How does forgoing a single cup of coffee sound? If you're anything like me, you'll rebuke the suggestion. But what if ditching the latte could make you a millionaire? Investing just $5 a day in S&P/ASX 200 Index (ASX: XJO) shares could prove a major wealth-building habit.
That's because of the magic that is compounding. Here's how it works.
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How I would turn $5 a day into $1m using ASX 200 shares
Compounding, in essence, means multiplying gains by further gains. It means that a relatively small investment, when added to consistently, can turn into a meaningful nest egg.
Let's take ASX 200 shares for example. Over the 10 years ended 2021, the ASX 200 returned an average of 9.3% annually. That's including both dividends and capital gains and assuming dividends are reinvested.
Now, if you're 20 years old – good for you. Let's see what might happen if a 20-year-old invests $5 a day and recognises a 9.3% annual return:
| Years gone by | Total deposits | Total investment value |
| 0 | $0 | $0 |
| 5 | $9,125 | $10,988 |
| 10 | $18,250 | $28,127 |
| 15 | $27,375 | $54,864 |
| 20 | $36,500 | $96,570 |
| 25 | $45,625 | $161,629 |
| 30 | $54,750 | $263,115 |
| 35 | $63,875 | $421,424 |
| 40 | $73,000 | $668,373 |
| 45 | $82,125 | $1,053,593 |
And voila! By the time our figurative 20-year-old investor approaches the Australian retirement age, they've got a nest egg worth more than $1 million without doing anything more than putting $5 away each day.
Remembering, however, past returns are not indicative of future returns.
But 45 years may be a little longer than many Aussies' investment thesis. If that were the case, I would either increase my targeted yield or amount I'm investing to meet my $1 million goal.
For instance, investing $15 a day – or $105 a week – could reap $1 million in 33 years. Investing $30 a day – or $210 a week – could see that target met in 26 years.
Meanwhile, if an investor was able to secure a 13% return, like the average annual return (including dividends) posted by ASX 200 bank Commonwealth Bank of Australia (ASX: CBA) over the last 10 years, $5 each day could become $1 million in a little over 35 years.
Of course, greater returns generally come with greater risks and, again, past returns don't guarantee future returns.
Some other factors I would consider
Additionally, there's likely a bit more to it than putting $5 a day aside to invest in ASX 200 shares.
A long-term investor might want to factor in inflation, thereby increasing the amount they invest by the inflation rate each year.
There's also the issue of sticking out the hard times. It might be extremely tempting to pull cash from investments when the market is going down and it's almost guaranteed that at least one bear market will occur in the coming decades.
But bailing on investments will likely impact the power of compounding. As investing great Charlie Munger is widely quoted as saying:
The first rule of compounding: Never interrupt in unnecessarily.
