Fool.com: Who <I>Really</I> Wants to Be a Millionaire?[Fool on the Hill] February 3, 2000

FOOL ON THE HILL
An Investment Opinion

Who Really Wants to be a Millionaire?

By Bill Barker (TMF Max)
February 3, 2000

I was somewhat taken aback to read somewhere yesterday that the phrase "Is that your final answer," derived from the runaway-smash-hit-of-the-new-millenium game show hosted by Regis Philbin, has now been accorded "national catch-phrase" status. Maybe it's that I've been unable to get into this "Who Wants to be a Millionaire?" phenomenon ever since I read in The Washington Post a couple of weeks ago that one of the questions that a contestant had to answer was, "Which two colors make up an Oreo cookie?" I hasten to add, I'm not making that up. By the way, it was a multiple-choice question. Seriously.

I leave it to more qualified humorists to create comedy with this kind of material, as mocking such matters is well beyond the scope of my limited abilities. I think to myself, "How can you improve upon it?" It's a daunting challenge, and one that I am not going to undertake. So, for a couple of reasons, this won't be some jeremiad about the state of our society when pop culture is awash in the concept that a riveting and acceptable way of creating millionaires is by searching for those informed enough to identify an Oreo's colors.

Still, a couple of admittedly Motley thoughts coagulate in my head as I consider millionaires and final answers. First -- the winners of "Who Wants" don't really become millionaires anyway; second -- you don't even need to know the composition of an Oreo to become a millionaire; and third, the "Is that your final answer?" catch-phrase element is something that jumps out at me as a good way to plug some really useful investment material that's recently become available. Let's take these in reverse order, so that I can finally get around to mentioning something relevant in this column subtitled "An Investment Opinion."

On the "Is that your final answer?" front, one thing that is worth bearing in mind is that investors should never really develop a final answer as to how to value securities as a whole. The rejection of this "open mind" approach, by the way, is the invariable trap into which so many Wise, and typically bearish, pontificators have fallen. The background justification that I keep reading for why the market is a bubble -- defined by mania or purely a channeler of greed rather than rational purchasing decisions -- always seems to cite historical price-to-earnings levels. Fine. If there is a "correct" P/E level for the market as a whole, those critiques might give one pause as to whether this is a market into which we should be committing our savings.

The problem with this "final answer" of understanding the market simply in terms of price-to-earnings models or price-to-earnings-to-growth models is that the model is dependent on the usefulness of a 500-year-old accounting system that was designed for a completely different purpose than what it is being shoehorned into serving now.

This point is presented quite eloquently in the writings available at the CAP@Columbia site. Now, if you're one of those people who just has to read every bit of copy that we put up on our site, you've probably already noticed more than once that various writers have linked to the material at CAP@Columbia as a great source of financial analyses by (of all people) some well-dressed Wall Street analysts. In fact, a one-time Fool on the Hill scribe, Alex Schay, left the Foolish fold to go work at CS First Boston and help write some of these items.

One of the newer articles, "The Triumph of Bits," helps frame the issue of the new "mental models" that investors need to add to their list of useful valuation tools. "Our current dual-entry accounting system was developed roughly 500 years ago. It was largely built to track the movement of physical goods for the benefit of creditors. In a world dominated by tangible capital, our currently employed accounting system worked fine. As the source of value creation shifts to intangible capital, however, the system becomes less and less reflective of economic reality. Examples include capturing intellectual capital, large employee stock-option claims, and the expensing versus capitalizing of investments. Investors must be aware that the financial score for the Information Revolution is kept with an outdated system."

The articles at CAP@Columbia are so worth reading because they provide some of the detailed math to support the conclusion, as it is stated at the end of "Absolute Power," that "the market is not dumb." This simple assertion stands in stark contrast to the majority of the commentary that you're likely to see from so many sources that seem informed by the wrong mental model. The wrong "final answer": the historic P/E model.

It's well worth working through this collection of articles for two reasons. You'll get a better feel for picking out some individual stocks, but also because if the simple proposition is supportable that the market is not dumb -- if the market is behaving as the well-informed rational aggregator of information that we hope it is -- it is likely that the answer for who gets to become a millionaire could well be anybody with time and discipline on his or her hands.

You can help frame the probability of becoming a millionaire in reasonably short order. Take about six seconds with this calculator from the Fool's School. The default inputs are 6% earnings on your savings, $5000 to start with, and monthly contributions of $300. That gives you $213,000 after taxes after 30 years, or $330,000 in a tax-deferred account.

However, if all you do is alter the return on your savings to 13% annually, the numbers become $503,000 after taxes or over $1.5 million in a tax-deferred account. (I pick a rate of 13% as that is the approximate return of the S&P 500 over the past 50 years. You could look it up.)

You don't have to accept a rate of 13% as your expected rate of return on savings, though 50 years is a reasonably hefty bit of evidence to consider. All I'll say is that if the market is kind of rational, as the CAP@Columbia articles indicate, then future returns in line with past returns isn't the pie-in-the-sky lunacy that is so frequently touted to be the case. Plugging in a lower rate of return to be on the cautious side certainly makes sense, especially if that is what is going to be the spur to make you save more, and to plan to do so for longer than 30 years. Whatever your route, it really doesn't seem like someday becoming a millionaire is a proposition that any reader with time to plan should be dismissing.

You'll notice that one of the things that stands out about any of the numbers that you plug in and out of that calculator is the very substantial percentage that taxes take out of the total. This is one of the things that they aren't mentioning on "Who Wants to be a Millionaire?" -- the winners are paying (I'm pretty sure) federal and state taxes probably in the neighborhood of half of their winnings. The show, unlike the market, isn't creating any actual millionaires. For that reason, and others, check out our expanded tax area.