Are you in the early stages of trying to build wealth over time? If you’ve managed to save a few thousand dollars, it might seem impossible to grow it to 10 times its current value or more by the time you’re ready to retire.
However, you don’t need to feel this way. In fact, you might be surprised at how effortless it can be to set yourself up for long-term returns with stock investments. Here’s how you can make it happen.
First, a little math
I completely realize not everyone enjoys doing calculations as much as I do, so I’ll try to keep this as brief as possible. But it’s important to illustrate the long-term power of compound returns.
If you’re starting with $5,000 and want to end with $50,000 in 30 years, that’s a $45,000 profit. This represents a 900% return from the original $5,000.
There’s an exponential growth formula for compound returns, and I’ll spare you the details. But to achieve a 900% return over a 30-year period, you would need to achieve an annualized return of about 8.00% per year for three decades. In simple terms, some years could be better or worse than this, but an average annualized return of 8.00% over three decades will get you there.
With even the best high-yield savings accounts and certificates of deposit (CDs) paying about 5.00% as of this writing, achieving 8.00% returns over a long period of time might seem like a daunting task. But think of it this way:
Over long periods of time, the stock market has delivered a performance that is significantly better than the 8.00% return required to grow your money by 10 times in 30 years. In fact, from 1965 through 2023, the S&P 500 delivered an annualized compound return of 10.20%.
Simply putting your $5,000 into a low-cost S&P 500 index fund compounded at this rate for 30 years would result in an ending value of more than $92,000. In other words, it would be mildly disappointing if an index fund investment like this only turned $5,000 into $50,000 in 30 years.
It’s a common misconception that the only way to achieve strong long-term investment returns is to exhaustively research and invest in individual stocks. But while I believe investors with the time, knowledge, and desire can beat the market with individual stocks, simply matching the stock market’s performance over long periods can be a surprisingly great way to generate wealth. As legendary investor Warren Buffett has said, “it is not necessary to do extraordinary things to get extraordinary results.”
How to get started
The first step toward putting the long-term compounding power of the stock market to work for you is to open a brokerage account (a specialized financial account designed to hold investments). There are plenty of choices, and there are some big differences between brokers, so consider your options. I’d also strongly suggest reading this primer on how index funds work that I wrote for The Motley Fool.
It’s also worth noting that if you’re looking to build wealth over a multi-decade period, opening an individual retirement account, or IRA, could be the best choice for you. These are brokerage accounts designed for retirement savings, and there are some big tax advantages — you may even be able to get a deduction this year thanks to your $5,000 investment!
As a final thought, we’ve seen that based on the S&P 500’s historic average rate of return, $5,000 would grow into more than $92,000 in 30 years. But that’s based on a one-time investment. Imagine if you opened an account and contributed $5,000 every year.
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