How to Become a Millionaire (The Power of Compounding and 3 Simple Steps)

For most people, having a net worth of a million dollars signifies that they “made it.” It's also something that most people feel is out of reach. When it comes down to it, though, becoming a millionaire is not that difficult if you have time on your side. This is especially true if you implement financial planning effectively and spend your money wisely.

This post will explore how to become a millionaire. You'll soon realize that everyday people earning average incomes can become millionaires quite easily. It turns out you don't need to be the CEO of a huge company or make some crazy investments to reach the two comma club. All you need is a bit of discipline and some time.

How to Become a Millionaire

The road to a million dollars may seem long, but when you break it down via savings and compound returns, a million dollars may not be as far off as you might expect.

The first step to figuring out how to become a millionaire is to understand the power of compound returns. Compounding is basically when you invest your money and it earns you a percentage return. Then, you reinvest your earnings and you earn a return on both your original investment and the new portion that you earned. Slowly this snowballs and you end up with a large nest egg of wealth.

A simple example demonstrating this is if we assume you invest $100 into something that returns 10% per year. After the first year, you would have $110 ($100 x 1.1), but then after the second year you would have $121. Notice that you earned $10 in the first year, but $11 the second year. This is because the return rate is applied to $110 instead of $100 so you end up compounding your money.

On a regular income, it might take you forever to save up a million dollars, but if you invest your money, your wealth building process could be sped up exponentially. Let's take a look at an example using some real numbers.

The Power of Compounding

Using the general stock market as a benchmark, we can view historical stock market data and see that since its inception, the overall stock market has returned around 10% annually (compounded). Of course, we need to factor in inflation (as money today is worth more than money tomorrow). Assuming an average inflation rate of 3% we can determine that an average real return for the stock market is around 7% annually.

With this number in mind there are only two other factors that affect your ability to become a millionaire: time and amount of money consistently invested.

If you want to become a millionaire in ten years you would need to invest about $6000 every month. For most people, putting aside $6000 a month is unrealistic. However, most people don't expect to become a millionaire in just ten years.

Using twenty years as a time horizon, you only need to invest about $2000 a month to become a millionaire. This means that if you're in your mid-twenties right now and you decide to put aside $2000 a month, you could be a millionaire before you hit your 50s.

Finally, if you're like most people and just want to have a nice nest egg for your retirement, you can use thirty years as a time horizon. To become a millionaire in 30 years, you only need to put aside around $860 per month. $890 is a lot of money to scrap up every month, but for most people earning a regular salary, this is completely doable. Some people have eating out expenses that are higher than $1000 a month, so if you substitute that with investing, you could become a millionaire in 30 years.

The Importance of Fees

Some might argue that the stock market is risky and that nobody can ever predict what will happen to it. Even if it does trend upward in the long run, what if the year you decide to take out your money is the same year that the stock market crashes?

These are valid concerns and there is no way to overstate the impact that investment volatility has on wealth-building plans. That being said, unless you spend tons of time doing smart equity research and trying to beat out large financial firms, there is no way to predict the stock market, and as such, it is an uncontrollable factor.

On the other hand, something that will have a significant impact on your total return and is completely within your control are the fees that you pay on your investments. A financial advisor might charge 1% annually for their services, which might not seem like a lot, but can have a huge impact on your returns.

If you're still trying to amass a million dollars in a thirty year time horizon, the amount of money you'd need invest every month shoots up from around $860 to $1030. That's almost an extra $200 you need to pay every month just for the services of a financial advisor.

If you use a mutual fund the fees could be even higher. Most mutual funds charge at least 2% per year, which will end up cutting into your investment even more. If you want to become a millionaire, one thing that you should definitely pay attention to is the amount of money you're giving away in fees.

Tips to Become a Millionaire Faster

Now that we've run through the math behind becoming a millionaire, let's dive into some ways that you can speed up the process of amassing a million dollars. Here are some tips you can follow to either help you save more money or cut down on expenses so that you're put on a fastlane to becoming a millionaire.

