Martin Thomson asked: Recently I was asked by a client, how to invest 1 million dollars. As a life coach I am exposed to all sort’s of private and varied questions by my client’s, but the conversation that led from that question was interesting, so I thought I would relay it in an article today.
When Randal Stewart arrived at my office it was raining heavily outside that morning and I recall watching him drip on my carpet as he stood there. Randal is an artist in the traditional sense and he creates beautiful canvases for galleries around our city that show his work on a commission basis. His income has always been fairly stable and his $40k to $50 per year had been fairly steady for the last 5 years.
He came in for our monthly debrief and progress report when he asked me a question that turned into a discussion which took up the whole morning. I was perplexed by his question, because I knew Randal did not have 1 million dollars. Randal Stewart barely had $1000 in his savings account as he often complained about the difficulty of putting money away. He told me the reason for his question was that he wanted to one day soon have $1 million dollars and felt he would assist that possibility by thinking more about how he would invest that type of money. The reasoning is sound. As Napoleon Hill would say, “If you can conceive it and believe it you can achieve it”
Our conversation was lengthy, but what transpired was quite a conclusion between the two of us. We began by looking at our own random knowledge about millionaires and began to assess where that money came from and what was done with it.
We agreed that there were 3 main areas where 1 million dollars came from in an effort to narrow down our conclusion. Real Estate, Business and Creative Enterprises like writing a hit song or best selling novel.
This narrowing down will give us an idea where 1 million dollars would be best invested. I referred to the Perato principle or the 80/20 rule which suggested that reality is not even, that 80 percent of results are typically obtained by 20 percent of ones activities.
We were trying to ascertain the best return on our million dollars. The first and least impressive was to put the million in a bank or buy government CD’s which on that amount of money would be a few percentage points above the overnight cash rate due to the bulk discount one would receive with a large investment like that.
At around 10% this example would return $100,000 per year. Not bad and one could easily live comfortably on $100,000 a year. But bear in mind, if you were to use that interest, to live on, your money would never really grow. The compounding effect would be absent because each year the interest earned would be withdrawn to live on. This meant with each year passing, inflation would consume our million dollars at a rate of 5% per year. This brought in another aspect.
If we had 1 million dollars, we would require 3 things from our investment. Namely a compounding return that covers, a years worth of living expenses after tax, which 10% would cover. We also need a further 5% to protect our million dollars from the ravages of inflation as time goes buy, so it would need to grow by 5% per year just to keep up with inflation and finally we need a reasonable return on top to cover our lost opportunity costs and compensate us adequately for our risk exposure. A further 10% would be a reasonable expectation.
This adds up to a whopping 25% per year! But ultimately if you look at it logically that is exactly the amount one would require to satisfactorily invest 1 million dollars.
So we applied our needs against the three earlier possibilities mentioned. Real estate was our first stop and if you look at the vehicle of real estate, it is not a bad option. According to statistics, a rental property will return on average over many years, around 7% in rents, and around 7% in capital gains. That is a lot better than 10% but falls 9% short of our 25% needs.
The second was by far the best return but most risky. Investing 1 million dollars into writing and promoting a book, novel or hit song is a dicey business. It is done every day by record companies who promote established artists, but if we assumed we were just an average person, we would need to steer clear of this type of investment. Ultimately the million would go into marketing the intellectual property,and if you look at the returns they are quite exceptional. 60 seconds of prime time air time may devour $1 million dollars easily, but the return, providing the production was good and the target audience was reached effectively, one could easily recoup their million and make a further 2 or three million. But the most compelling feature of course, is that it is not an manual occurrence. An advertising promotion can be produced and aired within weeks or a month and therefore, theoretically, one could do this 12 times a year or more. We are talking returns of 2000% or 3000% per year. Yes it’s risky, but the lucrativeness makes it viable for the right people.
Finally, Randal and I talked about business. This was less conservative than real estate as an investment but more conservative than the high flying intellectual property avenue. The advantage to business is control. Exerting a high level of control over your investment is highly desirable. Unlike the stock market or practically every other investment, a business is highly within your control and you can act quickly to cut losses and plow profits. It is however a very hands on type of investment. Not passive like a bank deposit.
We concluded that business can easily give returns of 50% to 100% if one places ones money into the most demand type of product or service. Also, we established that the main priority of business is a quick and rapid return. By far, the main priority is to invest as little as possible but return as much as you can for your activity.
So, business is one way to invest 1 million dollars best, even if you don’t have one million because your directive is to invest as least as possible. A riskless proposition.
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