How to become a millionaire with compound interest

As you age, you might take a close look at your financial history.

If you want to become a millionaire by the time you reach middle age, it’s time to get your personal finances and credit card debt in order.

The more you start investing now and the longer you keep money in your investment accounts, the faster you can reach your financial goals.

Even if you don’t feel like you’ve made enough money to put aside in an investment account, now is the time to start. Try cutting back on a few expenses each month, because every little amount you can save and invest now makes a difference, thanks to compound interest.

How Compound Interest Works

Suppose you need to put $1,000 into an account that has an interest rate of 9% and compounds (adds interest to the principal sum) once a year.

During the first year, the interest rate will be represented by a percentage of the starting balance. Each year, the interest is calculated by adding the starting balance and the interest.

Here’s how it works:

  • Opening balance: $1,000

  • Year 1: 9% interest on $1,000 = 1,000 X 1.09 = $1,090

  • Year 2: 9% interest on $1,090 = 1,090 X 1.09 = $1,144.50

  • Year 3: 9% interest on $1,144.50 = 1,144.50 X 1.09 = $1,247.51

Capitalization periods

As you might have guessed, the more compounding periods you have during the year, the more money you can earn each time. If you have an interest rate of 3% compounded semi-annually, you will earn more than if it were an interest rate of 6% compounded annually.

For example:

  • Opening balance: $1,000

  • 3% interest compounded semi-annually

  • First compounding: 3% interest on $1,000 = 1,000 X 1.03 = $1,030

  • Second compounding period: 3% interest on $1,030 = 1,030 X 1.03 = $1,060.90

  • 6% interest compounded annually

  • 6% compounded annually: 6% interest on $1,000 = 1,000 X 1.06 = $1,060.

While you may think the bigger number sounds better, an extra compounding period will make a difference. The longer you have invested and for longer periods of time, the more apparent this becomes.

Start now

A study by TD Ameritrade found that the average millennial doesn’t plan to start saving for retirement until their late thirties, and half don’t invest in the stock market.

Michael Taylor, a former bond salesman at Goldman Sachs (NYSE: GS), is now working to help people understand how important it is to start earlier.

“We have the wrong perception that it’s impossible to get rich,” Taylor said. “The hurdle to becoming a guaranteed millionaire is relatively low, provided you start early.”

Even if you start saving a few dollars a day, it will add up quickly. If you were to save $5 a day in an account that has a 10% annual return, that would become $2.3 million in 50 years.

Starting now and starting small is the secret to becoming a millionaire before you retire.

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