Don't Take on Too Much Bad Debt

One of the biggest things holding most people back from building wealth is excessive amounts of debt. Whether it's student loans, credit card debt, or personal loans, debt that can be paid off generally should be paid off.

Just like how returns on your investments can compound, so can the interest on your debt. The scary thing is that debt often has interest rates as high as 20% – 30%. If you can find an investment that can steadily return 20% – 30%, you're better off quitting your day job and working on Wall Street for Warren Buffett! As such, if you have outstanding debt, it's oftentimes a much better use of your money to pay down the debt rather than invest in the stock market (or any market for that matter).

Get Your Employer to Help You Make a Million Dollars

Most employers have plans that match (or match up a certain dollar amount) the amount of money that you put away for retirement. What this means is that if they have a one for one matching program and you put away $300 a month towards your retirement, your employer will contribute an additional $300 as well. In total, this would be an additional $600 a month and can help significantly speed up the process to becoming a millionaire.

Check with your current employer to see if they offer retirement savings matching plans or have any kind of contribution plan in place. You'll be surprised by how much benefit you can gain just by taking advantage of resources already available to you.

Keep Lifestyle Inflation in Check

One of the biggest roadblocks for most people trying to save money is lifestyle inflation. Lifestyle inflation is essentially when you let your expenses rise along with your income.

An example:

  • You currently make $3000 a month and opt to eat out twice a week.
  • Some weeks, when you run short on money, you decide to not eat out and eat at home instead.
  • One day, you get a promotion and start making $3500 a month.
  • Now, you think you're earning a lot more money so you start eating out three times a week and rarely cook at home.
  • Over time, you get used to eating out and it shifts over from your “wants” to your “needs”.

In essence, your lifestyle “inflated” and the additional money you're earning doesn't actually go towards your savings and rather gets eroded by additional expenses. Lifestyle inflation is why some of the most highly-paid professionals (doctors, lawyers, investment bankers) are often the ones with the most debt and most financial troubles.

To get ahead of the curve and speed up your path to building wealth, make sure that you don't succumb to lifestyle inflation. Every time you get a paycheck increase, take the increase and invest it. This way, not only will you prevent lifestyle inflation, but you'll also speed up your journey to a million dollars.

A Million Dollars Today Isn't What it Used to Be

With inflation as a constant in today's society, money itself is worth less and less every day. A million dollars today isn't what it was twenty years ago. In fact, if you live in North America, a million dollars today (2022) is only worth around $630,000 in 2002 currency.

The hype surrounding a million dollars has been around for a long time, but inflation is ever on the rise. In the 1950s, if you had a million dollars, you were really rich. You could afford all kind of luxuries and were considered to be part of the elite group in society. Of course, when we factor in inflation this all makes sense. A million dollars in 1950 would be around ten million dollars today.

Oftentimes, people who want a million dollars don't actually want the money, they want the associated lifestyle and luxuries that come with being a millionaire. Unfortunately, the hype surrounding the term “millionaire” has been around for a long time, so depending on which time reference you're using, you'll likely need to earn a lot more than a million dollars to achieve the luxury lifestyle you'd expect from a “millionaire.”

Financial Freedom vs. A Million Dollars

how to become a millionaire
How to Become a Millionaire (The Power of Compounding and 3 Simple Steps) 3

While it might be tempting to just work towards hitting a number goal, oftentimes what most people are seeking is financial freedom. This is basically when you have enough savings and investments that you can live the rest of your life without worrying about your finances.

When most people think about achieving a million dollars, what they usually want is actually financial freedom and not the cash value of a million dollars. Unlike a million dollars, financial freedom is subjective and varies from person to person.

Some people can comfortably gain financial freedom on just $500,000 while others may need more than a million dollars. The important thing is to figure out your goals and work towards them wisely so that you can look back and say with confidence that you really did what was financially right for yourself in the long run.

Jeff is a current Harvard student and author of the blog Financial Pupil who is passionate about learning, living, and sharing all things personal finance-related. He has experience working in the financial industry and enjoys the pursuit of financial freedom. Outside of blogging, he loves to cook, read, and golf in his spare time.