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How to turn $5,000 into $998,000

We all want to get rich but obviously not everyone achieves it. While it would be naive to say ‘getting rich is easy’, by utilising the following steps it certainly is achievable.

A recent article titled: “The power of compound interest – an investor’s best friend” by the Chief Economist, Dr Shane Oliver at AMP Limited (ASX: AMP), outlined a process to retire comfortably, which arguably is very achievable for many Australians.

To begin with investors need to acknowledge that the “key” to growing your wealth is to compound your earnings.

Working through a practical example can highlight this point:

Imagine you can save $5,000 per year over your working life. From a standing start – let’s say at the age of 25 – you begin setting aside $5,000 each year and investing it in the stock market perhaps in a high quality listed investment company such as Argo Investments Limited (ASX: ARG) or via a market-beating fund managed by the likes of Macquarie Group Ltd (ASX: MQG) or Platinum Asset Management Limited (ASX: PTM).

Taking a conservative outlook, let’s assume you are able to achieve a 7% return per annum (pa) on your investments. The maths is quite straight forward: an investment plan of $5,000 every year for 40 years at a return of 7% pa will grow thanks to the beauty of compounding into $998,176 by the time you are 65.

Who doesn’t want to be a millionaire!

There are a few key takeaways from this example.

Firstly, it takes time to build wealth. The earlier you start and the longer you allow your wealth to compound the better.

Secondly, compounding is a must – that means not taking any of your money out and reinvesting all your profits too.

Thirdly, spending less than you earn so that you can regularly add to your investment portfolio is necessary.

Fourthly, the average annual return achieved matters and can make a big difference. While 7% was used in this example, a review of successful long-term investor returns from equity portfolios shows that even higher average returns are not unrealistic.

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Motley Fool contributor Tim McArthur does not own shares in any of the companies mentioned in this article.

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