You may have seen this: A magician places a single loonie on his palm, closes his hand, waves mysteriously above it and a seemingly unending stream of loonies cascades from his still closed hand into a top hat. It’s a trick known as the mysteriously multiplying coins – and it is a trick, of course. But you can achieve the same effect with your investment dollars -- and it’s not a trick, it’s the magic of compounding.
When you make regular investments of even small amounts and leave them in a Registered Retirement Savings Plan (RRSP), the income your investments generate is reinvested – or compounded – and over the longer term, those small investments will grow seemingly magically because as your savings grow, you earn interest on an ever-larger pool of money.
The key is to start investing as soon as possible – because the sooner you invest, the longer your money will have time to potentially grow, and you’ll have more wealth when you need it, usually in retirement.
Here’s an example of the power of compounding (rates of return are for example purposes only):
You invest $10,000 at 10% and in a year, you will have earned $1,000 in interest.
- Add that $1,000 to your original $10,000 investment for a new total of $11,000 and in the following year, that new total earns $1,100 interest at the same rate.
- Assuming there was no immediate tax on the interest, you now have a total of $12,100 invested at 10%.
When you make regular investments, the results can be even more amazing. That’s because the money you earn in investments in your RRSP grows on a tax-deferred basis. Because you don’t pay tax until those funds are withdrawn from your investments in the RRSP, your yearly returns aren’t reduced. Every loonie of interest you earn is reinvested at its full value to earn even more money inside your RRSP.
For example, when you make an annual RRSP contribution of $5,000 to your investments held in your RRSP at the end of each year (and assuming an 8% annual return for example purposes only) you would have approximately $861,584 after 35 years. But when you contribute the same amount at the beginning of each year, you will have $930,511 in 35 years – a difference of $68,972.
Taking full advantage of your RRSP vehicle makes a significant difference in your eventual returns. Delay your $5,000 contribution for a single year and twenty years later (at an annual return of 8%), you’ll miss out on $23,305.
The magic of compounding is amazing – and to make the most of it, and every other aspect of your financial life, talk to your professional advisor soon.
This column, written and published by Investors Group Financial Services Inc. (in Québec – a Financial Services Firm), and Investors Group Securities Inc. (in Québec, a firm in Financial Planning) presents general information only and is not a solicitation to buy or sell any investments. Contact your own advisor for specific advice about your circumstances. For more information on this topic please contact your Investors Group Consultant.