I recently interviewed one of the three most famous value investors in the world. The first two are Warren Buffett and Charlie Munger.
Mohnish Pabrai draws wisdom from both. He describes a librarian who died with an estate of $4 million. The librarian donated it to the University of New Hampshire (UNH) in 2015 according to CNBC.
Mohnish explains that any normal eighteen-year-old with very few skills who can only get a minimum wage job can make it.
The young McDonald’s worker earns minimum wage of $15,000 for 2,000 hours of work per year. He can save ten percent because he is living at home and contributing 90% to the household budget.
The young man sets aside ten percent of $15,000 before taxes each year. The 18-year-old saves $1,500 each year into a Roth (after taxes) or employer sponsored IRA (before taxes).
This is a conservative example. The young man (for ease of example) does not get a boost from employer matching if he saves in an employer sponsored 401(k). This would allow him to save much more.
He earns 9% on a simple investment choice. His income rises modestly with inflation. For instance, if inflation is 2% this year he will save $1,530 in the next.
When he retires 50 years from now at the age of 68 he will have saved $75,000 over the years from his salary.
At 9%, the account doubles every 8 years as per the rule of 72. The approximate time to double an account is the number 72 divided by the rate of return on the investment.
How Much Does $75,000 of Drip Savings Grow at 9% in 50 Years? Answer: $1,332,662
Bankrate website has a calculator that shows that this scenario will produce a retirement account for the unskilled, minimum wage 18-year-old of $1,332,662.
Is this reasonable?
The most respected textbook on investments is “Essentials of Investments” by professors Bodie, Kane and Marcus. The chapter on portfolio theory reports that a portfolio of small U.S. stocks returned 11.80%, large U.S. stocks returned 9.62%, and world stocks 9.21%.
These are the geometric mean returns that investors enjoyed from 1920 to 2010 in the stock market.
A simple exchange traded fund such as the Diamond — SPDR Dow Jones Industrial Average (DIA) would have allowed this unskilled 18-year-old to capture a large stock return of 9.62% over that period.
The financial success of this 18-year-old comes from the power of compounding over a long time. The Pabrai fund has generated average returns of about 15%.
This higher return would generate a $12,450,561 portfolio for the eighteen-year-old. A difference of just over 5% produces a fortune nearly ten times greater!
-Doc Brown
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