthy and exercise. Both sound obvious. Yet, it’s impossible to achieve success without them.
Americans spent $37 billion on gym memberships in 2019. Yet a recent Harvard study estimated roughly 4 in 10 Americans are obese.
What gives? A study published in The American Journal of Clinical Nutrition found exercising makes you feel like you did something healthy, which leads folks to rationalize a post-workout food binge. Eating pizza after sitting on the couch all day might bring guilt. But scarfing junk food after running five miles feels justified.
The same happens in our financial lives. Spending more when, say, you get a raise is as tempting as eating junk food after exercise. It feels earned. But as my grandad used to say, “When your outgo exceeds your income, your upkeep becomes your downfall.”
Imagine you could only choose one of these for your kid:
#1: They’re a high earner, but spend every penny.
#2: They get a decent salary and save a lot of money.
I’d choose #2 every time. How much you earn is important, but it’s not nearly as important as how much you save. There’s a big difference between making a lot of money and becoming wealthy. The gap between what you earn and what you spend is what really matters. This pile of cash is what allows you to invest.
In his recent book, retirement expert Charley Ellis highlighted how important it is to start saving when you’re young. He found folks who began saving at 25 rather than 45 cut their required annual saving rate by two-thirds.
In other words, these folks can save 65% less than older savers each year and still build a dream retirement.
Step #2: You gotta own stocks
I’ve told you before that starting a successful business is the single best way to get rich. Amazon founder Jeff Bezos, who’s now worth around $200 billion, is the perfect example of this. But you don’t need to build the next trillion-dollar empire to get rich. You can piggyback on great CEOs by buying shares of their companies on the stock market.
The US stock market is the greatest money-making vehicle in history. You must own a piece of it. In 2020, a study from Arizona State University found: “Investments in US stocks improved the wealth of shareholders by over $47 trillion dollars between 1926 and 2019.”
For over nine decades, US stocks have handed shareholders $500 billion in profits each year, on average. That’s enough to cut every American a $1,500 annual check for their entire lives.
I told you, saving is the foundation of wealth creation. This is the first step—but it won’t make you rich. Vanguard founder John Bogle said: “I think whatever your view of the world is, you have to invest. You can’t put the money in the mattress and in this day and age of low interest rates, you can’t put it in the money market fund or a bank CD, so invest, you must.”
Throwing money into a CD account was a good option when banks paid you 5%. Today, the average one-year CD rate is a measly 0.18%. Meanwhile, the value of our hard-earned savings is constantly eaten away by inflation.
The US government’s own calculations show a dollar is worth 16% less than it was 10 years ago. And nearly 90% less than it was 50 years ago!
These days, owning a piece of a successful business, aka owning stocks, isn’t a nice-to-have. It’s a must. Buying stocks is one of the best ways to beat inflation.
Think of being a shareholder like having a lucrative second job without the hard work. With this second job, you earn money when you’re sleeping, when you’re on vacation, and when you’re retired.
Think about buying Amazon shares. Every time the disruptor bulldozes through another industry and its stock soars, you get a slice of the profits. When it crushes earnings and Jeff Bezos’s net worth surges, it means you win, too.
Step #3: You gotta own the megawinners
Just owning stocks isn’t enough. You must own the right stocks: the megawinners.
JPMorgan Asset Management recently published a great paper called Agony & Ecstasy.
It’s a deep dive into the performance of the US stock market over the past 40 years. And it confirmed an important investing truth: Most stocks suck.
JPMorgan found almost half of stocks suffered a “catastrophic loss” from 1980 to 2020. Meaning they plunged and never recovered. Another 26% of stocks produced returns lower than the overall market.
Effectively, all the market’s returns came from just 10% of stocks, which JPMorgan called “megawinners.”
Lots of losers… and a few big winners.
This is why picking individual stocks isn’t for everyone. In fact, many folks are better off owning a broad basket of US stocks or buying indexes. By simply owning the S&P 500 ETF (SPY), you would have doubled your money over the past five years. That’s a good, stress-free option.
But investors who really want to accelerate their wealth creation must go on the hunt for these megawinner stocks. You can build lasting wealth through owning great disruptive businesses.
In other words, back companies that are changing the world and transforming huge industries. Businesses that achieve this regularly turn out to be megawinners that can hand you many times your money.
If you’d like to learn how to find the stock market’s next megawinners… including details on my top 3 today… Click here.
Editor — Disruption Investor