This Simple Investing Concept Is the Key to Warren Buffett's Wealth

The way Warren Buffett made his billions is no secret, and any investor can follow the same approach.

Warren Buffett is widely regarded as one of the greatest investors of all time, and he currently has a net worth of over $100 billion. One of the most interesting facts about Buffett's fortune is that he made the vast majority of it later in life. In fact, he has earned more since his 80th birthday than he did in his first 80 years.

Has Buffett become a more skilled investor at a time when most are comfortably retired (or running for President)? It's possible, but that's not the reason his net worth has grown by leaps and bounds in his golden years. It's the simple investing concept of compound interest. This is when you earn interest not just on your initial investment, but also on the interest you've already earned.

For an example of how compound interest works, imagine you put $1,000 in an investment that earns 10% per year. After the first year, you earn $100 in interest for a balance of $1,100. Next year, you'd earn $110 in interest for a balance of $1,210. Every year, the amount you'd earn this way would increase.

Buffett himself has said, "My wealth has come from a combination of living in America, some lucky genes, and compound interest.” Lucky genes may be out of our control, but compound interest is a powerful tool that anyone can use to build wealth.

The power of compound interest

When you think of great investing, it may bring to mind someone making big money from brilliant stock picks. Although there are people who have done this, the truth is that most great investing is a lot more boring, but in a good way. There are really only two steps involved.

Step 1: Put your money in low-risk, long-term investments. For most investors, exchange-traded funds (ETFs) or mutual funds tracking the S&P 500 are a smart choice. These give you exposure to the largest companies in the stock market. As long as you plan to hold your investments for five to 10 years or longer, this type of investment typically provides a solid return with minimal risk of losing money.

Step 2: Let compound interest go to work. When you invest consistently and you're earning compound interest, you can get incredible returns on your money.

The best way to demonstrate just how much these returns can be is with an example. Let's say you start by putting $10,000 in an S&P 500 fund. You continue to invest $1,000 per month, for a total of $12,000 per year. The average stock market return over the past five decades is about 10% per year, so we'll use that as the yearly interest. Here's how much you'd earn over the next 40 years:

Even though you're contributing the same amount every year, the balance grows much more the longer you hold your investment. During the first decade, your nest egg grows by $236,311. From year 30 to year 40, it grows by nearly $4 million, and you're only contributing $120,000 of that.

Remember that you don't need to invest much money to get results. You could start with $0 and invest $100 per month. At a 10% annual return, you'd still have $584,222 after 40 years, with over $500,000 of that coming from compound interest.

Time is on your side

We've had a volatile stock market this year, and that always leads to doubts about whether it's the best place for your money. At times like these, it's especially important to remember that investing in stocks is one of the most effective ways to improve your financial situation.

Like any billionaire, Buffett is an outlier. Most of us won't come anywhere near his level of wealth. But the path he took to get there is open to anyone, and it's easy to follow. If you make sound investments, like an S&P 500 fund, and you give it time, compound interest will do the rest.