If your clients dabble in the world of investments, they should know about the power of compounding interest on their investment accounts. That is, the money they invest today – let’s say $100 at a 5% annual interest rate – will earn them $105 in one year. Likewise, if they take that $105 and re-invest it yet again at 5% the following year, your client will earn $110.25, and so on, year after year.
Yes, it is a fairly simple concept but one that your clients should be aware of. The key reason for your client to invest is to earn money on that investment. However, when those savings are increased via monthly deposits or PACS (pre-authorized cheques), they can help your client save on an even larger scale.
Let’s take a look at what your client’s savings could look like with the power of compounding interest using a monthly pre-authorized deposit, within 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 | $250,000 |
| Investment earnings | ─ | $23,470 | $99,435 | $260,907 | $561,662 |
| Balance | $10,000 | $93,470 | $229,435 | $450,907 | $811,662 |
(From Mawer Investment Management’s How Compound Investing Works, illustration as of April 27, 2020)
As you can see from the above table, if your client makes an initial $10,000 investment and continues to add an additional $500 per month (that’s $6000 per year) at a %5 rate of return, their investment will triple within 40 years.
Who doesn’t like a good twist? Let’s add one. What if your client were to increase their annual contribution by $20, $50, or $100 a month on an annual basis? Just like our cost of living increases every year by 1% to 2%, your client’s savings should increase by the same amount, because let’s face it, $1 dollar of goods today will not be worth $1 dollar of goods next year. Inflation – the gift that keeps on giving.
The example below illustrates the benefits of increased savings on an annual basis partnered with the power of compound interest – the results are quite impressive!
Growth of Savings Over 30 Years
| 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 |
Assumes you increase by $20/month, $50/month & $100/month once a year for 30 years and that you have enough TFSA contribution room for the above increases.
(From A Wealth of Common Sense, illustration as of November 13, 2020)
In the above scenario, your client would invest an initial $6000 or a one-year max contribution into their TFSA. If your client raises their monthly deposit from $20 in year one, to $40 a month in year two, and so on, they will earn approximately $260,000 in 30 years with a 7% rate of return. And by increasing that annual monthly deposit to $100 per month, that original $260,000 can turn into $1.3 million!
All of us have expenses, so retirement success can look different for everyone. Increasing savings by $1,200 per year may not be an option for all of your clients. However, a $240 per year increase is certainly doable. Today is the day to have a real conversation with your clients about increased savings and the power of compound interest and how it can help them retire with peace and security.
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The Power of Compound Interest