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How to Use Compound Growth to Create Wealth

Updated on August 28, 2011
Create Wealth
Create Wealth | Source

Many people don't realize the power of compound growth to create wealth. A lot of money can be accumulated by saving and investing regularly in one's early and middle years of working. Compound growth rates determine how fast and how much money accumulates, but the earlier one starts to save for retirement, for example, the better the long term result in creating wealth.

Begin Investing a Proportion of Your Income

First, set aside 10% to 20% of your income for savings and investments. (You must be able to do this before you can begin creating wealth. Then choose an investment strategy that maximizes compound growth to create wealth. This strategy can work within a 401k plan, an IRA (Individual Retirement Account), or be completely independent of those programs.

Consider Using Mutual Funds

For long term investments, a good strategy to create wealth would be to choose a family of low cost mutual funds and select four or five different types of funds as your investment vehicles. For example, equal proportions of your investments could be placed in each the following five fund types: Aggressive Growth, Growth, Growth and Income, International, and an Industry or Sector fund like Energy or Technology. All these funds should have good track records over a period of the previous five to ten years.

Invest $5,000 or More Each Year

Once selected, at least $5,000 a year should be invested in these funds to create wealth over time. After 10 years you would have $50,000 of your money invested, plus any growth during that period. Let's assume that your investment funds grew to a total of $75,000 at the end of 10 years and your experience tells you to expect an 8% return over the long term. Let's also assume that you started investing at age 20 and are now 30 years old, and you expect to retire at age 66. That's 36 more years for your funds to grow at a compound rate.

You can use the "rule of 72" to estimate how much money you will have at the end. At an 8% compound annual return, your money will double every nine years (72/8 = 9). That means your first ten years of investments will double four times by age 66 (36 years/9 years = 4 times).

Compute the Compound Growth

Count your money: $75,000 doubled four times is $1.2 million. (One double = $150,000, two doubles = $300,000, three doubles = $600,000, and the fourth double = $1.2 million.) That's the almost magical power of compound growth to create wealth!

Keep Investing Over Your Lifetime

Keep investing! Of course that $1.2 million is only the money you invested from the age of 20 to 30. It does not count the money you would invest from age 30 to 66, nor the compound growth for that $180,000 ($5,000 per year for 36 years). That should grow to about $700,000 giving you a grand total of $1.9 million at age 66, and a lot less stress during your working years because you'll know that you're on the road to create wealth and won't have to worry about financial security in retirement.

The Reward of Disciplined Saving and Compound Growth

Remember, the magic in this wealth creation stems from letting a modest investment each year grow for a long time at a compound growth rate. You would have invested $230,000 over 46 years ($5,000 x 46 = $230,000) but wound up with $1.9 million. This occurred because your investments grew at 8% per year over many years. That shows both the power of compound growth to create wealth and the reward of disciplined saving.


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    • saxrunner profile image

      saxrunner 6 years ago

      Aha, thank you sir!

    • Rob McKelvie profile image

      Rob McKelvie 6 years ago from USA and UK

      The rule of 72 is a mathematical shortcut used to determine how many years it will take for money to double based on the rate of return or interest rate it gets. At a 4% compound annual return money will double every 18 years (72 divided by the 4% return per year = 18) and money will double every 12 years if it earns a compound return of 6% (72/6=12).

    • saxrunner profile image

      saxrunner 6 years ago

      What exactly is the "rule of 72"?