Mar 172016
 

Start Compounding As Early As Possible

I recently came across a retirement guide made by J.P. Morgan Asset Management. It includes a nifty comparison between those who starts investing earlier vs later. The results show how time can play a significant part when it comes to compound returns. 🙂

JPMorgan shows outcomes for 4 hypothetical investors who each invests $10,000 a year at a 6.5% annual rate of return over different periods of their lives:

  • Chloe invests for her entire career of 40 years, from age 25 to 65.
  • Lyla starts 10 years later, investing 30 years from 35 to 65.
  • Quincy starts to invest early but stops after 10 years, contributing from 25 to 35.
  • Noah saves for 40 years like Chloe from 25 to 65, but instead of being moderately aggressive he simply holds cash, term deposits, GICs or CDs, etc and receives a 2.25% average annual return.

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Let’s break down the results.

  • Chloe begins investing early, plus she’s consistent, which is why she has nearly $1.9 million at retirement. 😀
  • Even though Lyla started just 10 years later than Chloe, she only ends up with $920K, which means postponing investing for just 10 years while we’re young will cost us almost a million dollars once we’re old. ?
  • Quincy, who invests for only 10 years, still ends up with $951K at retirement, which is surprisingly more than Lyla’s portfolio, even though Lyla spends 30 years investing.
  • Finally Noah, who has a lower risk tolerance than the others, ends up with only $652K at retirement even though he contributed for 40 years.

Of course no one can guarantee a 6.5% annual return. The chart is for illustrative purposes only and does not represent a real life investment plan. It simply demonstrates how annual rates of return and the passage of time can effect the outcome of a retirement portfolio. The earlier we start investing, the better. 🙂 But just for fun, here’s a look at how the following asset classes performed over the past 10 years.

  • Canadian Equities – 3% annual return
  • U.S. Equities – 6%
  • Fixed Income – 5%
  • Canadian Real Estate – 12%
  • U.S Real Estate – 3%
  • Gold – 9%
  • Farmland – 12%

Depending on our asset allocation it’s possible to have made 6.5% annual returns with a moderately aggressive portfolio over the past 10 years.

Stay on Track

In terms of gauging the adequacy of our current retirement savings JP Morgan also provided a retirement savings checkpoints table so we can see if we’re on track to our goals.

This table assumes a pre-retirement investment return of 6.5%, which drops to 5% after we retire at the age of 65. It also assumes we will spend 30 years in retirement, and the inflation rate is 2.25%. Same as before, this table is for illustrative purposes only and shouldn’t be relied upon to make actual investment decisions.

Saving early and often, and investing what we save in a balanced portfolio that is not overly conservative or aggressive, are keys to building up a successful retirement fund thanks to power of compounding over the long term.

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Random Useless Fact

Spiders are the only web developers that are happy to find bugs. 😀

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10 Comments on "The Importance of Investing Early – Compounding Returns"

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ABCD
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ABCD
03/17/2016 6:56 am

Do you know what the JP Morgan plan says about whether this Checkpoint amount should include should include your primary residence in the total or not? That is, if your check point amount is the $260k from the example, does that include equity in your house or not?

Anon
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Anon
03/17/2016 10:29 am

The article makes no mention of fees and taxes and other costs, thus giving a very incomplete and simplistic picture of investing.

As well, JPMorgan (and many others) has publicly stated that we are entering a “low-return world”, thus their 6.5% return used in their marketing scheme is in direct conflict of what they actually assume.

I guess the take away, demonstrated with simple math, is start early and often.

Gen X Investor
Guest
03/18/2016 11:10 am

Some good advice here. For myself investing has always been more of a “time” game than anything else, and that has everything to do with compounding. I think that a 6-7% return over time is reasonable and if someone starts early enough and keeps it up over their working life they should do alright.

Have a great weekend!

carla
Guest
carla
03/20/2016 10:51 am

I really enjoyed seeing how different asset classes have performed. I notice you didn’t include international stocks. Do you own any international indexes?

Derek @ MoneyAhoy
Guest
03/22/2016 6:22 am

Sadly, I acted like Noah for the first 10 years of my “investing” life from age 22 to age 32. So, hopefully I will end up somewhere between Chloe and Lyla. As many hear know, time if your biggest “weapon” when it comes to investing returns!

FerdiS
Guest
03/22/2016 8:15 am

Thanks for sharing! Knowing that saving longer is better and acting on that knowledge are two different things. If I could turn back time, I would have started earlier, despite needing to get rid of debt first!

Cheers
FerdiS, DivGro

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