We all want to get rich but obviously not everyone achieves it. While it would be naive to say "getting rich is easy", by utilising the following steps it certainly is achievable.
Albert Einstein is credited as having said "compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn't, pays it."
While there is some conjecture over whether Einstein did really make this statement or not, it's hard to deny that compound interest is indeed a very powerful tool to harness and to have working in your portfolio's favour.
Working through a practical example can highlight this point…
Imagine you can save $5,000 per year over your working life. From a standing start – let's say at the age of 25 – you begin setting aside $5,000 each year and investing it in the stock market perhaps in a listed investment company (LIC) with a track record of solid performance such as Argo Investments Limited (ASX:ARG) or WAM Capital Limited (ASX:WAM), or via a market beating fund managed by the likes of BT Investment Management Ltd (ASX:BTT).
For argument's sake, let's assume you achieve a 10% return per annum (pa) on your investments – that's certainly no slouch for a return but it's also not an impossible achievement either.
The maths is quite straight forward: an investment plan committing $5,000 every year for 40 years at a return of 10% pa will grow –thanks to the beauty of compounding – into $1,689,412 by the time you are 65.
Who doesn't want to be a millionaire!
There are a few key takeaways from this example:
Firstly, it takes time to build wealth. The earlier you start and the longer you allow your wealth to compound the better.
Secondly, compounding is a must – that means not drawing an income or taking any money out of your portfolio and reinvesting all your profits too. It's worth noting that under this example 'only' $200,000 of savings are contributed over the 40 years, the balance of nearly $1.5 million is all thanks to compounding.
Thirdly, you must spend less than you earn so that you can regularly add to your investment portfolio.
Fourthly, the average annual return achieved matters and can make a big difference. While 10% was used in this example, a review of the returns achieved by successful long-term investors' shows that even higher returns are possible. Taking the time to carefully construct a portfolio that will maximise your returns can make a huge difference to your wealth.
