A lit­tle math can add up in your re­tire­ment sav­ings

Learn­ing more about com­pound­ing can save you money ... and it’s fun

Montreal Gazette - - YOU - WANDA MOR­RIS Grey Mat­ters is a weekly col­umn by Wanda Mor­ris, the VP of Ad­vo­cacy for CARP, a 300,000 mem­ber na­tional, non-par­ti­san, non-profit or­ga­ni­za­tion that ad­vo­cates for fi­nan­cial se­cu­rity, im­proved health-care for Cana­di­ans as we age. Missed a week?

When I was lit­tle, my dad used to sit my two sis­ters and me at the kitchen ta­ble and play the Smar­ties game. He would ask us ques­tions and we’d get a Smar­tie when we got one right. When we got one wrong, he’d get a Smar­tie — or two or three. The Smar­ties game taught me my times ta­bles and com­bined two loves that shaped my life: math and choco­late.

Be­cause of this early pos­i­tive ex­po­sure, I al­ways saw math as fun. In my Univer­sity of Calgary days when I was, ad­mit­tedly, some­what ob­nox­ious, I took great joy in point­ing out math er­rors in text­books and leav­ing ex­ams early to show how easy they were.

I un­der­stand that many peo­ple find no joy in math at all. That’s too bad. Not only are they miss­ing out on the fun, but un­der­stand­ing math is fun­da­men­tal to our fi­nan­cial se­cu­rity. To miss the first is re­gret­table; to miss the sec­ond can en­dan­ger your re­tire­ment.

The good news is that there is one sin­gle spe­cific math­e­mat­i­cal con­cept that any­one can learn to greatly help in­crease fi­nan­cial se­cu­rity: com­pound­ing.

Imag­ine you re­ceive a be­quest of $100,000 and de­cide to in­vest it for 25 years then use it to fund your re­tire­ment. You don’t know how much of a re­turn you’ll make on your wind­fall, but let’s say ei­ther four per cent, six per cent, eight per cent or 10 per cent.

You de­cide you need a fi­nan­cial ad­viser to draw up a fi­nan­cial plan (an ex­cel­lent idea) and make and mon­i­tor your mu­tual fund in­vest­ments. You find one you like who will do all this by in­vest­ing your money in mu­tual funds which in­clude an em­bed­ded com­mis­sion of two per cent of your as­sets a year. (Mu­tual fund fees typ­i­cally run be­tween 1.5 per cent and 2.5 per cent an­nu­ally.)

Depend­ing on the gross re­turn on your mu­tual fund in­vest­ment, af­ter 25 years, your $100,000 would be worth:

Mu­tual funds earn­ing four per cent will grow to $164,000

Mu­tual funds earn­ing six per cent will grow to $267,000

Mu­tual funds earn­ing eight per cent will grow to $429,000

Mu­tual funds earn­ing 10 per cent will grow to $685,000

Imag­ine that in­stead you visit a fee-for-ser­vice fi­nan­cial plan­ner who pro­vides you with a fi­nan­cial plan; you then in­vest your money into in­dex funds. Let’s as­sume you pay $2,500 for your fi­nan­cial

plan and your in­dex fund costs you one per cent a year. You start out with $2,500 less but pay one per cent less per year in fees every year. What hap­pens to your in­vest­ment over time? Again it de­pends on the re­turn you earn. Here are the re­turns af­ter 25 years on $97,500 at dif­fer­ent rates of re­turn:

In­dex funds earn­ing four per cent will grow to $204,000

In­dex funds earn­ing six per cent will grow to $330,000

In­dex funds earn­ing eight per cent will grow to $529,000

In­dex funds earn­ing 10 per cent will grow to $841,000

The ex­tra re­turn, whether $40,000 for an in­vest­ment earn­ing four per cent or $100,000 for one earn­ing eight per cent, is the com­pounded ef­fect of the one per cent dif­fer­ence in in­vest­ment fees. (Note that many ex­change­traded funds have an even lower in­vest­ment cost, but they typ­i­cally re­quire a min­i­mum in­vest­ment and at­tract trad­ing costs, so I’ve used in­dex funds for this ex­am­ple.)

Now you may be think­ing, noth­ing I’d love bet­ter than an ex­tra $40,000 in my re­tire­ment fund, un­less of course it’s an ex­tra $100,000, but how do I know if this ap­plies to my sit­u­a­tion?

The good news is that CARP has part­nered with ex-banker Larry Bates to give ev­ery­one this in­for­ma­tion through a tool he de­vel­oped to help you un­der­stand how com­pound­ing af­fects you.

Go to carp.ca/TREX to get your own T-Rex score (an in­vestor’s to­tal re­turn ef­fi­ciency in­dex) and find out how big a bite fees and com­mis­sions are tak­ing out of your sav­ings.

And when you’re done, why not treat your­self to some Smar­ties? Be­cause math can save you money and be fun, too.

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