The Secret to Becoming a Millionaire

4 - The Secret to Becoming a Millionaire - Header ImageHow do you become a millionaire? Invent the next disruptive cloud-based technology? Become an executive at a large company?

Actually, you don’t have to do any of these things. The secret to becoming a millionaire is so boring that it’s almost embarrassing, but here it is:

Just. Keep. Saving. As much as you can. And try to save a little more every year.

That’s it.

Can it really be so easy?

Well, not completely. You can’t save $1,000 a year for 20 years an expect miracles. But prioritizing savings wherever you could help you reach that popular milestone of financial independence.

It’s all due to the phenomenon that Albert Einstein reportedly called the “eighth wonder of the world”: compound interest.

Here’s how it works

If you’ve ever carried a balance on a credit card, you’ve seen compounding in action.

Let’s say you have a credit card balance of $1,000 and you pay 10% interest per year. You’ll notice the amount of interest paid and your total balance quickly starts to grow over time – even if you never add any new charges.

Take a look:

Time period (in years)  Interest charged Closing balance
Day 1 $1,000
1 $100 (10% of $1,000) $1,100
2 $110 $1,210
3 $121 $1,331
4 $133 $1,464
5 $146 $1,610

By the end of 5 years, you’ve gone from paying $100 in interest to almost $150 – and your balance has ballooned from $1,000 to $1,610! (please keep in mind that this example is for illustrative purposes only and does not reflect real-life factors such as fees, credit card payments, etc.).

This is the power of compound interest: by building on the results of steady growth over time, compound interest creates a snowball effect that can build momentum surprisingly quickly.

However, while many Americans fall victim to compound interest because of high-interest debt, you can also use it to fuel and grow your wealth.

Where to start

If you’re currently carrying credit card debt or other high-interest loans, it’s typically advisable to start by paying them down as quickly as possible.

Extra payments – even if they’re modest – can significantly reduce the amount of interest you pay and help you curb the significant costs of high-interest debt. As such, consider making this a priority when it comes to building wealth.

Building a base of savings

Of course, it’s also useful and important have readily-accessible savings on-hand. An emergency fund can help you weather the unexpected issues that arise in everyone’s day-to-day life.

Recommendations for how much to save vary and will depend in large part on your personal financial situation. One rule of thumb is to set aside 3 to 6 months of living expenses. This money should be separated from your checking account but easily accessible should you need it.

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Do I pay debt or start saving first?

Depending on your financial picture, you may want to start building your savings at the same time as paying down your debt. It’s difficult to offer a blanket recommendation here because so much depends on the specifics of your situation.

To help make a decision about how to balance saving and debt, think through some of these issues first:

  • Your practical financial needs, obligations, and risk areas. Do you have children? A mortgage? Potentially high payments for medical services (as with a high-deductible insurance plan)? In these situations, it could make sense to put relatively more emphasis on savings depending on your other needs and resources.
  • Your debt balances and interest rates. High interest rates take the power of compound interest and magnify it to an unbelievable degree. If you have high-interest loans or credit card balances, it could make sense to focus more on debt.
  • Your alternative options. Do you have good credit? If you’re carrying a balance on your credit card and have the option to transfer it to another one with a low or zero teaser rate, it could make sense to do so – provided, of course, that you use the extra breathing room to tackle your financial priorities.
  • Your other resources. If you have savings already or access to help or other assets in the event of an emergency, you may be able to shift more focus to managing debt.

It might seem like these types of considerations raise more questions rather than answering them. Unfortunately, there’s no simple instruction manual here: every family and every individual situation is different.

Get ready for the long run

With a handle on your debt and a foundation of emergency savings, you can really start to focus on the long-term project of building wealth.

This is the part that’s both incredibly simple and incredibly difficult to do: it takes time, patience, prioritization, and persistence.

The formula is simple:

  • Save as much as you can.
  • Invest in a way that’s prudent for you and takes account of your risk tolerance, time horizon, and other financial and personal factors.
  • Keep on saving, year in and year out.

That’s it! At a bare minimum, it’s useful to manage your savings in a way that helps you offset the impact of inflation (which eats away at the buying power of your money over time).

In other words, keeping your money in an interest-free checking account, while convenient, probably doesn’t make sense. If you’re looking to grow your wealth over time, investing is likely one of the options you’re considering.

To learn more about getting started as an investor, please browse through our Investor Education center to learn more.

Does this really work?

It does work – but it requires effort and a real focus on saving versus other financial priorities. As with everything in life, there’s no such thing as a free lunch, and building wealth often takes a whole lot of discipline.

Let’s look at a simple example.

Here’s one way to accumulate a million dollars:

  • Start by saving $1,400 every month, or $16,800 per year.
  • Increase the amount you save by about 2.5% per year.
  • Shoot for an average 5% annual return on your savings.
  • Keep going for 25 years.

In this simple example, which doesn’t account for fees, taxes, transaction costs and other “real world” issues, you would accumulate over $1 million by the end of that 25 years.

Again, it’s simple mathematically, but that doesn’t necessarily make it easy! Saving takes discipline and focus, and it often means choosing to set money aside rather than spending that money on something else.

Now obviously, in the real world, not everyone can prioritize savings in this way. But if you can make it a priority, you do have a shot at reaching the million dollar mark.

What else can I do?

Being financially savvy means being strategic, especially about major spending categories.

One of the biggest? Our kids! The average cost to raise a child these days is $230,000 – are you making the most of that money? Download our free guide to making smart decisions about the cost of childrearing today!

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Let Us Help!

We can discuss this topic and more at a complimentary appointment. As a bay area retirement planning coaches, we can give you a review and make suggestions based on your retirement objectives.

Important disclosures

& Associates Insurance Services or United Planners. The opinions voiced in this article are for general information only. They are not intended to provide specific advice or recommendations for any individual and do not constitute an endorsement by United Planners. The listing of a product on this site does not constitute an endorsement or warranty of the product by United Planners.

To determine which investments may be appropriate for you, consult with your financial professional. Please remember that investment decisions should be based on an individual’s goals, time horizon, and tolerance for risk.

Neither diversification nor asset allocation can ensure a profit or prevention of loss in times of declining values. United Planners does not render tax advice.