Research shows that the average net worth of an American in their 60s is over $1.6 million. Given this fact, you’re probably wondering: how are so many people becoming millionaires? There are a few explanations, like the fact that home equity accounts for about 45% of net worth on average, but the rest usually consists of investments.
The good news is that you don’t have to save a million dollars to have a million dollars. Instead, you just need to take advantage of compound growth in your investment portfolio.
What is compound investment growth?
Compound growth is the result of earning returns on prior investment returns. You’re likely familiar with this concept if you’ve ever had a mortgage with compounding interest. However, in your investment portfolio you are the one reaping the benefits of compounding – not your bank.
It works by allowing your investments to accumulate dividends and capital appreciation over a lengthy period of time. You can do this by investing a lump sum and allowing it to grow or by investing smaller amounts periodically. In either case, your investment growth is based on the value of your entire portfolio – not just your new additions. This way, you have the opportunity to grow your total account value much more quickly than saving alone.
An Example of Compound Investment Growth
To illustrate the power of compound investment growth, consider this simplified example. You save $6,000 per year from age 20 to age 60. If you put that money under your mattress, you’d have $246,000 at the end of the timeframe. On the other hand, if you invested it at a steady rate of 7% per year, you’d have about $1.38 million at age 60.
As the graph below shows, your investment returns are relatively small in the first few years as you earn interest on a small portfolio value. About ten years into the timeframe, however, your annual earnings outpace your contributions and continue to grow from there as you earn a return on your constantly growing portfolio value.
Compound Growth Helps You Reach Financial Goals with Less Money Out of Pocket
As the prior example showed, compound investment returns can help your portfolio grow far more quickly than saving alone. In fact, it would take about 230 years to reach the $1.38 million ending portfolio value with the same $6,000 annual investment and no investment returns.
Compound returns are also effective over a shorter period of time but require more money out of pocket to achieve the same result. For example, if you waited until age 40 to start saving and wanted to achieve roughly the same result of a $1.38 million portfolio, you would need to save $28,700 per year rather than $6,000. In this scenario, you would need to invest a total of $603,000 – about 2.5 times more than the 40-year time frame.
See the chart below for a visual representation of compound growth over a 20-year time frame.
How do I take advantage of compound growth?
Compound growth is a powerful concept and, fortunately, it is simple to implement in your own portfolio. To start taking advantage of compound returns, you first need to start saving.
Start Saving Early
As the previous examples showed, compound growth is more effective with a longer time horizon. For this reason, you need to start planning now.
Work with an experienced financial advisor to put your goals into words and quantify the amount of money it will take to turn those goals into a reality. Then, your advisor can help you decide how much to save and which type of account best suits your needs. Finally, you need to put the plan you develop with your financial advisor into action – and start saving!
Choose Wise Investments
The investments you choose can have a significant impact on your portfolio return and the amount of risk you are willing to accept. An experienced financial advisor can help you determine the level of risk you are comfortable with and choose investments that are intended to provide compound growth without unnecessary risk.
Prepare For Down Years
Investment growth is rarely as linear as the simplified examples in this article show. Therefore, you should prepare for years when your portfolio loses value based on the economic situation and market factors.
Once again, a partnership with an experienced financial advisor is pivotal to managing this risk. Your advisor should help you decide when to hold your investments through tough times and when to sell to maximize portfolio performance.
Take Advantage of Compound Growth with Meld Financial
At Meld Financial, we have spent the last four decades helping clients take advantage of compound growth to reach their financial goals – and we can do the same for you. We prioritize careful planning and prudent investment management based on your individual situation to help you create the future you envision.
Our proprietary wealth management program – Financial Fingerprint™ – accounts for your unique risk tolerance, financial situation, and goals. With this nimble plan and a partnership with our experienced team, you can harness the power of compound growth to turn your financial goals into a reality.
Contact us to learn more and get started with Financial Fingerprint™ today.
