The best way to reward yourself for those several years of hard work is to enjoy a comfortable retirement. And what is a comfortable retirement without the funds? Experts have proposed several methods of garnering wealth for your retirement. One of these is compound interest. This article discusses how you can leverage compound interest for an easy retirement.
What is compound interest?
We can easily describe compound interest as interest paid on interest and principal over a certain period. Now, let’s drive home this point with a simple example. Imagine you invest $1,000 in an investment that returns 3% annually. You would have $1,030 by the end of the first year. Now, if you leave the money there – both the principal and the interest – untouched for the second year, your investment becomes $1,060.9. Leaving it for the third year means you get $1,092.7, and it continues like that.
Compound interest is what is at play above. It is a way to make your money work harder for you. By this principle, you can double a $10,000 investment with an interest rate of 10% yearly by compounding it for seven years. If you manage to compound for 28 years, it becomes $160,000. That is $10,000 to $160,000 in less than three decades. No, it’s not magic – it is the power of compounding. Your Ottawa Certified Financial Professionals can tell you even more about the power of compound interest.
How do you maximize compounding for retirement?
Again, let’s consider a hypothetical situation involving a monthly pre-authorized withdrawal from your bank account within a TFSA or an RRSP:
If you invest $10,000 into your retirement account and add $500 every month at a 5% interest rate, you will triple your investment in just 40 years. It gets even better if you increase your contributions by $100, $50, or even $20 every month over the years. This would be a smart thing to do if you consider the usual increase in the cost of living, which is usually 1% or 2% every year. Preparing ahead means you can cope with these situations when they arise.
The chart below represents the situation where you increase your monthly deposit on an annual basis. This, combined with the power of compounding interest, leaves you with unbelievable results.
NB: This chart is based on the assumption that you increase your investment by $20, $50, and $100 every month once a year for 30 years. It also assumes you have sufficient TFSA contribution room to allow this increase.
The initial investment above is $6,000, which equals a one-year max contribution to the TFSA. However, you must be ready to raise your monthly pre-authorized deposit from $20 in the first year to $40 monthly in the second year and so on. With this, you can conveniently save about $260,000 in three decades at a 7% investment rate. What about when you increase your annual, monthly deposit to $100 monthly? Then you may be looking at $1.3 million in savings.
To round up…
Retirement comes with all sorts of expenses, including school tuition, car payments, and even a mortgage. While not everyone would be able to afford a$1,200 increase in savings every year, a $240 increase is really more feasible. Saving requires discipline, but if correctly done, it is one way to ensure a successful retirement. You can start small and grow gradually every year, and by the time you realize it, you have some more dollars to spend when you retire. If you are stuck at any point in the process, feel free to reach out to your Ottawa CFP.
