By utilising compound interest and giving it time, it’s mathematically possible to grow a $1 million share portfolio by investing $1,000 a month.
What’s compound interest?
Normal interest is pretty easy to understand. If you have $100 in a bank account with a 2% annual interest rate, you should have $102 after one year. If you started with $1,000 in the bank then you’d finish the year with $1,020 in the account.
The power of compound interest is when the interest starts earning interest. Using the example of starting with $1,000, the extra $20 earnings during year one would earn $0.40 of interest itself in year two. The original $1,000 would also earn another $20 of interest. When you do that process of interest earning interest for many years in a row it can lead to a lot of growth of the original amount of money.
Albert Einstein once supposedly said about compound interest: “Compound interest is the eighth wonder of the world. He who understands it, earns it, he who doesn’t, pays it.”
With a 5% interest rate, a single $100 investment will only make $5 over one year. But if that $100 is given 10 years to grow at a 5% annual interest rate, and the money is re-invested each year, then it grows to become $163 after a decade. It takes less than 15 years for the $100 to double to be worth $200.
But the money can compound into much larger numbers, like a $1 million share portfolio, if the dollar contributions are higher and the return on investment (ROI) is stronger that 2% or 5%.
Share market returns
The share market has often been the best performing asset over the long-term. According to Vanguard, Australian shares have produced returns of 9.6% per annum since 1970. Going back decades prior to that, the average return has been roughly 10% per annum.
Those returns didn’t require finding shares like CSL Limited (ASX: CSL), Fortescue Metals Group Ltd (ASX: FMG) or Xero Limited (ASX: XRO) before their meteoric rises, it’s just achieving the market average.
How to make a $1 million share portfolio by investing $1,000 a month
There are various compound interest calculators out there that can help people play around with different scenarios. Moneysmart has one.
Using the power of the ASX share market average historical returns of 10% per annum, and investing $1,000 per month, it would take less than 23 years for the portfolio to reach the $1 million share portfolio starting at $0. That averages out to be $12,000 a year.
Different households have different income and expenses, so some households may be able to invest more than that, whereas others may not be able to invest as much.
Don’t forget, most employees receive regular superannuation contributes which may could make up a sizeable proportion of the $12,000 annual target.
Just to give a couple of other examples, if a household could only invest an average of $750 a month then it would take just over 25 years to reach the $1 million share portfolio using 10% as the average return per annum in the calculation. If a household could invest $1,250 a month then it’d take less than 21 years to reach the $1 million goal.
The only other variable that can be changed would be the average return figure of 10% per annum. That’s what the market average has done, but there have been ASX shares that have produced stronger returns than that in recent years and there may be others in the future.