There's one often-cited example of the power of compound interest. If Christopher Columbus had placed a single penny in a 6 percent interest-bearing account and instructed someone to remove the interest every year, the value of the interest earned by 2005 would be almost 31 cents. But if he had placed the same penny into the same interest-bearing account but left the earned interest to compound -- earning interest upon the interest -- the resulting balance for 513 years would be $95,919,936,112. That's $95 billion!
All over the Internet, you'll find calculators that tell you how much you need to save each month in order to have a million dollars by an age you specify. For instance, if you're 30 years old, have $5,000 already, save $100 per month, and can earn 8 percent interest, you'll be a millionaire in a mere 51 years -- at the ripe old age of 81. Most calculators will also tell you how much that million will actually be worth by that time because of inflation. In our example case of 51 years, a million dollars will only be worth $213,215 in today's dollars, which probably won't be enough for financial freedom.
This means that you have to work to make that million happen in fewer years. Not only will you get to retire sooner, but when you do, your money will have more buying power. Let's go back to our calculator and change the numbers a bit. Let's say that, instead of $100 a month, we save $200. That changes our million-dollar mark to age 73, or only 43 years. It also changes the adjusted worth to $265,069. Now, let's say we find a way to scrape together $500 a month to save. That drops our million-dollar mark to age 63, or only 33 years. Not bad. And, the value at that time will be $361,977. Now, what if instead of 8 percent interest, we invest our funds well and can average 10 percent earnings? Now we'll be millionaires at age 59. Granted, that million will still be worth less than $500,000 in today's dollars ($414,882).
You should also determine how much money you will need. A million dollars sounds like a lot of money and a good amount to shoot for but depending on your lifestyle, it probably won't be enough to retire on when the time comes if that's your goal. Usually, the same Web sites that have those handy millionaire calculators also have retirement calculators. By plugging in your current expenses and an estimate of your expenses once you retire, you can come up with a more realistic financial goal for retirement. You may find that you need to be a multimillionaire in order to retire with the lifestyle you want.
Of course, simply being a millionaire (or multimillionaire) at retirement isn't everyone's goal. Most of us would like to experience the millionaire lifestyle sooner rather than later. We want financial freedom so that our investment interest is enough to pay our living expenses. In that case, let's talk about how you can make that happen.
There's no one way to become a millionaire, but there are some basic, common-sense steps that you can take. Even if becoming a millionaire isn't your goal, these tips can help you save money and become financially stable.
Know your current net worth
In order to successfully travel anywhere you have to first know where you're starting out, right? So, the first thing you have to determine is your current net worth, because knowing your starting point will help you pinpoint that all important estimated time of arrival.
Set your goals
How soon do you want to be millionaire? In a year? In five years? Or are you just hoping to make it by the time you retire? Whether you want to make it in one year or 30, you need to have a written goal. If you're thinking about your retirement years, do you plan to downsize to a smaller and less expensive home? Do you plan to travel? Or are you content with cable TV and an occasional fishing trip? Whatever your pleasure, you need know how much money you're going to need in order to live the life you want.
Determine your strategy
Now is the time to determine how you want to make that money. Most millionaires own their own businesses, but several (not counting sports stars and actors) have achieved millionaire status working for others. Many physicians, attorneys and corporate executives also earn incomes that enable them to achieve great wealth -- particularly if it's managed wisely. Obviously, if you want to make a million dollars in a short amount of time, say 5 to 10 years, you're going to need a pretty aggressive plan in order to succeed, and that usually means you'll need to branch out on your own.
Set up an emergency fund
One of the first rules you hear about managing your finances is to always have accessible cash in the event you're are laid off, injured, or some other catastrophe takes away your ability to earn a living. Recommendations vary, but usually that amount should be three to six months living expenses.
Set a budget and manage your money wisely
Budgets are something most people don't worry about if they have enough money from month to month. They don't see the need. The problem is they also don't see how much money they are throwing away on things that don't really matter. How much money do you spend on things like fast food lattes or movies? Do you shop because you're bored, buying things you really don't even care about?
Think about how much money you spend buying things on a whim. Keeping track of where your money goes is one of the best ways to increase your wealth. Spend your money only on things that are actually worth it. Using a financial management software program makes tracking where your money goes much easier.
Setting a budget also helps you save more money. At the end of each month, any money you haven't spent on necessities (or budgeted items) could be transferred into savings or invested.
Pay off your debt
Start with your smallest debt first and chip away at it until it's gone. Then add the money you had been paying on the smallest debt toward your next smallest debt until it's paid off and so on until you're debt-free.
Start saving and investing early
As the Rolling Stones put it, time is on your side. When it comes to investing and even putting money into high-yield savings or money market accounts, the longer it sits there, the more free money you'll get.