When I was a kid, my dad’s idea of fun was to teach his children math and science (he still reads anatomy and medical textbooks as a hobby. Serious). He first introduced me to compound interest when I was about eight years old.

“If you saved $100 every year and the interest rate was 10%, how much money would you have in 5 years? 10 years? See how it has grown?!” My dad wanted me to see the magic of compound growth¹.

I didn’t. I did the math exercises because I was promised popsicles. When the “fun” was done, I went on my merry way to play. When I was a bit older, I would always grimace at the mention of “compound interest,” recollecting memories of calculations- done by hand- while other kids watched TV (We never had cable at home; it was an expense my dad wasn’t willing to pay). Now, as an adult and a parent myself, I hope my dad will be willing to teach my kids math and the magic of compound growth. Because, boy, is it magical!

How the Magic of Compound Growth Works

Albert Einstein referred to compound interest as the “the most powerful force in the universe.” It is the concept of money that continually generates earnings. An initial sum of money earns interest. Over time, that interest also earns interest; it’s a snowball of growth earning growth!

Borrowing from Robert Brown’s Wealthing like Rabbits, imagine an island with no rabbits- not a single one. If you were to introduce a few onto the island and let the rabbits do what they do best, how many rabbits would you think would there be on the island after 60 years? That, in a nutshell, is the magic of compound growth.

“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”
– Albert Einstein

For example, suppose I saved $100 and it gains $5 in interest, at the end of the compounding period- say a year- I will have a total of $105. The $105 then gains interest over the next year. By the end of the that period, I will have earned another $5.25 and my total will have grown to $110.15.

Okay, that doesn’t seem like much so let’s look at larger sums of money over a longer period of time. Let’s say I invest $3,000 with an interest rate of 5% into Little Sister’s RESP on the day she was born. By the time she is ready for post-secondary school at 18 years later, the money will have grown to $7,219.86. That’s from doing absolutely nothing!

Let’s take it one step further. Say I continue to add to her RESP over time and invest $3,000 each year instead of just at the time she was born. At the end of 18 years, I will have invested a total of $54,000, but my investments will have grown to $88,617.01. If you get excited about finding $1 on the sidewalk, think of what you could do with an extra $33K. You’d have compounding interest to thank. In short, the more you save over a longer period of time, the more you will earn. This compounding is quite something, isn’t it?

Compounding Interest and Retirement

Do you want to see the real magic? Forget about the children (real or hypothetical) and see how much money you can have saved up for retirement. Let’s assume I start with no savings and there is another 35 years until I retire in my mid-sixties. If I invest $10,000 every year over 35 years, my nest egg will sit at $893,203 waiting for me to retire. MAGIC.

Interested in seeing how your money can grow? Play around with our nifty Investment Calculator to see how compound growth works. Even small amounts of savings can add up over time.

FREE INVESTMENT GROWTH CALCULATOR

The Last Word: Collect Interest, Not Dust

When Benjamin Franklin died in 1790, he bestowed $4,500 to the cities of Boston and Philadelphia. The money was held in trust and not to be touched for 100 years. After that, the cities could withdraw $500,000 from trust; the rest of the money had to remain untouched yet another 100 years. 200 years later, in 1990, each city’s endowment was worth over $2 million. Now, you won’t have 200 years to invest your money, but understanding the concept of compound growth will have a major impact on your financial success.

Check out our new Investment Growth Calculator and see how the magic can work for you!

Note:
¹My dad also showed me how compound interest can work against me, like in the case of borrowing money or not paying off my credit cards (which is why I have always clear my balance at the end of the month). He also taught me how to build circuit boards, program in two different languages, and build websites, all before the average family had internet at home. Unfortunately for him, the only information I retained was some basic HTML, which was I guess was useful when I re-designed the website. Daddy, between never having consumer debt and saving money from not having to hire a designer for this website, be proud.

UPDATE: According to CBC– The TFSA rollback is likely to be announced on Monday, with the vote taking place on Wednesday

The fate of the Tax-Free Saving Account (TFSA) contribution limit was a point of heated contention leading up to the federal election. In an effort to bolster savings for the middle class, the Conservatives raised the limit in 2015 to a non-inflation-indexed $10,000 per annum. The Liberals pledged to reduce the limit back to the inflation indexed $5,500, siting that the increase only benefitted the wealthy. Now with the Liberals in power, we’re likely to see the TFSA’s contribution limit return to $5,500 starting in 2016.

All this back and forth is confusing and left a very important question unanswered: Should I scrape together all my savings to top up my TFSA before the $10K contribution room disappears when the limit is changed?

