As you grow older, you might take a hard look at your financial history.
If you want to become a millionaire by the time you reach middle age, it is time to get your personal finance and credit card debt in order.
The more you start to invest now, and the more time you keep the money in your investment accounts, the faster you can reach your financial goals.
Even though you might not feel like you are making enough money to put some aside in an investment account, now is the critical time to start. Try to cut a few expenses each month, because every small amount you can save and invest now makes a difference — thanks to compound interest.
How Compound Interest Works
Say you were to put $1,000 in an account that has an interest rate of 9% and compounds (adds interest to the principal sum) once a year.
During year one, the interest rate will be represented by a percentage of the starting balance. Each year, the interest is calculated by adding together the starting balance as well as the interest.
Here’s how it works:
- Beginning 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
As you might have guessed, when you have more compounding periods during the year, the more money you can earn each time. If you have a 3% interest rate that is compounded semi-annually, you will make more than if it were a 6% interest rate compounded annually.
- Beginning 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.
Even though you might think the bigger number sounds better, an extra compounding period will make a difference. The more you have invested, and for longer periods of time, the more apparent this becomes.
Michael Taylor, a former bond seller at Goldman Sachs (NYSE: GS), now works to help people understand how important it is to start earlier.
“We have the wrong perception that getting wealthy is impossible,” Taylor said. “The hurdle to being a guaranteed millionaire is relatively small, provided you start early.”
Even if you start just saving a couple of dollars a day, it will quickly add up. If you were to save $5 a day in an account that has a 10% annual return, it becomes $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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