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The power of compounding

The power of compounding

By Carla Hindman, Director of Financial Education, Visa Canada

I wish I had learned about the power of compounding a long time ago. As a kid I walked dogs in the neighbourhood, earning $5 a week. If I'd started investing that weekly $5 from age nine until 65, it would have grown to approx. $258,000, assuming an eight per cent return.

Unfortunately, I didn't catch compounding fever until much later. I missed out on maximizing my first few years of Registered Retirement Savings Plan (RRSP) contributions, which would have made a huge difference at retirement.

So what is compounding? Basically, it's where you put aside money – whether in savings, a retirement account or the stock market – and then essentially leave it alone. As your account earns interest or dividends, you continually reinvest those profits, thereby generating (compounding) additional earnings at an accelerated rate.

Numerous interactive calculators are available online to help you estimate potential savings under different scenarios. Practical Money Skills Canada (, a free financial literacy program to help Canadians understand the fundamentals of money management, has a number of calculators available to help you assess your financial decisions.

Using the "How Much Will My Savings Grow?" calculator, you can estimate how quickly an investment will grow at varying interest rates and periods of time with consistent monthly contributions. For example, a $10,000 investment earning eight per cent interest and adding $1,000 annually, would be worth approx. $37,235 after 10 years; $96,032 after 20 years; and $222,972 after 30 years.

If you'd like to know how long it will take to become a millionaire, the "Save A Million" calculator can help. If you began saving $100 a month at age 21 and earned eight per cent interest, it would take you 53 years to reach $1,000,000. Increasing the monthly contribution to $200 would mean you could reach your goal by age 66.

The riskier the investment, the greater your potential gains – and losses. For example, regular savings accounts typically offer very low interest rates in exchange for very low risk of loss. On the other hand, investing in the stock market can potentially earn double-digit investment rates over long periods of time. (Of course, stocks can be a risky short-term investment.)

So why not simply park your money in a safe haven? Simple: inflation. If your money is earning two per cent interest but the inflation rate is three per cent, you'll actually net a one per cent loss.

Using the "Save A Million " $200-a-month example above, if you expect to earn eight per cent interest but factor in a three per cent expected annual inflation rate, and therefore only earn five per cent interest, you won't reach your goal until age 83.

The longer you delay saving, the harder it is to catch up. According to the "How Much Will My Savings Grow?" calculator, if you save $200 a month at eight per cent interest, after 30 years your account would be worth $293,630. But wait only two years to begin saving and that balance would shrink to only $247,118 – that's $46,512 less. A five-year delay would knock it down to only $189,490.

Bottom line: Don't procrastinate on starting to save. And get your kids on the compounding bandwagon as well; they'll thank you once they reach your age.

This article is intended to provide general information and should not be considered legal, tax or financial advice. It's always a good idea to consult a tax or financial advisor for specific information on how certain laws apply to your situation and about your individual financial situation.

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