This retirement savings strategy is almost guaranteed to vastly improve your future financial security, as long as you stick with the plan.
There’s nothing like a good life hack to make your life easier and better. For example, if you’re working on learning a language, try watching children’s shows in that language, as they’ll focus on words and simple conversation. If you manage people, aim to give praise in public and criticism in private. If you have a pet, give them a treat whenever an alarm goes off. That way, they’ll learn to come running whenever there’s a possible emergency.
There are financial life hacks, too. Here’s a closer look at a retirement savings hack that could turn you into a millionaire — or multimillionaire!
Image source: Getty Images.
Compounding — it’s simple math
The retirement savings hack involves simple math. And it’s verifiable because, again, it’s just math. The hack: Taking advantage of the power of compounded growth.
Here’s how to understand compounding. Let’s first look at non-compounding growth. If you have $100 and it grows by 10% each year, it will add $10 in the first year and $10 in the second, and $10 in the third, etc. So your total goes from $100 to $110 to $120 to $130.
But with compounded growth, not only does your $100 grow over time, but the amount by which it grows also increases. For example: In year one, you gain $10 and end up with $110. In year two, that $110 grows by 10%, so $11, not $10, is added, getting you to $121. In year three, you add $12.10, making the total now $133.10. As you can see, you’re starting to get well ahead of the previous example — thanks to compounding.
All that might be interesting, but it’s not exciting. Here’s where compounding gets exciting — when you see what can happen if you regularly sock significant sums away and they grow over many years. The table below, for example, uses an 8% average annual growth rate and illustrates how your money might grow over time:
|
Growing at 8% for |
$7,500 Invested Annually |
$15,000 Invested Annually |
|---|---|---|
|
5 years |
$47,519 |
$95,039 |
|
10 years |
$117,341 |
$234,682 |
|
15 years |
$219,932 |
$439,864 |
|
20 years |
$370,672 |
$741,344 |
|
25 years |
$592,158 |
$1,184,316 |
|
30 years |
$917,594 |
$1,835,188 |
|
35 years |
$1,395,766 |
$2,791,532 |
|
40 years |
$2,098,358 |
$4,196,716 |
Source: Calculations by author.
See? That’s pretty exciting. It’s a marvelous retirement savings hack, too.
How you can build a compounding machine
You can make good use of the phenomenon of compounded growth by focusing on three factors:
- How much you can invest
- How quickly your money can grow
- How many years your money has to grow
Let’s take a closer look at each.
How much you can invest
The table above shows what a difference the amount you invest makes. Not everyone will be able to sock away $7,500 annually (about $625 per month, on average). And some people will be able to save and invest much more than $15,000 annually ($1,250 monthly). The more you can sock away, obviously, the more you can make.
Another key point to appreciate is that your earliest invested dollars are your most powerful, as they have the most time in which to grow.
How quickly your money can grow
This factor can also make a big difference in your results. For long-term investing, it’s hard to beat the stock market, which has averaged annual returns near 10% over long periods. You can certainly aim higher than that, perhaps by chasing some growth stocks, but those are not guaranteed to soar and some might even implode. (Still, if you take the time to learn more about them, you might do well.)
A safer and also very effective way to build long-term wealth is via a simple, low-fee index fund — such as one that tracks the S&P 500 index or an even broader index. Here are a few low-fee index funds to consider:
- Vanguard S&P 500 ETF (NYSEMKT: VOO)
- Vanguard Total Stock Market ETF (NYSEMKT: VTI)
- Vanguard Total World Stock ETF (NYSEMKT: VT)
How many years your money has to grow
Finally, there’s time. The longer you save and invest, rinse and repeat, the more you can amass. But that’s far easier said than done. You really need to stick to the plan — for a long, long time. It can be easy to get discouraged during all those years, or to simply take your eyes off the prize. Don’t let that happen. Understand that you’ll make money in many years and you’ll lose money in some. Understand that you’ll get a little wealthier in most years early on — and then crazy wonderful things will happen.
So let the power of compounding work for you. If you simply save significantly and invest effectively for a long time, it will be hard not to get a lot wealthier.
Selena Maranjian has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Vanguard Index Funds-Vanguard Total Stock Market ETF and Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.