Anyone can turn $500 into $500,000 -- if you have the time and the patience.
Don't believe it? Read further to discover the secrets of how consistent savings and long-term stock market returns can add up to a half-million bucks.
Image source: Getty Images.
Getting started
First things first: In order to grow a nest egg, you must save. So, let's imagine a hypothetical investor who has it within their means to save $500 per month.
Next, let's imagine a base case where our hypothetical investor poured this $500 per month into a five-year certificate of deposit (CD) that paid 5% annually. Furthermore, let's also assume that our hypothetical investor could roll their nest egg every five years into a new CD with the same 5% annual rate.
| Time Period | Value of Nest Egg |
|---|---|
| Year 5 | $33,907 |
| Year 10 | $77,182 |
| Year 20 | $202,902 |
| Year 25 | $292,867 |
Calculations by author.
As you can see, after five years, our investor's nest egg will have grown to nearly $34,000. In 10 years, it would be worth more than $77,000. And in 25 years, their nest egg will have grown to almost $300,000.
Not bad. But the stock market can put those 5% annual returns to shame. Here's how.
How to use a basic index fund to grow a nest egg
Let's start by identifying a simple, well-known index exchange-traded fund. I like the Invesco QQQ Trust (QQQ 1.95%). It's chock-full of technology stocks like Microsoft, Apple and Nvidia. It also offers some diversification. It has holdings in PepsiCo, Amgen, Costco Wholesale, Starbucks, and CSX, to name just a few.
NASDAQ: QQQ
Key Data Points
At any rate, what's of particular interest is the fund's annual returns. Because over the last 10 years, this fund has generated a compound annual growth rate (CAGR) of 17.2%.
QQQ Total Return Level data by YCharts
Granted, the last 10 years have been excellent for the stock market -- and for tech stocks in particular. So, if we extend the performance window back to 1999, giving us 25 years of data, the fund's CAGR slips to 9.1%.
QQQ Total Return Level data by YCharts
To be conservative, let's use this lower CAGR of 9.1% and see how 25 years of investing could help our hypothetical investor turn $500 into $500,000.
How stock market returns measure up
By applying a 9.1% CAGR to the nest egg, we begin to see how a seemingly small change in annual return can truly ramp up investment returns.
| Time Period | Value of Nest Egg (9.1% CAGR) | Value of Nest Egg (5% CAGR) |
|---|---|---|
| Year 5 | $37,457 | $33,907 |
| Year 10 | $95,354 | $77,182 |
| Year 20 | $323,171 | $202,902 |
| Year 25 | $536,981 | $292,867 |
Calculations by author.
At first, the difference is small -- almost imperceptible. Five years in, the investment nest egg has only generated about $3,500 more.
However, after 10 years, the difference is more apparent. By then, there is an almost $20,000 difference between the two nest eggs.
By year 20, there's no mistaking the point -- a larger annual return changes everything. After 25 years, the investment nest egg is 83% larger than the money market nest egg.
In summary, the basic index fund outperformed CDs by nearly $250,000. But that's not all. Remember, in this scenario, we've used a very conservative growth rate for the index (9.2%). We've also used a very optimistic interest rate for CDs (5%). Over many periods of time, the stock market has outperformed CDs by an even greater margin.
That's why investing in a simple index-tracking ETF is one of the best ways to grow wealth. And it's one way to turn $500 a month into $500,000.
