It’s the dream of many to become a millionaire, and even those with just a little dough to start can achieve this goal with careful planning. While selecting the right investments is important, one other factor is still more important if you’re starting out with a relatively small nest egg: time.
Bankrate spoke with a wealth advisor to get her take on how to turn $1,000 into $1 million.
How to turn $1,000 into a million dollars
You can sum up the process of turning a thousand dollars into one million in three simple steps.
1. Let time work its magic
Even more than picking the right investment, time is the most important element in turning small money into big money. A few extra years of compounding your money can really have a huge impact on the total snowball you can roll up.
“Start investing as early as you can,” says Andrea Zoeller, wealth manager and partner at Merit Financial Advisors. “There are several studies that show an investor that starts early and saves often can end with a portfolio value larger than one who starts later in life.”
How powerful is starting now? Let’s use a simplified example, where you invest $1,000 each year to show the value of starting early.
- You start investing at age 22 and invest $1,000 annually with 10 percent annual returns. If you retire at age 62, you’ll have saved $40,000 over those 40 years, but that money would have compounded to more than $440,000, assuming no taxes.
- You start investing at age 32 and invest $1,000 annually with 10 percent annual returns. If you retire at age 62, you’ll have saved $30,000 over those 30 years, but that money would have compounded to more than $160,000, assuming no taxes.
“The money has been invested longer when someone starts earlier in life and will have more time to generate compounding interest in the lifetime compared to someone who didn’t start until later in life,” says Zoeller.
The tax laws favor investments, too. You won’t pay any taxes on your capital gains until you sell the investment, meaning you can compound your wealth for decades without the drag of taxes.
Does 10 percent sound like too high of a return? In fact, every investor can purchase an investment that’s returned about 10 percent on average over time.
2. Pick a strong investment
You might think that you need to trade in and out of the market with the very best investments to build a million dollars. Sure, it’s better to have the best investment, but you’ll do just fine over time with a consistent performer that delivers solid returns in most years.
The best solution? Invest in a low-cost index fund, says Zoeller.
A stock index fund provides the weighted average return of all its stock holdings. A fund based on the S&P 500 index, which includes hundreds of America’s top companies, has returned about 10 percent per year on average over long periods. These kinds of funds are accessible to anyone with a brokerage account, and you don’t need specialized expertise to purchase them.
Low-cost funds keep more money in your pocket and working for you, and you have many choices among them. The best S&P 500 index funds charge low fees — typically less than $10 annually for every $10,000 you have invested, and some even just $3 — so you invest in a solid index fund and enjoy strong returns over time at a low cost.
Looking for even better index funds? Here are some of the best index funds in the market.
Need an advisor to help you build wealth?
3. Hold on over time
It can be easy to overlook, but you are your own worst enemy when it comes to investing. That’s because you’ll sabotage your progress by doing things that you think are safe or smart. For example, it’s easy to sell when the market is rocky and the economy looks rough.
“Time in the market is more important than timing the market,” says Zoeller. “Missing out on the best positive days in the market because you are trying to time the market has shown to erode investor returns over time even when staying invested during down markets.”
So if you’re looking to achieve the returns of the index funds you’re invested in, you’ll want to stay invested. Plus, staying invested allows you to avoid paying capital gains taxes on your profits. If you sell a winner, you’re guaranteeing that your bankroll will decline in value.
“Be patient,” says Zoeller. “Building wealth is a marathon, not a race. It takes a lot of time and consistency.”
While our example uses $1,000 as a starting point, if you can add money to your portfolio over time — especially when the market falls — you can continue to earn attractive profits.
Other tips for building wealth
So that’s how you can turn $1,000 into a million — give yourself plenty of time, buy a strong index fund and then hold on. Here are some other tips for building wealth.
- Avoid selling after the market has gone down. “This is the No. 1 mistake that will erode your returns over time because there is no telling when you will get back into the market,” says Zoeller. “Oftentimes, by the time you get back in the market, it is after the recovery has happened, so you are consequently selling low and buying back at the top before possibly seeing another fall in the market.”
- Take advantage of tax-free accounts. If you’re investing for retirement, it makes sense to use a 401(k) plan or an IRA. Both accounts allow you to defer or avoid taxes on gains, allowing you to compound your money even faster. Your employer’s 401(k) plan may also pay you matching funds if you make a contribution, and it’s the easiest return you can ever make.
- Watch out for emotional decision-making. When the market becomes volatile, it can feel safe to sell first and ask questions later. “Be careful about making irrational decisions based on emotion or what other people are doing before understanding the meaning of what is happening in the markets,” says Zoeller. If you sell a winner, you’ll lock in taxes and you’ll slow your ability to compound your money.
- Work with a professional. Working with a financial advisor can yield a ton of benefits. “A professional can guide you through market volatility and educate you on how to make smart investing decisions and avoid the mistakes in investing,” says Zoeller.
You can find a financial advisor to consult in your area through Bankrate’s AdvisorMatch.
Bottom line
Time is your biggest ally when it comes to building wealth, but you can really help yourself out by finding a strong index fund and then holding on to it. You’ll also grow your wealth faster if you’re able to keep adding to your account each week or month and get more money working for you.
Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.
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