Some financial experts suggest that you may need one million dollars to retire comfortably. Of course, this depends on your living expenses, what you consider a comfortable life, and how long retirement will last for you.
For people who come from money, this might not seem like a lofty goal. For those of us working normal jobs (and even living paycheck-to-paycheck), the idea of becoming a millionaire may feel like a far-off dream.
If you're in that second category, you should know about compound interest. Is it possible that it can turn you into a millionaire if you play your cards right? Read on to learn all about it.
In basic terms, compound interest is "interest on interest." It's the total of all of the interest value combined with the principal (the original sum of money that goes into a loan or investment) minus the present value of the principal.
Simple interest is only based on the initial amount of money that someone invests. Compound interest adds together all of the money that accumulates because of the building interest.
In other words, you reinvest the small amount of money that you get as interest, and it builds up over time.
Compounding can happen at different intervals. It can be daily, monthly, or even yearly.
The younger you are (and thus the more time you have to accrue interest), the more compound interest can benefit you in the long run as long as you're willing and able to leave your money untouched.
The sooner you start investing for retirement, the better off you'll be.
Let's say you start with $1000, to keep it simple. The interest on that is 5%.
After the first year, that 5% initial interest will turn your $1000 into $1050. You then add that extra $50 back into your investment, so by year 2, you're at $1102.50. By year 3, you're at over $1157.
While this seems like slow growth, that slow growth adds up over time. Of course, you should be planning to add more money to that investment as well.
Compounding isn't a replacement for continuing to add money to your investment account. It's a way to make that money grow more quickly without any extra effort or risk.
It's recommended that people start investing at or before age 25, but it's never too late.
Whether or not you become a millionaire will depend on how much money you're able to invest. At the end of the day, compound interest will get you closer to becoming a millionaire than simple interest, and if you're able to put aside even $5 per day into an account with an 8% return, you'll have over one million dollars in 50 years.
If you're able to invest more than that, the process will be much quicker.
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