How Compound Interest Can Help You Retire a Millionaire -- Even on a Modest Income

Does it seem like there's just not enough money left behind after paying all your monthly bills to even bother investing for retirement? If so, it's understandable. There's some truth to the cliché "it takes money to make money."

If you think it takes a ton of money to matter, however, think again. Plenty of seven-figure nest eggs have been built with meager starts and average returns. The key is something else.

Here's the math of how so many stock market millionaires built their fortunes when they seemingly shouldn't have been able to, and how you can do the same for yourself.

A smoldering start eventually turns into a wildfire

Can you come up with an extra $500 every month? It's certainly easier said than done. After all, everything's expensive these days.

Still, with the average monthly payment for a new car currently standing at $748 (according to credit bureau Experian), a more affordable used car could get you close to that target. The Bureau of Labor Statistics adds that the average American household -- consisting of an average of 2.5 people -- spends more than $800 per month on food, far too much of which ends up being thrown out before it's eaten. These households are also paying a little over $100 per month, on average, on credit card interest (according to the U.S. Federal Reserve). Never even mind the 5.4 digital subscriptions that Bango says the typical American household pays for, often without using them enough to justify keeping them.

The point is, if you're willing to make a bit of a sacrifice to do so, many people living and working in the United States could find an extra $500 per month to put toward their retirement.

And that would be enough. As the graphic below illustrates, investing $500 every month in an S&P 500 (SNPINDEX: ^GSPC) index fund earning its long-term average return of 10% per year would leave you with $1.13 million after 30 years. That's $180,000 worth of your own capital and $950,000 worth of investment gains on that capital.

Calculations by author via Calculator.net.

Surprised? That's the power of compounding, or using your gains on your investments to buy more of whatever's driving those gains over and over again.

Now take a second, closer look at the chart above. Specifically, examine when the majority of this retirement fund's growth occurred. Half of it took shape in just the last five years of the 30-year stretch. That's the discouraging part of compounding -- it doesn't feel like you're making much progress for the first half of however long you're saving. In fact, in the scenario above your net investment gains didn't eclipse your cumulative contributions until the 13th year of the 30-year time frame. That's when things really start to get going, although the fireworks don't start in earnest until years 23 and 24.

The trick? You want to tuck away as much capital as you possibly can every year of this 30-year stretch so you have enough to matter when the fireworks finally start to fly. For perspective, every $1 invested (and then reinvested) in an S&P 500 index fund today could be worth $2.59 in a decade, $6.73 in 20 years, but $17.45 in 30 years.

More food for thought

Yes, the math works. Just bear in mind there's more to the matter than simple mathematical projections. Like taxes, for instance -- if you save this money in an ordinary tax-deductible IRA or 401(k), distributions from these retirement accounts will be taxable (but not so for Roths, although contributions to Roth accounts aren't tax-deductible).

There's also inflation. A nest egg of $1.3 million in today's dollars is a healthy sum, but assuming an average annual inflation rate of 2.5%, in 30 years' time that money will only have about half the amount of buying power it does today.

Of course, you'll also receive pay raises over time, allowing you to invest more than the $500 per month you're trying to scrape together today.

Image source: Getty Images.

Strategy-wise, though, perhaps the most important thing most people should consider doing is using their employer's 401(k) plan as the core vehicle for their retirement savings. Most companies will match anywhere from half to all of their workers' own contribution, up to a limit of anywhere between 3% and 6% of their salary. Mutual fund company and retirement plan administrator Fidelity reports that in 2024 the average employer contributed $4,770 to each of their workers' 401(k) accounts, in addition to each worker's own average contribution of $8,800. Even if you can't afford $8,800 out of your annual paycheck, you should at least make a point of maximizing the amount of free money your company is willing to put into your retirement account on your behalf.

More than anything, though, just bear in mind that something is better than nothing, and sooner is better than later. You can always add more money to the mix as it becomes available. But time is the one thing you can never get back, and it does most of the work for most investors.

James Brumley has no position in any of the stocks mentioned. The Motley Fool recommends Experian Plc. The Motley Fool has a disclosure policy.