Saving money can be a challenge at the best of times. But did you know that with a regular savings plan in place, and an early start, you could be much further ahead when it comes time to consider retirement?
That’s because when you start saving early, your money has more time to grow, allowing it to benefit from compound growth. Compounding can help your money grow, in most cases, far beyond the amount you originally invested. So, how does it work?
Compound growth is similar to compound interest. With compound interest you’re essentially earning interest on interest – you earn interest on the money you put in at the start, as well as the money you add later, plus on all the interest that collects over time. This gives you a larger total amount to earn future interest on, leading to even more growth. Over time, you have a powerful recipe to help you grow your money.
The concept of compound growth is similar to growing a forest of trees. The forest can grow in two ways – trees can be planted by hand (like your regular investment contributions), while others may grow on their own through seeds that fall from mature trees (like compound growth on your contributions). In time, a few trees planted early can grow into an entire forest without much effort.
To understand how this could affect your savings, consider the journey of $240,000, saved two different ways. If you save $500 per month with an annual return rate of six per cent compounded monthly, beginning at age 25, you would have $1,000,724 at age 651. Conversely, if you tried to catch up on your savings, contributing $1,000 with the same annual rate of return beginning at age 45, you would only have $464,361 at age 652. Under both scenarios, you’ve invested the same amount with the same growth rate, but in the first scenario, your money has twice as long to grow, and you end up with more than twice as much.
The beauty of saving early and relying on the power of compounding is it doesn’t take a lot of money to get started. Relatively small amounts consistently invested regularly, especially when you are young and early into your career, can make a significant difference in the total size of your savings down the road. Those small deposits can be the difference between being confident with your investment success and having to worry about it much later in your life. It can be as easy as sitting back while you let your money do all the work and grow into something much bigger.
The strategy for compounding:
- Invest early – the longer your money is invested, the more time it has to grow. When it comes to compounding returns, time is on your side.
- Contribute regularly – regardless of the amount you can afford – the important thing is to start and be consistent. Even small contributions made each month will grow. You can increase your contributions as your financial situation changes throughout your life.
- Don’t take money out – as your savings grow and earn compound returns, the gains made through compounding will also help you build your wealth.
Whether it’s through a registered retirement savings plan (RRSP) or a tax-free savings account (TFSA), saving early and saving often can give you a head start on planning for retirement. And that planning may allow you to reach your financial goals sooner. A financial security advisor with Freedom 55 Financial can help you review your financial goals and prepare for the future.
1Assumes $500 invested on the first day of every month over 40 years, with a 6% annual rate of return, compounded monthly. The rate of return does not take into account segregated fund and/or mutual fund fees. 6% annual rate of return is based on historical S&P/TSX composite total return data. This example is for illustrative purposes only. Past performance is not an indicator of future performance.
2Assumes $1,000 invested on the first day of every month over 20 years, with a 6% annual rate of return, compounded monthly. The rate of return does not take into account segregated fund and/or mutual fund fees. This example is for illustrative purposes only. 6% annual rate of return is based on historical S&P/TSX composite total return data. Past performance is not an indicator of future performance.