Few things come easy in life, so we all may just want to thank the universe for compound interest. The power of compound interest cannot be overstated - it is simply astounding, and something that no one can afford to be blind to. We here in Canada are lucky enough to have access to the power of compound interest through various economic markets with relatively low initial investment. Examples include but are not limited to stocks, bonds, ETFs, and mutual funds. More on those in another post.

But yes, compound interest, how about we run some numbers for a quick illustration of it’s might and surprising effects.

Take for example, Kayla. She is 25 years old, has a job but $0 of investments, and will probably retire sometime around 40 years from now when she’s about 65. She decides to invest $5000 every year, or $416 per month, for 40 years and ends up making a mere 5% each year on her investments. By the year she turns 66 she will have just shy of $640,000. Not too bad.

Kayla has a friend, Mariam. Mariam is the same age as Kayla, also has a job and $0 of investments, but she also doesn’t start investing until she is 45 years old. She will retire when she’s also about 65, which is 20 years after she starts investing. How much money does Mariam need to save each year to reach $640,000, the same amount that her friend Kayla will have at age 65? Assuming the same 5% interest rate, Mariam will need to invest $17,900 every year, or $1,492 per month!

The total out-of-pocket principal contribution when Kayla saves $5,000 for 40 years is $200,000. When Mariam saves $17,900 for 20 years her principal contribution is $358,000. Mariam literally had to invest $158,000 more of her own hard earned money when investing for 20 years instead of 40 to end up with the same amount as Kayla!

The takeaway? Saving small amounts early can be very advantageous.

The trick is that the longer you invest, the more benefits you will reap from accumulated interest. On the other side, if you are in your 20’s or 30’s how do you know you will even retire at 65? or 55? or at all? And how can you possibly know how much money you will need? Is investing your money now even the best use of your money? What if you want to do something else like start a business, or have kids in the near future? Also, isn’t there just a chance you can die early and all your frugal life savings will be for nothing? Some of these questions are really difficult to answer, and some of the answers will change from person to person.

This is the first post in a series of blog entries on the topic of Personal Finance.