Turning $1,000 Into $277 Trillion

Again with the trillions ...
Recently, I wrote a little article (with nearly the same name as this one) aimed at exposing a fairly common market myth: the idea that any individual can trade his or her way to supersized returns, day in and day out.

"All I need is the chart," these hopeful traders tell me. They say, "Give me jumpy, high-volume, popular stocks like Ciena, which can swing more than 5% in a day and jump 9% in a week, and I can skim a few percent per trade, 50% or 100% a month.

"That will make me rich!"

Or so the story goes.

It sure would make you rich. A trillionaire, actually. And in short time. Starting with $1,000 and getting those 100% returns every month, you'd have a tidy $34 trillion before the end of three years. If you could actually compound at 5% per trade, 15 times a month, my Excel spreadsheet tells me you'd have $277 trillion at the end of 36 months. This alone should have been sufficient evidence to prove that the thesis is bunk.

But some folks (well-meaning, to be sure) misunderstood and wrote asking me for further details on this amazing money-making plan.

So much for subtlety.

Let's set the record straight right here: This is not possible.

Bad news? Not really. I mean, who really needs $277 trillion?

The good news is: It is possible to turn thousands into millions, but not via the trading gimmicks. The keys to making millions in the market are persistence, patience, and time.

Uh-oh. I think we just lost the get-rich-quick crowd.

But congratulations to those of you who remain. Avoiding the bogus promises of the "no work, free money" industry is step one to investing successfully. The next is embracing the obvious. The data show that the way to beat the market isn't with stomach-curdling hot tamales but with boring value stocks.

About that good news
My colleague Bill Barker recently penned an article called "70 Times Better Than the Next Microsoft." (Yes, we've got a special on inflammatory titles.) In it, he explains why value wins in the long run. Here's a one-sentence summary:

It's because the growth-chasers out there always overpay.

A few well-known examples will show how this can crush you, even when you avoid high-priced junk that goes to zero. Overpaying gets you into trouble even when you buy good, established, money-making companies. Here's a table showing a mix of both types. Pay special attention to that last column, which is the return you got as a shareholder.

Home Depot (NYSE:HD) was a highflier around the same time, and though business has been largely OK, the stock was too expensive then, and has posted no gains over the period

Folks who bought when everyone thought these companies could do no wrong are still nursing some wounds, even some serious wounds. The best off are little better than breakeven over more than half a decade. But even folks who bought after the bubble had burst and dried up (2003) have seen the price-to-earnings ratios contract. This is exactly the reason crotchety stockwatchers like me constantly warn investors not to chase stuff like Basin Water (NASDAQ:BWTR) further into the stratosphere simply because it's got a hot-sounding story.

Even good companies sometimes end up on the "don't buy" list. Heck, I loved Chico's FAS (NYSE:CHS) the company, too, but it was trading way too rich, and luckily, I said no thanks. Urban Outfitters before the crash? Also took a pass. I spent plenty of time playing with the valuation on those, and they had one thing in common: I had to assume crazy growth rates to make those prices look like a buy. (They've both fallen on hard times more recently, which may just lend support to our thesis.)

Let's reiterate. Some of these are superior businesses, no doubt. But superior businesses at the wrong price do not make for superior investment returns.

Turn it around
Here's where you profit from market mania: by making a habit of buying solid businesses that the market presumes to be closer to dead and buried. Look at the same figures for two boring, well-known companies over that same period.

Which stocks were you buying in 1999? Which would you rather have been buying? When everyone thought the Internet would change the world, no one wanted companies that did things like build campers or sell wine. But the companies doing these things continued to prosper, and they treated shareholders to amazing returns once the Street came back to its senses.

The lesson is simple: Investors invariably do better in the long run by refusing to overpay, and you can do that when you buy what everyone else ignores. Bill cites some compelling numbers suggesting that from 1927 until 2004, "value" stocks of the large- and smaller-cap variety returned 12.4% to 15.4% annually. "Growth" of all stripes couldn't even turn 10%.

A dose of reality
Bill's a groovy guy, but here's where I think his argument got a bit ripe: He compounded those hypothetical returns over a 78-year time frame. That assumes you started investing the moment you slid out of the womb in 1927 and were content to slide into the grave without ever touching any of that hard-earned dough. Does that sound reasonable?

No? I didn't think so. But we don't have to go to extremes to prove our point. Let's assume you start investing at age 21 and you want to pull up stakes 40 years later. Let's further assume that you do this saving in a tax-advantaged Roth IRA, starting with $4,000 and investing only to the current $4,000 limit per year. Finally, I'm going to assume you can get blended historical value returns, splitting the difference between the two figures cited above, compounded annually. Let's be honest -- this is a pretty aggressive assumption, but I believe it is possible.

As you'll see, reality might not be 70 times better than the next Microsoft, but it could still be pretty sweet.

What does this mean? The bottom line here is simple: There is no way to get rich quick. But -- with apologies to the grammar police -- there is a way to get rich slow.

Yes, you can retire with millions, but you absolutely must be persistent with your savings, and you must buy what the market doesn't want. That's exactly the kind of no-nonsense approach we follow at Motley Fool Inside Value, where we look for those 1999 Winnebagos and Constellations while the market is looking elsewhere. And guess what? Some of those former tech superstars are now being treated like Altria and Deere were back then. They're among the most maligned stocks on Wall Street. A 30-day free guest pass will let you see what meets our current measure of cheap and -- better yet -- explain why.

This article was originally published in June 2006. It has been updated.

Seth Jayson is no longer working on that 5% per trade. At the time of publication, he had shares of Home Depot and Intel, both of which are Inside Value recommendations. View his stock holdings and Fool profile here. Fool rules are here.