There are no shortages of investment literature on the topic of getting rich, what seemingly is a very popular advice is that to have a million by “x” years, all you need to do is save and invest “y” amount every year , invest it in a vehicle that grows by “z” percentage, use the compounding assumption and voila! You are a brand new millionaire!
Unfortunately, this advice won’t work in the real world; the major flaw of this formula is that it assumes a steady linear progression of “z”-in layman’s term it is assuming that the investment will give a constant rate of return every year, as current investors will sadly attest, this is “impossible” in a financial market that is repeatedly swayed by economic shocks like the present “sub-prime” crisis.
Let us define “z” as hurdle rate (the minimum your investment should grow to reach your target)
To illustrate:
Let us say the hurdle rate of your investment is 8.0%/year-a reasonable expectation, in a year when the market is down by 20%, do you know that you need to earn at least 25% the succeeding year just to recover your losses, you need 33% just to be on track with last year’s projection, and at least 40% to bring it back to alignment with your 8.0% annual growth assumption.
Investment returns is a function of the level of risk that you are willing to assume, to be realistic, the hurdle rate that you have set should not be a “constant” but a dynamic objective that you adjusts at least once a year to reflect actual market experience. In market downturns such as what is happening now, you either have to “add” more funds to your “becoming a millionaire fund” or take on higher risk investment to compensate.
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