If you've found a get-rich-quick scheme that works successfully and consistently, consider yourself very lucky and one of very few.
For the rest of us, building up a decent nest egg to support us during our retirement, or even to allow us to retire when we want rather than when the government says we can requires getting rich slowly.
The biggest and best weapon in our arsenal to achieve our financial goal – whatever it is – is compounding investing. Over time, compound growth generates earnings on earnings on earnings…
The longer the time period, the larger the pot at the end of the rainbow.
Here are a couple of scenarios…
An initial investment of $5,000 earning 15% per annum for 37 years would end up being worth $1,242,694 according to ASIC's Moneysmart calculator. In other words, a 30-year-old looking to retire at age 67 would only need to start with $5,000, and never contribute another cent – as long as they could achieve returns of 15% on average every year.
That's tough to do. The S&P/ASX 200 (Index: ^AXJO) (ASX: XJO) has returned around 10% on average per year over the long term. Most fund managers will struggle to beat that – although there are some.
Wilson asset management's WAM Capital Limited (ASX: WAM) has achieved returns of 18.2% since August 1999 (17 years) – although that's before expenses, fees and taxes.
The Magellan Flagship Fund Limited (ASX: MFF) has achieved returns of 19.8% over the past 7 years, while the Hunter Hall Value Growth Trust has returned 14.7% after fees over the last 20 years – an astonishing performance – more than double the 9.2% achieved by the ALL Ordinaries (Index: ^AORD) (ASX: XAO) Index, which includes dividends reinvested.
$10,000 invested at inception in May 1994 would now be worth $183,083. Another 10 years at those rates and that $183,083 would grow to $789,191 and be worth more than $1 million in 12 years. And remember that that is without making any further contributions.
Australians also have the advantage of compulsory super which means contributions every year for most workers. That has two positive effects. A shorter time frame to achieve your goal, and potentially a much larger balance.
Foolish takeaway
The keys to growing $5,000 into a $1 million are compound interest and letting time do your work for you. A high rate of return is also essential and the best way to achieve that is by investing in the stock market – either directly – or indirectly via a listed investment company or managed fund like the ones listed above.
