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3 steps I think you need to follow to get rich

Being able to build a large financial nest egg and retire early is the dream for many people. Unfortunately, many people make a couple of simple financial mistakes that prevent this

With this being the case, here are three steps you can follow to get rich and retire early and avoid making these mistakes along the way.

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Start saving

The first big mistake people make is not saving. Even if you’re saving a few pounds a week, it can make a big difference. The sooner you start saving, the better, as it allows the power of compound interest to start working its magic.

For example, putting £5 a week into a savings account with an interest rate of 1.5% from the age of 18 will leave you with a savings pot of £18k at the time of retirement (65 years of age). During this period, your money will have earned £5.7k of interest.

Start investing

If you’re saving a little every month, the next step on the journey to wealth is to start investing your money. As the example above shows, with interest rates where they are today, even if you save diligently for decades, your money won’t grow in a cash account.

If, on the other hand, the same £5 a week is invested in the stock market, after 47 years it could be worth £97k. That’s assuming an annual rate of return of 7%.

Let the market do the hard work

Investing your money can turbocharge returns, but it can also expose you to risk. There are two main risks investors need to be on the lookout for. Bad investments and high fees. Bad investments can end up costing you a lot of money and setting back your retirement plans. High fees will do the same.

Using the same figures as the example above, a saver who’s unlucky enough to choose a fund with a 2% annual charge will end up paying £51k worth of fees during the 47-year holding period.

A great solution to both of these problems is to buy a low-cost index tracker fund. Index tracker funds are great because they let you track the market for almost no cost whatsoever. There’s also no stock-picking risk associated with the fund. They just own the underlying index and leave it at that.

This does mean there’s no chance of beating the market. However, research shows that most active managers don’t outperform the market over the long term anyway. So there’s no reason to pay higher fees in the hopes of achieving a better performance. The odds are you’ll end up paying more for an average performance.

Today, there are FTSE 100 and FTSE 250 tracker funds on the market that charge less than 0.1% per annum in fees.

Putting it all together

Since its inception, the FTSE 100 has produced an average annual return for investors in the region of 9%, and the FTSE 250 has returned around 12%.

These figures imply an investor who saves £200 a month would be able to accumulate a savings pot of £1.5m over 47 years using the FTSE 100 (and paying 0.1% per annum in fees). An FTSE 250 investor will be able to accumulate a nest egg of £4.2m, based on the above returns.

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Rupert Hargreaves owns no share 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 us better investors.