Ghostwriter – Author – Journalist

The Slow Road to Riches

By on October 26, 2017 in Articles with 0 Comments

We’re not talking about Bill Gates type riches, just a comfortable cushion to live on if you fall on hard times or stop working. There is a two-word solution: Compound interest.

Compound interest is when you earn interest on your interest. Say you have $500 in a bond or stock and it pays you 5 per cent (in the real world, you should be so lucky, but it makes this example easier) or $25 once a year. That is simple interest. After 10 years, you’ll have $750.

If instead the $25 stays invested, you now have $525. Next year, that 5 per cent of the new number produces $26.50, actually a bit more if it compounds every month instead of every year. You are earning interest on your interest. That is compound interest. After 10 years, you’ll have $823.50.

Seems simple enough, but only 39 per cent of adults surveyed by the Ontario Securities Commission understood the principle of compound interest. Numbers confuse people, but this is just the arithmetic we all learned by Grade 5.

Readers of this space get the benefit of compound interest in RRSPs and tax-free savings accounts (TFSA). Because it is tax-free, the TFSA produces spectacular returns. Using an online calculator from CIBC generates the following results for someone who lives in Ontario and, for example, otherwise earns an annual income of $50,000:

Saving: $5,500 a year, the maximum amount allowed. The calculator builds in the tax rate, in this case in Ontario

Earning: 6.21% interest, the actual five-year return in the AFBS TFSA General Fund

Amount after 35 years in a taxable account in Ontario: $439,439

Amount after 35 years in a tax-free account: $664,289

The result: An extra $224,850, almost a quarter of a million dollars. It is the amount you would have lost by paying taxes over the years if invested in a taxable account. The numbers vary by province and annual income.

Compound interest also works in registered retirement savings plans (RRSP). The difference is when that money is withdrawn, it is taxed – and you are forced to start to withdraw it after the year in which you turn 71. Of course, that is the whole point of the RRSP, to provide income in retirement.

The TFSA is a different animal. When you take money out, there is no tax. Without a doubt, the best place to work the magic compound interest is in a TFSA.

Starting to save at an early age makes getting richer easier. Say you want to have a million dollars by the time you reach 65. If you start at the age of 20, you only have to put away $361 a month. The chart below from Business Insider shows that starting just five years later means putting away an extra $138.60 a month.

Source: Business Insider
The person who starts at age 25 will end up with twice as much as the one who starts at 35, if they both put away the same amount. All of this is brought to you by that marvellous instrument: Compound interest.

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About the Author

About the Author: Fred has had a full career as a CBC TV host and reporter. He has written countless articles for many renowned publications such as The Economist, The Globe and Mail, BusinessWeek and many more, as well as more than 2000 obituaries. He is also a successfully published author and ghostwriter. His current projects include writing and co-authoring books, as well as lending his talents as a speaker and interviewer for webcasts. .


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