The World's Greatest Get-Rich Formula

You should be highly skeptical of any and all get-rich schemes ... except for the super-simple formula I'm going to show you below. Because this one really works.

It works so well that it's been used by the world's billionaires -- from moguls of yesteryear such as Rockefeller and Ford to today's tycoons Carlos Slim and Warren Buffett.

But enough already. Let's get to the formula.

The formula
It is, simply:

FV = PV * (1+r) ^ n

Where:

FV = future value
PV = present value
r = rate of return
n = time (or number of years)

Compounding 101
Now, some astute finance brains will know that equation not as some mystical secret but as the "future value of money" (FVM) equation taught in college.

The FVM formula simply states that your future wealth (FV) is a function of three variables: the amount of money invested today (PV), the rate of return generated (r), and the length of time in which that money is put to work (n). So maximizing future riches requires three steps.

Step 1: Increase PV
It takes money to make money. But by actively and consistently slivering off a portion of your earnings every month to save and invest, you'll have more and more of that money working for you.

All things equal, the greater amount you invest today (PV), the greater wealth you'll build for tomorrow (FV).

Step 2: Increase r
Next, you'll need a way to grow that capital. Historically, the stock market has been the most effective wealth-building vehicle of all. Plowing your money into a low-cost index fund wouldn't be a bad idea.

But if you really want to maximize r, you'll need to allocate a portion of your portfolio to the best segment of the market over the past 50 years: small-cap value stocks. The reason is simple. Unlike behemoths such as $115 billion Merck (NYSE: MRK  ) and $190 billion Johnson & Johnson (NYSE: JNJ  ) -- whose spectacular growth days are behind them -- reasonably priced small caps have tons of room to rocket. Take a look at Fama and French data, which tracked stocks from 1956 to 2005:

Value

Growth

Large caps

13.3%

9.7%

Small caps

17.3%

8.7%

Total stock market

10.5%

 
Not adjusted for inflation.

All things equal, the greater your rate of return (r), the greater wealth you'll build for tomorrow (FV).

Step 3: Increase n
The last ingredient in our super-simple wealth building recipe: maximum time in the market.

Look back at the equation. You'll see that n is an exponential function -- meaning that for every year you're not invested, you give up the awesome (almost magical) benefits of compounding.

All things equal, the longer you're invested (n), the greater wealth you'll build for tomorrow (FV).

Plug and chug
To get a feel for the three-step process in action, let's go back in time to see what kind of wealth would have been generated had someone:

  1. Invested $40,000 in the stock market
  2. Started 10 years ago
  3. Divided the money among five stocks having: market caps less than $2 billion (to screen for small size), sales growth greater than 15% (to screen for above-average opportunities), and price-to-sales ratios of less than 1.5 (to screen for a good price).

Here's what it would look like:

Company

Amount Invested
10 Years Ago

AverageCompounded
Return Over Past
10 Years

Total Value
of Investment Today

Best Buy (NYSE: BBY  )

$8,000

33.9%

$148,075

FTI Consulting (NYSE: FCN  )

$8,000

27.7%

$91,892

Expeditors International of Washington (Nasdaq: EXPD  )

$8,000

24.2%

$69,682

Florida Rock Industries (NYSE: FRK  )

$8,000

23.7%

$66,947

Fossil (Nasdaq: FOSL  )

$8,000

25.9%

$80,332

 

Total amount invested (PV)

Avg. annual return
of portfolio (r)

Total value of portfolio today (FV)

 

$40,000

27.6%

$456,929

By having bought into five high-quality, reasonably priced companies while they were still babies, that $40,000 stake would be worth nearly $500,000 today.

Of course, you can always fiddle with the numbers to generate different levels of FV, but our objective should remain the same:

  1. Maximize PV by sticking to an investment plan.
  2. Maximize r by devoting a chunk of your portfolio to superior small caps at attractive prices.
  3. Maximize n by investing as soon as possible and for as long as possible.

The final Foolish variable
So don't waste another "n." Start plugging whopping returns into your own real-life wealth equation today.

If you need a few small-cap ideas to start you off, our specialists at Motley Fool Hidden Gems can help. Advisors Tom Gardner and Bill Mann make sure subscribers get the absolute most from the FVM formula. Since the newsletter's inception in 2003, their picks are up an average of 63%, versus 27% for like amounts invested in the S&P 500. You can see their five favorite small caps for new money with a free, 30-day trial. To learn more, click here.

Fool contributor Brian Pacampara tried to get rich quick once, but his idea for a cold-air balloon never got off the ground. He owns no position in any of the companies mentioned. Johnson & Johnson is a Motley Fool Income Investor recommendation. Best Buy is both an Inside Value and Stock Advisor pick. The Fool's disclosure policy always adds up.


Read/Post Comments (4) | Recommend This Article (117)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 19, 2007, at 8:10 PM, jimlamp31 wrote:

    This was a very good article. I liked how it explained the future value equation in detail. I always enjoy reading articles from Motley Fool even if I already know the content.

  • Report this Comment On October 20, 2007, at 7:57 AM, kayakmastr wrote:

    Clever article and analysis. The FV equation can also help screen stocks. For example, if you wnat a 50% gain in 3 years, it tells you that you should only invest in stocks that you expect to grow 15% or more each year.

  • Report this Comment On October 20, 2007, at 9:10 AM, boris9 wrote:

    once in a while its good to see a "back to basics" article that we can pass on to others.

  • Report this Comment On October 21, 2007, at 10:54 AM, seedhom wrote:

    Although this is a good pitch about the FV of money, it is misleading. It does not take into account INFLATION!! It does not tell you that $40k 10 years ago was a fortune for most of us and if it was not a fortune for you back then, $500k is probably not a fortune for you now. To factor in the decrease in dollar value in your life, don't use the national US figures for that , that is just too abstract and meaningless for most of us. Use the inflation in your particular locale were you live to check the value of $40k. Best measure for local inflation is land. How many vacant acres of land in your neighborhood would $40k have bought you 10 years ago? Let's say 10 vacant acres for the sake of argument. How much would the same 10 vacant acres go for now? Again, for argument sake let us say $100k.

    Use the formula in the article FV = PV * (1 r) ^ n to calculate the inflation rate r where

    FV = 100k, PV = 40k, n=10 year. 100000 = 40000 * (1 r) ^ 10

    gives you r = -10%

    Your actual rate of money "value reduction" in the last 10 years averaged 10% per year.

    In other words, the 27.6% in this article should be 17.6%.

    Still good but not as great as the article would have you believe.

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