Why do we invest our money? One of the key reasons is to benefit from the power of compound interest, which allows the money we invest today to grow if placed in the right investment accounts. The basic idea is that if we invest $100 today at a 5% annual interest rate, it will grow to $105 in a year. If you then take that $105 and reinvest it at the same rate, in another year, you will have $110.25, and so on. Making our savings earn more money is the fundamental reason why we invest. By increasing our savings via monthly, pre-authorized deposits, we can help increase our savings on an even larger scale.
Understanding Compound Interest
To see an example of the power of compounding interest, let’s use a scenario where an individual sets up a monthly pre-authorized withdrawal from their bank account into an RRSP or a TFSA:
Day 1
After 10 Years
After 20 Years
After 30 Years
After 40 Years
Deposits
$10,000
$70,000
$130,000
$190,000
Investment Earnings
─
$23,470
$99,435
$260,907
Balance
$10,000
$93,470
$229,435
$450,907
(From Mawer Investment Management’s “How Compound Investing Works”, illustration as of April 27, 2020)
As shown above, by investing an initial $10,000 and adding $500 per month (equating to $6,000 per year) at a 5% rate of return, your investment can triple within 40 years. Not bad at all.
Maximizing Compound Interest
Now, let’s add a little twist – try to increase your contributions by $20, $50, or $100 a month on an annual basis. Just like the cost of living increases by 1% to 2% each year, your savings should ideally increase similarly, because $1 worth of goods today might not be worth $1 worth of goods in a year.
To illustrate, here’s how these savings grow over 30 years if increased annually:
Returns
$20/Month
$50/Month
$100/Month
7%
$260,737
$651,841
$1,303,683
6%
$228,119
$570,298
$1,140,596
5%
$200,394
$500,986
$1,001,972
(From “A Wealth of Common Sense”, illustration as of November 13, 2020)
In the above scenario, the initial investment is $6,000, which is the maximum annual contribution into a TFSA. By planning to raise your monthly pre-authorized deposit from $20 in year one to $40 a month in year two, and so on, you can see that in 30 years, you would save approximately $260,000 with a 7% rate of return. By increasing that annual monthly deposit to $100 per month, you could save as much as $1.3 million!
Building Your Financial Future
A mortgage, car payments, school tuition – we all have expenses, and retirement can look different for each of us. Increasing your savings by $1,200 a year may be on the higher end of the savings spectrum and might not be an option for everyone. However, saving $240 more each year may be doable. The truth is, your retirement success is based on how much you save, so if you can start saving today, even a little each year, your savings will grow, giving you a few extra dollars to spend in your retirement, and the peace of mind knowing you are secure.
For more information or to discuss your financial goals, contact us at Bowie Financial. Our experienced advisors are here to help you achieve your investment aspirations with confidence and peace of mind.