The answer is: No, you don’t have to. There is no need to rush because the $10K in contribution room that was allowed for in 2015 isn’t going anywhere. As of right now, the contribution limit for 2014 was $5,500, the limit for 2015 is $10K, and the limit for 2016 will likely be $5,500. That means you’re free to continue saving and investing in your TFSA- business as usual- even if that means waiting until next year to make more contributions.

Related: The Beginner’s Guide to the TFSA

There have been some reports of a 2016 $1, 000 limit for those who have contributed $10K, but let’s face it: Trudeau isn’t going meddle with the limits retroactively. It would take quite an amount of effort on the government’s part with little benefit. It would be of little consequence even in the very unlikely event that the extra $4,500 was clawed back. Withdrawals from the TFSA are tax-free, putting that money right back in our collective pockets.

As of 2015, the maximum contribution room in a TFSA is $41,000. In 2016, the maximum contribution room will likely grow to $46,500 instead of $51,000 with the coming changes. It’s as simple as that. Move along. Nothing to see here.

Welcome back to our irregularly scheduled programming!

We kicked off 2014 by participating in the Grow Your Dough Throwdown with the intention of learning about different styles of investing and demonstrating how simple investing can really be.

The idea was for bloggers to grow $1000 over the course of a year. Participants invested the money however they wanted and the results were compared. Well 2014 has come and gone- and the final results from the GYDT came out a while ago. Read on to find how my portfolio, The Index Strikes Back, did for the year.

Do…or Do Not

My biggest hurdle when I started investing was deciding on where to invest the money I had carefully saved. Do I pick stocks, bonds, ETFs or mutual funds? I didn’t know what stocks to pick, didn’t have enough confidence to buy ETFs and had read about the negative effect of Management Expense Ratios on mutual fund returns. Instead, I read about a special type of mutual fund called an index fund which offers broad diversification at a low cost. So it came down to a decision: let my money sit “under the mattress” or to figure out how to make it grow.

I invested my $1000 in TD e-Series Index funds dividing Canadian, US and International equity into the following allocations. I left out a fixed income bond index, feeling it was worth the risk for the short term purpose of this exercise. With these funds, I invested in 1664 companies in multiple industries spread out all over the world.

Punch It

Here’s the snapshot of the portfolio’s performance for the year, ending December 31, 2014.

After costs, my initial $1,000 investment turned into $1,133.11 for a growth of 13.52%.

The Competition

In the 2014 GYDT March Update, the Index Strikes Back was up 6.46% with a value of $1,062.67. My portfolio sat comfortably in 5th position of the 14 contestants reporting in.

By the end of July 2014, the portfolio was up 9.10% to date with a value of $1,088.98. The result was also good enough for 5^th of 14.

Where do you think the Index Strikes Back will place? Oh the suspense!

The GYDT final results post revealed that the 1^st and 2^nd place winners came in with portfolio values of $1327.05 and $1313.55, respectively. Unfortunately, all others contestants were relegated to obscurity and a year-end chart wasn’t published. So I did a little digging around and found some year-end values from around the web. For the portfolio’s I couldn’t find, I just filled in the blanks assuming their balances from the GYDT November update as their year-end value. Not exactly accurate, but good enough.

After spending most of the year in 5^th, I ended the year in the top 20%: 4^th out of 22 – by $0.05. I’m going to call it.

It’s a tie for 3^rd.

The Last Word

According to the SPIVA U.S. Scorecard Year-End 2014 study, the S&P 500 returned 13.69%. Using a low cost passive indexing approach, the Index Strikes Back portfolio came pretty close, returning 13.52%. Based on data from the study, that puts me ahead of 86.44% of large-cap fund managers underperformed the benchmark.

I spent about 15 minutes to invest the money in the account. I left it untouched for 12 months. It turns out I beat professional full time money managers with minimal effort. Seriously, that’s insane!

When I first started out, I had my doubts as to whether or not an approach this simple could be effective. It’s not rocket science- you get the returns of the market and if this exercise showed anything, is that market returns do just fine over time. This exercise though, was an example of investing in the short term. It’s great that the value went up for the year, but the idea of investing is to leave the money untouched for as many years as possible. How much would it grow to be if left for 10, 20 or 30 years?

With historical rate of return of the S&P 500 at 9.5% per year (according to The Little Book of Common Sense Investing), $1000 could potentially compound to $15,220.31 after 30 years. Start saving up!

With our daughter on her way, we have a tighter-than-usual budget this year. In order to meet our saving goals, there are two things we can do: spending less or make more. We haven’t figured out how to increase income, but we have figured out four ways to cut expenses.

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