The Australian Taxation Office’s latest statistics revealed the 10 occupations with the highest annual salaries. Surgeons were number one, earning an average of around $375,000 a year. Also near the top – anaesthetists, medical specialists, mining engineers and legal professionals.

So is joining one of these professions the key to becoming financially free? Not necessarily.

The power of compounding means if you start saving early and earn decent returns, you could end up better off than someone who saves more, but starts later.

Let’s say your goal is to have a portfolio worth $1 million. By saving $10,000 a year and compounding at 10%, you will hit your target after around 25 years. Someone who doesn’t start saving for the first 10 years would have to then save $30,000 a year for 15 years to finish with a similar balance.

compound25

Looking at it another way, someone who saves and invests $10,000 a year for 10 years and then stops adding to their portfolio will still be miles in front of someone who saves nothing for 10 years and then adds $10,000 a year for the following 40 years!

compound50

If you can earn a return of 10%, your portfolio will double roughly every 7 years. After around 8 years, returns from your portfolio will be adding more to the balance each year than your annual contribution of $10,000.

Time is the key, and the earlier you start the better. Once you do start, the keys to successful compounding are:

  1. Patience. Initially, returns might seem barely noticeable, but eventually, time will work its magic. Warren Buffett made around 95% of his wealth after the age of 60.
  2. Maximising your net returns by considering fees, commissions, taxes and inflation. If you run the numbers, you will realise that long-term buy and hold investing is hard to beat.

Index funds are a great solution. A diversified portfolio of well-run companies with a strong competitive advantage such as REA Group Limited (ASX: REA) and Ramsay Health Care Limited (ASX: RHC), or high performing funds such as WAM Capital Limited (ASX: WAM) have a good chance of doing even better.

Lastly, the following chart shows how long it might take to hit a $1 million target, depending on the growth rate you can achieve.

compoundyears

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Motley Fool contributor Matthew Bugden has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.