If I told you that you could become a millionaire with just £250 and a simple investment in the FTSE 100, you probably wouldn’t believe me at first. But while this might seem like an unachievable target, it is entirely possible.
It all comes down to the power of compounding. This is the process of money making money and the higher the rate of return, the more potential your money has in the long run.
Look to investing
It’s only really possible to become a millionaire with a small regular investment by investing in stocks. As the average savings account currently offers less than 1% per annum, it is virtually impossible to build wealth by saving cash alone as right now, the real return (after inflation) is negative. Equities offer much higher returns.
Over the 100 years between 1917 and 2017, the average annual return for the FTSE All-Share is 7% (similar returns are available for the FTSE 100). Over the same period, the S&P 500, the leading US equity index has returned around 9% per annum.
If you can grow your wealth at a rate of 7% to 9% per year, it won’t take much for you to be able to build a life-changing savings pot.
Time to start saving
The earlier you start, the better. If you start saving for your future at 20 rather than 40, the extra 20 years will give you a huge leg up. Unfortunately, most people in their early 20s are still in the initial stages of their careers and do not earn enough to be able to live comfortably and save for the future. So it’s often the case that saving doesn’t begin until their 30s or 40s, which means they have to contribute more to generate similar returns.
For example, if you plan to retire at 70 and start saving at age 20 with a 7% return per annum, £100 a month will be worth £506,000 by retirement. If you start saving in your 40s with the same performance, monthly contribution and retirement age, by the time you retire your savings will only be worth £117,600.
Time is the greatest instrument savers have, so every saver should seek to make the most of this valuable tool to build wealth.
Leaving time for your money to grow
If you plan to retire at 65, you need to start saving to hit the £1m target at age 23. This example assumes you put away £250 a month and your contributions grow in line with inflation (estimated 2.5% per annum).
If you’re prepared to delay your retirement by a few years to 70, you need only start saving at age 28, although if you can start earlier, you won’t need to save as much every month.
If you start saving at age 20, at a rate of 7% per annum you only need to put away £135 a month to hit the million pound target by 70.
It’s never too late
If you’ve already missed the 20-year-old starting point, it is still possible to hit the £1m retirement fund benchmark if you invest in the US. Based on the S&P 500’s average return over the past 100 years of 9% per annum, if you start saving at age 30 and aim to retire by 65, a contribution of £275 per month will give you a comfortable £1m to retire on.
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Rupert Hargreaves has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes