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Here’s how to turn $4,000 into $1,142,997 when investing in stocks

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.

An article by the chief economist, Dr Shane Oliver, at AMP Limited (ASX: AMP) titled: “The power of compound interest – an investor’s best friend” outlined a process to retire comfortable which arguably is 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:

From a standing start – let’s say from the age of 20 – you begin setting aside $4,000 each year and investing it in the stock market. Perhaps you pick stocks yourself, or perhaps you outsource to a high-quality listed investment company (LIC) such as Australian Foundation Investment Co.Ltd. (ASX: AFI), or via a market-beating fund managed by the likes of Macquarie Group Ltd (ASX: MQG) or Magellan Financial Group Ltd (ASX: MFG).

Taking a conservative outlook, let’s assume you achieve a 7% return per annum (pa) on your investments. The maths is quite straight forward: an investment plan of $4,000 every year for 45 years at a return of 7% pa will grow thanks to the beauty of compounding into $1,142,997 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 as necessary.
  • Fourthly, the average annual return achieved matters and makes a big difference. While 7% was used in this example, a review of the long-term performance records of successful investors shows that even higher returns are not unrealistic.

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

 

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