Back To Financial Basics: Time Matters

Tax and financial advisors can take an important role in the financial education of young Canadians. As we approach Financial Literacy Month this November, it’s important to revisit the role of financial educator. It’s a critical piece of family wealth management that prepares heirs for their future financial responsibilities and brings peace of mind to their parents, too.

Over the next several weeks, KBR will feature financial literacy gems to discuss with your clients. This week, a lesson in the time value of money, excerpted from The One Financial Habit That Can Change Your Life, by Robert Ironside and Edwin Au Yeung:

When you are young, time is your friend. This is especially true when it comes to your money. Every year that you wait to start saving is a year that you can never recover. If you wait even a few years, until you can “afford to save some money”, the amount that you will have to save each year to achieve the same retirement wealth will grow dramatically.

Consider the following example:  if you were to save $1,000 per year from the age of 15 to 65 and you were able to invest the money to earn 10%, compounded annually, you would end up with a retirement wealth at the age of 65 of $1,163,909.

However, what if you were to wait only five years, until the age of 20, to start saving? Now you would have to save $1,619 per year to achieve the same retirement wealth at the age of 65.

What if you were to wait until the age of 30 to start saving? Now you need to save $4,294 a year to reach a retirement wealth of $1,163,909. Even worse, if you start saving at the age of 40, you need to save $11,835 a year or almost $1,000 per month, to achieve the same amount of retirement wealth.

Of course, there is another way to achieve the same retirement wealth and that is to search for a higher annually compounded rate of return. Unfortunately, as we search for higher yield, we almost always have to assume greater risk.  One way to mitigate risk is to control tax efficiency.  A tax and financial advisor working together with the investor can be a valuable resource. 

The lesson is clear – time is your friend – and so is tax efficiency. Start saving as early as you can and long before you think you can or should!  This year end, maximizing investments in a TFSA is very important, to offset risk with tax free savings.

Financial Literacy Counts. . .learn more about the time value of money, managing risk and return and how to earn a better after-tax result from Knowledge Bureau Newsbooks.