Donald Trump traveled an old-fashioned route to fortune.
As he explained when he announced his bid for the 2016 Republican nomination for president:
“I made it the old-fashioned way. It’s real estate. You know, it’s real estate.”
While Trump did have a big head start — his father, Fred, was a multimillionaire New York real estate developer — there’s no doubt The Donald has created a fortune of his own. But if he’d stopped working 30 years ago, he could have done much better.
All he had to do was shift away from real estate and park his money in the same place that you can: an unmanaged stock index fund.
To compare Trump’s performance to that of an unmanaged index fund, we need to know two things: his beginning net worth and his current net worth.
There’s considerable debate about Trump’s net worth. It’s estimated at $4.1 billion in the latest “Forbes 400” list, which puts him in the No. 133 spot of the richest folks in America. However, in July, he issued a press release announcing his net worth at $10 billion.
Fine. Let’s give him the benefit of the doubt and assume his net worth is $10 billion.
Now we need to establish his net worth at some point in the past.
Trump was on the Forbes 400 in 1982, when the magazine published its first annual list of America’s wealthiest denizens.
That year, Forbes said Trump’s fortune was “estimated at over $200 million,” but also acknowledged that Trump claimed it was “$500 million,” according to Timothy L. O’Brien’s book “TrumpNation: The Art of Being The Donald.”
Again, let’s give Trump the benefit of the doubt and assume he was worth $500 million in 1982.
Imagine Trump had retired in 1982, sold his real estate holdings and invested his $500 million in the S&P 500 — that is, 500 stocks representing the American stock market.
From 1982 through the end of 2014, the S&P 500 index had an annualized return, including reinvested dividends, of 11.86 percent, according to MoneyChimp’s S&P 500 Compound Annual Growth Rate calculator.
Per this calculator, every dollar invested in January 1982 would have been worth $40 by December of 2014. That means Trump’s initial $500 million would have grown to $20 billion. That’s twice what Trump says he’s worth today.
You can beat The Donald
This comparison is notable for two reasons. First, it reveals that Trump may not always be as shrewd as he’d have you believe, especially considering he’s filed four corporate bankruptcies since 1982.
More relevant to your life, however, is that you can do what he didn’t: harness the twin tools of stocks and compound interest.
While few of us have the resources to invest in the stocks of 500 of America’s largest companies, nearly all of us have the ability to do so through mutual funds, like an S&P 500 index fund.
You probably have an S&P index fund, or something similar, in your 401(k) at work. They also can be found at nearly every investment firm, either as a mutual fund or an exchange traded fund, commonly known as an ETF.
If you decide to take on more risk and chase The Donald, you will need to make a couple of important decisions:
1. Pick an asset class. You could buy stocks or bonds, as well as choose from a slew of other alternative investments. To keep things simple, however, nothing wrong with sticking with just stocks and bonds.
Many experts urge average investors to put their money in mutual funds rather than buy individual stocks and bonds. You can choose a stock mutual fund, a bond mutual fund or a portfolio of mutual funds that includes both stocks and bonds.
In our hypothetical example above, we chose a pure stock mutual fund. That’s because, in the long run, stocks offer a greater rate of return than other asset classes such as bonds.
As Money Talks News founder Stacy Johnson explains in “Beginning Stock Investor? Here’s All You Need to Know“:
Depending on how you measure it, stocks have averaged 8 percent to 10 percent annually over the last 100 years. Of course, stocks entail risk; that’s why they pay more.
Fortunately, mutual funds help mitigate risk because they are made up of a wide variety of stocks. That helps spread the risk — if one company in your mutual fund goes bankrupt, it won’t wipe you out.
2. Pick active or passive management: Actively managed stock mutual funds are run by financial professionals who decide which individual stocks within the fund to buy and sell. They make these judgments based on their expectations of future market performance.
Such managers aim to outperform stock market indices — and they charge higher fees for their effort.
Passively managed stock mutual funds, often referred to as index funds, simply aim to mirror the success of a stock market index.
Here’s Johnson again:
Owning an index fund is like owning the entire stock market, as represented by an index, like the S&P 500. Since all an index fund manager has to do is buy the stocks in the index, a chimpanzee could do it. And because management is simple, the fees charged are minimal.
Study after study has shown that index funds historically have performed better — at a lower cost to the investor — than managed funds over a long period of time.
Johnson is hardly the only expert who champions index funds.
Warren Buffett, billionaire investor and CEO of Berkshire Hathaway, made headlines last year when he wrote in his annual letter to shareholders that his fortune is destined for index funds. Buffett wrote of the instructions laid out in his will:
My advice to the trustee could not be more simple: Put 10 percent of the cash in short-term government bonds and 90 percent in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors — whether pension funds, institutions or individuals — who employ high-fee managers.
Perhaps that wisdom is why Buffett is in the No. 2 spot on the Forbes 400.