When I was younger, I rarely needed to consider how the food I ate affected my health. My metabolism seemed to burn up everything I ate – healthy or otherwise. Now, as I approach age 50, my situation is quite different. I still exercise regularly and I’m very careful about the food I eat, but every year my weight seems to go up just a little.
What I’m going through now started 30 years ago. While all the French fries and root beer seemed insignificant then, the fat cells I created in my youth remain with me today. The more fat cells you have, the easier it is to store fat. Had I not generated as much fat over the years, I might not have had as much to burn today.
In other words, small contributions made early on can have lasting effects over time. What else is this true for?
The parallel is the power of investing smaller amounts of money when you’re young. Based on the historic returns in most equity markets, the longer someone has to invest, the greater the average year-over-year return should be. In addition, the effects of short-term volatility are diminished. More significant is the compounding effect from more years in the market.
If I had started investing in a standard equity mutual fund portfolio when I was 20, I could have expected an average rate of return of 12 per cent per year. With a typical management fee of 2.5 per cent (some are more, some are less), it would be reasonable to have an average rate of return of 9.5 per cent over 30 years. If I had invested $245 every month (and saved two per cent more each year) by the time I turned 55 I could have a portfolio worth just over $1,000,000. (Note: This assumes no exposure to taxation.)
Waiting to start saving until age 25 makes a big difference, even without changing the rates of return. Losing five years of compounding means I would need to save $402 each month (indexed at two per cent) just to reach the same $1,000,000. Waiting five years would cost me $157 per month – and it only gets worse.
Waiting to start saving until age 30 reduces the investment duration, and the rates of return also diminish. Historic 25-year average returns have been 10.1 per cent, so the best I could expect to receive would be 7.6 per cent after management fees. With only 25 years to age 55 and lower returns, I would need to set aside $890 each month – more than double what my savings requirements were five years before.
Delaying healthy eating habits in my youth means I have to work harder to reach fitness goals today, in the same way that putting off savings means having to save more in subsequent years. So, be kind to your future self – make small, healthy and wealthy choices now to help ensure your well-being in the future.
This information is general in nature, and is intended for informational purposes only. For specific situations you should consult the appropriate legal, accounting or tax advisor.
The financial calculations in this article are based on historic results for Canadian equity markets and are for illustrative purposes only. They do not represent a prediction of future results.
Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the Fund Facts before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated.