Becoming a millionaire is easy. It doesn’t take years of hard work or an unrivalled investment prowess to reach the watermark £1m figure.
You may be reading this thinking that I don’t know what I’m talking about, or I’m out of touch with the real world. But it’s true: most people can become a millionaire with almost no effort whatsoever. All it takes is a basic understanding of savings.
The power of compounding
Building a fortune most people can only dream of takes nothing more than a basic understanding of compounding and a savings plan. The earlier you embark on your path to a million the better, as time is the single best tool for wealth creation.
It all comes down to compounding or compound interest. In its simplest form, this is your money making more money. When coupled with a rigorous savings plan and budget to make sure you never need to dip into your investment pot, the power of compounding is without a doubt more important than any other financial planning aspect.
Let’s say you save £100 a month for 10 years. At the end of the decade without any interest compounding, you will have a total of £12,000. In another scenario, let’s say you save £100 a month to 10 years but receive 5% per annum in interest paid monthly. In this scenario, after ten years your £100 per month investment will have become £15,600. If you carried on investing £100 a month and getting 5% per annum in interest, by year 15 your investment pot will be worth just under £27,000 and will be generating more in interest every year than your monthly payments.
Getting started early
To illustrate how easy it is to build wealth over the long term using the power of compounding, David Bach crunched the numbers in his new book, Smart Couples Finish Rich.
The amazing conclusion to Bach’s calculations is that investors only need to save as little as £61 a month or £730 a year to build a fortune of £1m by the age of 65. This calculation is based on the investor starting their savings career at age 20, and achieving an annual return on their investments of 12%. Granted, an annual return of 12% per annum is extremely high but not totally unachievable. More to the point, these figures illustrate how easy it is to build a £1m fortune by just sticking to a long-term savings plan.
On the other hand, delaying your savings goals can have a severe impact on your long-term financial position. Indeed, Bach’s figures show that if you were to start saving for your £1m target at age 40, you would need to put aside £625 a month or £7,500 a year, almost 10 times more than the amount required at age 20. If you were to start saving at age 50, you would need to put aside a staggering £26,800 a year to reach the £1m target by 65.
So overall, by using the power of time and a rigorous saving plan it’s easy to become a millionaire.
Make money, not mistakes
A recent study conducted by financial research firm DALBAR found that the average investor realised an annual return of only 3.7% a year over the past three decades, underperforming the wider market by around 5.3% annually thanks to poor investment decisions.
To help you streamline your investment process, realise and understand the most common investor mis-steps, the Motley Fool has put together this new free report entitled The Worst Mistakes Investors Make.
Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.