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WHEN WE AIM FOR financial independence, what we’re usually trying to do is to convert our current work time into future free time. We exchange our time and labor for money today. The wealth we accumulate then buys us a future that’s free from labor.
Given this exchange of labor for future freedom, what’s the most efficient way to speed our progress? According to a research paper, “Capitalists in the 21st Century,” the best strategy is to own a business.
The study, which analyzed federal tax returns, found the most statistically probable way to reach the top 0.01% of U.S. income is to own a business with pass-through income, such as a law firm, investment firm, medical office or auto dealership. Such business owners make up 84% of taxpayers in the top stratum of income.
This makes sense. Each of us converting our present work time to future free time can’t achieve massive scale. We cannot duplicate ourselves or our labors. When we own equity in a business, however, profits may come from the work of others. Business owners achieve economies of scale using other people’s time.
Most of us aren’t going to own a share of a law firm or auto dealership. Fewer still will found a major company, as did Jeff Bezos of Amazon, Sara Blakely of Spanx, Robert Johnson of BET Network, Whitney Wolfe Herd of Bumble or Amar Bose of Bose. Most of us are going to be good old W-2 employees—working stiffs—or, as the Japanese say, a “salaryman.”
We can stick to being the proverbial “man (or woman) in the gray flannel suit,” but that simply puts us on a treadmill. We sell our present time for money, which—in 1950s style—we’d deposit in a savings account, where it would be slowly devoured by inflation. We would convert our present work time into future free time at a glacial pace.
Is there a better way? Yes. To bypass the treadmill and get on the autobahn of wealth creation, workers should own shares of businesses—in the form of publicly traded companies. My choice is an index fund based on the S&P 500.
Every month, I convert some of my work time into stock of 500 leading public companies, as chosen by Standard & Poor’s. I get to leverage the brains and production of millions of workers around the world to create my future free time.
Large-cap U.S. stocks have returned about 10% a year, on average, over the past century. This means we can potentially double our money—or future free time—approximately every seven years.
Before we get too excited, though, we need to understand the risks. For starters, only 4% of stocks have powered the majority of U.S. stock returns since 1926. Good luck picking those 4% on your own.
On top of that, share prices are prone to crashing. The S&P 500 has a jarring 20% fall every four years, on average. Sure enough, that’s what we’ve seen this year. The market also sees a troubling 30% drop, on average, every nine years.
As I tell my children, the price of admission to this stock game is emotional pain and suffering. If we can’t stand the heat, we shouldn’t bother entering this kitchen. Because—and this is crucial—we need to stay in the game. Always. If we cannot, we will lose our money quickly and often.
According to this really cool video from Dimensional Fund Advisors, if we’d invested $1,000 in an S&P 500 index fund in 1990, we’d have had $20,451 by the end of 2020—providing we stayed the entire 30 years. If we missed the best-performing single day because, say, we got spooked during a 10% correction, we’d have $18,329. What if we missed the best 25 days because we thought we could time the market? We’d have just $4,376.
What we know from research is that the best way to get wealthy is through business ownership, but finding the very best stocks is really hard. We’re looking for a needle. What should we do? Just buy the entire haystack, keep buying more every month—and then hang on for the ride of our lives.
Tanvir Alam has been practicing corporate law for more than two decades, but you shouldn’t hold that against him. He lives in New York’s Hudson Valley with his patient wife and two skeptical teenagers. Tanvir is interested in personal finance and travel, and is trying desperately to become a runner. Follow him on Twitter @Docket75, read his blog at StealthWealthBlog.com and check out his earlier articles.
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Great job, Tanvir! A simple, clear lesson on the wealth-building benefits of capitalism. Although often portrayed otherwise, the bar to wealth-building in this country is remarkably low. The DFA video inspired me to write a blog for my clients on the importance of staying invested during the occasional bouts of market turmoil. Thanks!
Thank you Neil!
You haven’t said anything that most financially curious people know BUT…
You’ve said it succinctly with support by embedding supporting links in the article that I’ve saved it as a favorite, something I rarely do. I’ve saved it for my future reference and to share with others as I try to help people with basic finance questions. Thank you so much for this article.
Edwin, that’s the best compliment I think any financial writer could receive. Thank you and I’m so happy to help. That’s the reason I write.
Thanks for the perspective on market timing. It helps reinforce why it is so important to stay invested.
“It is wise for investors to be fearful when others are greedy, and greedy when others are fearful” – Warren Buffett, CEO – Berkshire Hathaway Inc.
“Look – don’t you all get it? Potter’s not selling…Potter’s buying! And why? Because you’re panicking and he’s not. That’s why. He’s just picking up some bargains.” – George Bailey, CEO – Bailey Brothers Building & Loan LLC
https://www.forbes.com/sites/sergeiklebnikov/2022/05/17/warren-buffetts-51-billion-stock-market-shopping-spree-heres-what-hes-buying/?sh=790effee147c
Why only the S&P500? Why not the whole market? Why not some international? I’m in favor of owning stocks (in a cheap index fund), but I’m also in favor of diversification.
I totally agree. My allocation is 60% S&P 500, 20% MSCI ex US Index, and 20% US Small Cap Index. However, for those that don’t want to bother with asset allocation research, I think the S&P 500 is a good starter and that’s why I referred to it.
This correction or bear market is the market getting back to average returns.
The last time my net worth was this low was in November of 2020. Nineteen months since then over which I saw it increase by $650,000 then go back down by the same $650,000. Feels like running on a treadmill and not getting anywhere! Fortunately it doesn’t matter, I’m fine, but I know this kind of drop is hard on younger investors who haven’t been through it a few times in the past like I have. I second the motion of getting back to average returns!
I feel the same pain. This market isn’t a relatively quick drop (4Q 2018, 1Q 2020) and a bounce back. This is a slow grinder that will likely over-correct to the downside. I can’t remember the last time that happened (2014-2015?).
Its painful watching that net worth number drop month after month for 6 months, but that’s the price to pay for entry. It does drive the speculators out. Apparently, JP Morgan said, “In bear markets, stocks return to their rightful owners.” By rightful owners, I’m guessing he meant long term investors.
I wish we would get back to some of those “on average” returns.
My guess is that we grind lower and lower through the midterm elections and then things start to stabilize as inflation comes down (fingers crossed). After that, hopefully we get some nice, “average” gains.
Why do you think the midterm elections will bring inflation down?
Me too!