The Importance of Investing Early – Compounding Returns

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.

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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