The following excerpt is from Lesley Scorgie's book Rich by 40: A Young Couple's Guide to Building Net Worth . Ms. Scorgie has been writing and speaking about personal finance for nearly a decade, and has appeared on many TV shows including The Oprah Winfrey Show and MTV Live.
Key #1: Get Started-The Longer You Wait, the More You Lose Out
Zach, thirty, has been investing in stocks since he graduated from university. His parents, on the other hand, are in their mid-fifties and just started saving for retirement. Zach worries about his parents' financial security. No matter how diligently they save over the next ten years, it's going to be tough to save enough money for their fast-approaching retirement.
In Chapter 2, I introduced the concept of compound interest and reinvested returns. The way it works isn't magic at all: you earn interest and returns on your initial investment (the principal), which is then reinvested, allowing you to earn interest and returns on it, as well. So now you're earning interest and returns on top of your existing interest and returns. Then you start earning greater interest and returns because they're reinvested on top of the principal. On and on it goes, growing your money exponentially over time. The more time you have to allow compound interest and reinvested returns to compound itself, the more money you'll earn.
When you wait to invest, you lose time, which affects your exponential growth potential. Let's say you start investing $150 a month at the age of twenty and earn a 9 per cent annualized return on your portfolio. By the time you retire at sixty-five, you'd have approximately $1 million in your portfolio. Not a bad sum of money considering you had to contribute only $81,000 of your own money ($150 per month X 12 months a year X 45 years).
Now let's say you wait to start investing until you're thirty. If you invest that same $150 a month and earn a 9 per cent annualized return on your portfolio, at sixty-five, you'd have approximately $425,000 in your portfolio; significantly less than if you had started investing at age twenty. In this instance, you would have contributed $63,000 of your own money ($150 per month X 12 months X 35 years).
If you wait until age forty, using the same scenario, you'd have less than $170,000 in your portfolio, having contributed $45,000 of your own money ($150 per month X 12 months X 25 years). The size of this investment portfolio is significantly smaller than both examples above.
What's so shocking about this comparison is that if you wanted to have $1 million at retirement, and you started saving at age thirty, you'd need to save $350 per month until age sixty-five, earning a 9 per cent annualized return. That's $200 more each month than if you'd started saving $150 per month at age twenty. In total, you'd have to contribute $147,000 of your own money to achieve the same result. Now if you wait until you're forty to start, you'd need to invest $900 per month until sixty-five to have that same $1 million, earning a 9 per cent annualized return on the portfolio. That's $750 more each month than if you'd started saving at age twenty. In total, you'd invest $270,000 of your own money to achieve the same result.
The earlier you start investing, the more you will benefit from the power of compound interest and reinvested returns. And you'll end up shelling out a lot less of your own money. Don't get discouraged if you're starting to invest a little later in life. You can still catch up by contributing more money into your savings and investment plans. You're likely earning more money as you'll be a little further into your career so you can afford to allocate more into your plan. Visit www.getsmarteraboutmoney.ca to calculate your investment scenario using their calculators.
Key #2: Use the Right Plans
Tasha jokes with her co-workers that her retirement savings plan is her $10 weekly lucky lotto ticket. She doesn't know much about money, but she still contributes a small amount to a TFSA and RRSP each month. For her, investing isn't a top priority. She'd rather focus on planning her next vacation with her boyfriend.