You’ve probably seen plenty of internet scams in your day. Scammers always comment on how you can “make $1,000 today from home” under social media posts. But I’m here to tell you that you can legitimately turn a $10,000 investment into $160,000 with the stock market.
No, it won’t happen in one day or one week, not even a year. But investment returns break down into simple math, an equation where you can control the variables. Understand how building wealth works, and you’ll have the tools to build the financial future you’ve always wanted.
Multiple paths to the same destination
Building wealth is a personal journey, which means that the right path for you might not be suitable for somebody else. Someone more experienced or confident enough may pick individual stocks, while someone who doesn’t want to put the time into tracking companies may opt for index funds and ETFs. Of course, you can also combine the two — a portfolio can have a base of funds with complementary stocks to add more potential upside (or perhaps dividends for income investors as another example).
The stock market has historically averaged about 10% annual returns, though results could vary widely from year to year. The S&P 500 is an index of 500 of the largest and most influential companies in the U.S. and a benchmark for the broader stock market. Several funds mimic the S&P 500 and will give you returns mirroring the index. They are great ways to participate in the stock market without getting too far into the weeds. A fund like the Vanguard S&P 500 ETF (VOO -0.90%) is a great example.
Individual stocks can give you more upside in exchange for taking on more risk. Remember that an index like the S&P 500 represents hundreds of stocks, while picking individual stocks means that each one can have a much more significant impact on your portfolio returns (good or bad). It’s always a good idea to diversify your portfolio by holding at least 25 stocks, though be careful not to over-diversify your investments. Know your risk tolerance to make sure you choose the right investment strategy.
Understanding the math of building wealth
Math can be as straightforward or as complicated as you make it. One of my favorite (and simple) rules is the Rule of 72. It states that if you divide the number 72 by a growth rate, the result will tell you how approximately long it will take to double a number. For example, imagine you invest $10,000. If that investment grows 10% yearly, your $10,000 will grow to $20,000 after 7.2 years (72 divided by 10). Remember that the market averages 10% annual returns, so this is a rough baseline for what you could expect from an S&P 500 index fund.
Growing $10,000 to $160,000 would mean your investment doubled four times, so that would take just over 28 years, using the math from the above example. You can play with the inputs to adjust your investment strategy. Is 28 years too long? Generating 20% annual returns would double your money every 3.6 years, which would get you to $160,000 in just over 14 years.
It all boils down to how much you invest, how fast your investment grows, and how much time you give compounding to do the heavy lifting. Again, you want to build this around a strategy that works for you. There’s no free lunch — higher rates of return generally mean more risk. Chasing 20% annual returns will naturally mean taking more risks. It’s not all about risk, though. Investing more (a larger starting number) or starting earlier (more time for compounding) can aid your efforts.
There will be volatility
It sounds simple enough, but your investment returns probably won’t be. The reality is that you can’t escape stock market volatility. A stock’s fundamentals (growth, financials, execution) will have a lot of say in where a share price goes long term, but fear and greed can steer the boat in the short term. I like to say that the market acts like a daily montage of knee-jerk reactions. So you might average 10% over time, but it could look like a 20% loss this year, a 40% gain the following year, and so on.
How do you deal with this? Take a long-term perspective and invest money you know you won’t need for several years. Having a solid financial foundation can help with that. Make sure to pay off things like credit cards or other high-interest debt before putting your money to work in the stock market. If you financially prepare yourself, think through a strategy, and embrace the bumps in the road, you’ll be in a great position to get where you’re trying to go.
Justin Pope has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.