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

For many people, the million-dollar mark has long been a symbol of financial accomplishment. There's something about hitting the seven-figure mark that makes people feel as though they've secured a large part of their financial future.

Hitting the million-dollar mark strictly by saving is virtually impossible for most people. Even if you're able to set aside $25,000 annually, it would take 40 years to hit that mark. If you were able to set aside $50,000 annually -- which is higher than the U.S. personal median income -- it would take 20 years to get there.

However, with investing and the power of compound interest, reaching the million-dollar mark is much more attainable, even for those with modest incomes.

Image source: Getty Images.

The power of compound interest

Compound interest occurs when the interest you earn on investments begins to earn interest on itself. For example, let's assume that you invest $1,000 in a stock that returns 10% annually. In the first year, you're making 10% on $1,000 ($100); in the second year, you're making 10% on $1,100 ($110); in the third year, you're making 10% on $1,121 ($121.10); and so forth.

It's like a snowball that continues to grow bigger as it rolls down a hill of snow, and it's one of the biggest -- if not the biggest -- wealth-building phenomena that you'll find in the money world.

The one key to getting the most from compound interest is giving it time. It's the biggest factor in ensuring that compound interest does the heavy lifting for you, growing your investments and building wealth.

How you can retire a millionaire with a simple investment

To see the power of compound interest, we'll use the Vanguard S&P 500 ETF (NYSEMKT: VOO), which tracks the S&P 500 index, as the basis. We'll use this because the S&P 500 is the stock market's most-followed (and important) index, and I consider it a one-stop shop for most investors.

Since its September 2010 inception, VOO has averaged 12.7% annual returns. Past results don't guarantee future performance, but for the sake of illustration, we'll assume it continues to average 12% annual returns over the long term.

VOO data by YCharts.

If you were to invest $1,000 monthly with those returns, you could hit the million-dollar mark in just over 21 years (accounting for VOO's 0.03% expense ratio). If $1,000 is too much and you can only invest $500 monthly, you could hit $1 million in around 27 years.

Let dividends speed up the process

A lot of focus is put on stock price appreciation, but dividends can be a major catalyst in building wealth. This is especially true if you use your brokerage platform's dividend reinvestment plan (DRIP), which automatically reinvests dividends in the stock or ETF that paid them.

For example, the total returns for the VOO ETF jump to 14.8% since its inception when dividends are accounted for. Again, past results don't guarantee future performance, and we can't predict how a stock will perform, but let's assume it continues to average 14% total returns over the long haul.

Here is how much different monthly investments could grow to in different numbers of years to get you to the million-dollar mark:

Table by author. Investment values are rounded down to the nearest hundred.

The amount of time needed will inevitably depend on how much you invest and your returns, but the larger point is that compound interest can take relatively small investments and turn them into substantial wealth, given enough time. The more time you have, the less you'll need to invest to hit the same marks.

The most important thing is starting, regardless of how "small."

Stefon Walters has positions in Vanguard S&P 500 ETF. The Motley Fool has positions in and recommends Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.