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 Applied Micro Circuits (NASDAQ:AMCC), 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, in very little 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. Others have written me to tell me they can do this, but when I tell them to send me their results so that I can verify the record -- and hand over my money to them for management -- the lines suddenly go silent.

So much for the subtle approach. 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 once penned an article called 70 Times Better Than the Next Microsoft. In it, he explained why value investing wins. 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.

*Data from Capital IQ. Returns calculated on dividend-adjusted closing prices.

Folks who bought when everyone thought these companies could do no wrong are still nursing some wounds, even some serious wounds. The best off made only 61% over seven years. 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 Hansen Natural or Crocs into the stratosphere. I spent plenty of time playing with the valuations on these and other "premium" stocks, and they had one thing in common. I had to assume crazy growth rates to make those prices look like a buy. And when those don't materialize, it gets very ugly very quickly.

Even 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 a few more boring, well-known companies over that same period, companies trading for cheap or reasonable prices.

Data from Capital IQ. Returns calculated on dividend-adjusted closing prices.

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 sell chewing tobacco, burgers, or booze. 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 went astray: 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.

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 Constellation Brands-types and USTs while the market is looking elsewhere. And guess what? Some of those former tech superstars are now being treated like the boring winners 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 on Feb. 24, 2006. It has been updated.

Seth Jayson is no longer working on that 5% per trade. At the time of publication, he had no position in any company mentioned above. Crocs is a Hidden Gems Pay Dirt selection. Fool rules are here.