There are two great secrets you need to know to conquer your financial future—time and compound interest. That’s it. No smoke, no mirrors, no magic—the easy mathematical formula for making your money grow and grow is to invest your money, earn a return on it, invest some more, and earn a return on that, year after year, decade after decade.
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This is how it works: if you save and invest $5,500 a year, earn 8% a year (long-term market averages are around 9-10%) for the next 37 years, you will reach over $1.2 million. Leave it in, keep investing, and in three more years you will have over $1.5 million.
Here is the expanded version: if you invest $5,500 at age 23, earn 8% on your investment (which is $440), you will have $5,940 at the end of the year. Leave that invested, add another $5,500, leave all of that invested, earn 8% ($915), you will end up $12,355. Continue this “save, invest, earn” pattern and this is how you will end up with your $1.2 million after 37 years.
And fortunately, if you have nothing but time ahead of you, you have the greatest financial advantage over everybody who is older than you are—the time to put the concept of compound interest to work. No wonder Einstein called compounding “the eighth wonder of the world.”
Current government sanctioned retirement accounts such as a Roth IRA allow an investment of $5,500 a year (for younger people) to grow tax-free every year and is tax-free to withdraw after age 59 ½.
Can’t spare $5,500 to invest each year? At least start somewhere. $2,000 a year, for 37 years, at 8%, yields almost $438,000. That sure beats the average of only $20,000 that most people in America have saved for retirement.
For those who want to be overachievers, invest more, earn a higher rate of return, or invest for a longer time. Or do all three. (Be aware of tax consequences on yearly amounts invested over $5,500 or those not invested in government retirement accounts.) The “I Want to Be a Millionaire” app is great for plugging in your ideas and getting instant answers.
The big payoff comes when you can finally harvest your gains. If you have accumulated $1 million and continue to earn 8% a year, you actually can withdraw $80,000 a year (tax-free) without disturbing your principal. It’s like having your own money tree that grows new $100 bills every year. Just go out and pick ‘em. At this point, you have actually achieved the ultimate financial success–your money goes off to work for you everyday instead of your working for your money.
Even at a more conservative (and perhaps, less risky) 5% return, you can withdraw almost $50,000 a year and enjoy every minute of it.
You don’t really want to wait to start investing because you may have a lot of catching up to do. Start at age 30, and you will have to invest more than $10,000 a year to reach the same goal. Invest at age 45, and you will have to invest at least $44,000 a year to reach the same goal. (And remember, that in most cases, only $5,500 a year is eligible for favorable “IRA retirement” treatment.) You also may not have the “long-term” advantage of a higher percentage return in the market if you wait.