Racking up $1 million or more for retirement isn't something everyone can pull off. However, more and more people are reaching the million-dollar mark every year by following a few simple steps. If you're trying to add up how it's possible, it might not make sense at first. For example, if you managed to max out your Roth IRA this year, which is $7,000 for those under 50, and kept that up for the next 70 years, your contributions wouldn't even hit half a million if you just let the money sit in your account.
But frankly, if you're like me, you'd rather not be forced to save up money for over five decades and still not be halfway to the finish line. If you want a shot at reaching your goal in a decent amount of time, there's one simple retirement savings hack that will be key to speeding up your million-dollar progress.
Image source: Getty Images.
Compounding never goes out of style
If you've been in the investing world for some time or have an affinity for math, the name Albert Einstein probably rings a bell. Back in the day, Einstein supposedly summed up the power of compounding by noting, "Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn't, pays it." Even today, other well-known financial experts, like Warren Buffett, echo this sentiment.
People have been saving for retirement for decades, and for the most part, the same strategies still apply, give or take a few tweaks. This is especially true when it comes to the power of compounding. This investing tool can help you transform annual contributions of $7,000 into a million-dollar portfolio in less than three decades -- something that's not possible with savings alone.
Let's break down how compounding works by using simple math. If you put $1,000 into a savings account, and it grows 5% each year, you'll have $1,050 in the first year. In the second year, that $1,050 grows by 5%, so $52.50 is added, and you'll have $1,102.50. In year 3, your balance grows to approximately $1,157.63 by earning interest on your interest. Without compounding, your $1,000 that's growing at 5% each year would add $50 in the first year, $50 in the second year, $50 in the third year, and so on. So your balance would go from $1,000 to $1,050 to $1,100 to $1,150.
Beefing up your retirement savings through compounding
Although compound interest can work against you in situations like paying credit card debt, it can work in your favor when it comes to retirement savings. Building a million-dollar retirement portfolio becomes a lot easier when your money starts earning more money, supercharging your portfolio exponentially over time.
Let's say you invested $7,000 every year for retirement and earned an average 11% annual return, which isn't far off from the stock market's historical average over the last five decades. You would be able to reach the million-dollar mark in less than three decades. That beats what you would earn without the power of compounding working on your side.
Take a look below at how much compounding can supercharge your portfolio depending on the average return you actually get.
|
$7,000 Invested Annually For: |
Growing at 8% |
Growing at 9% |
Growing at 10% |
Growing at 11% |
Growing at 12% |
|---|---|---|---|---|---|
|
10 years |
$109,518 |
$115,922 |
$122,718 |
$129,930 |
$137,582 |
|
20 years |
$345,960 |
$390,352 |
$441,017 |
$498,856 |
564,891 |
|
30 years |
$856,421 |
$1,040,027 |
$1,266,604 |
$1,546,392 |
$1,892,048 |
|
40 years |
$1,958,467 |
$2,578,043 |
$3,407,963 |
$4,520,789 |
$6,013,997 |
Data source: Author calculations.
While high annual returns are the goal, they aren't always guaranteed. Investment returns can fluctuate significantly based on market conditions, making it hard to pinpoint exactly how long it will take to reach the million-dollar mark. But if you're able to stick it out during the bad times, you'll give compounding more time to work its magic and get you closer to that million-dollar milestone.
