Before you feel ready to retire, you will need money. For most, that means saving up money from various sources. I have met many young (and not-so-young) people who see retirement as something very far away, and who have little interest in starting to save early. I am willing to accept that saving money does not sound exciting. However, it can become exciting once one sees the admirable effects it can have! Indeed, the long-term effects of compound interest are, in the words of Albert Einstein, the “eighth wonder of the world.”
Consider the “Rule of 72”. When determining how much you need to invest, you need to understand the basic rule that governs all investing, known as the “Rule of 72”, or the “Banker’s Rule”. This rule states that 72 divided by the interest rate approximately determines how long it takes for your money to double. For example, if you are receiving 3% interest, your money would double in approximately 24 years (72 divided by 3); if you are receiving 12 percent, it would only take approximately 6 years (72 divided by 12). This is important because you need to know how many doubling periods you have in your life before retirement. While the rule of 72 may work to your advantage when investing, it will work against you when you have debt, as debt doubles in the same manner.
Most families wait too long to start investing, making it difficult to apply the guidelines delineated above. You need to start saving and investing as soon as you get the chance. If you do not, you will not get the full benefit of compound interest and the Rule of 72, so missing a year has a significant impact in the long run. Think of the early investment as a small snowball that gradually grows. Without making that initial snowball, you will never get the opportunity to watch it grow due to the power of compound interest, as manifested by the rule of 72.
Rule of 72
| Years | 3% | 6% | 12% |
| 0 | $5,000 | $5,000 | $5,000 |
| 6 | $10,000 | ||
| 12 | $10,000 | $20,000 | |
| 18 | $40,000 | ||
| 24 | $10,000 | $20,000 | $80,000 |
| 30 | $160,000 | ||
| 36 | $40,000 | $320,000 | |
| 42 | $640,000 | ||
| 48 | $20,000 | $80,000 | $1,280,000 |
Let’s say that you are 25 and, for simplicity, you want to save $1,000,000 by the time you turn 65. The best time to start saving would be yesterday, but since that is not possible, you should start today. To get to that target of $1,000,000, if you were earning a rate of return of 9% at age 25, you would have to put away $214 each month; at age 35, this would increase to $541; at 45, to $1,491; and if you start investing at 55, to a staggering $5,168, as illustrated below.
| Age | Monthly investment | Balance at age 65 |
| 25 | $214 | $1,000,000 |
| 35 | $541 | $1,000,000 |
| 45 | $1,491 | $1,000,000 |
| 55 | $5,168 | $1,000,000 |
Most Canadians are usually able to retire comfortably on 70 to 80 percent of their previous income (adjusted for inflation). Achieving this goal takes a lot of discipline and planning on the retirees’ part. Traditionally, the sources of retirement income are employer-sponsored pension plans, Registered Savings Plans (RRSPs), Tax-Free Savings Accounts (TFSAs), non-registered accounts, and government pension plans. Each of these accounts has a different source, which we will address later in the book. In most cases, retirees are pulling income from many different sources, and planning to use one source is typically not enough. Do not conclude that you have saved enough for retirement unless you have thoroughly calculated how much you can expect from each of these sources, and whether that aligns with how much you need. Furthermore, in most instances it usually makes sense to have your retirement in different types of accounts for tax and retirement planning reasons.
Of compound interest, Einstein is also reputed to have said, “He who understands it, earns it; he who doesn’t, pays it.” In the worst-case scenario, you want to start saving for retirement at least 15 years before your retirement age. Failing that, you will find that you are working longer and harder than you intended, and are unable to afford the retirement lifestyle that you expected. By your mid to late forties, you should aim to start putting larger amounts of funds toward your retirement, as you enter what is likely to be your peak income-earning years; your children should be close to being adults, and most of your large asset acquisitions have been made. However, if you are able to start putting money away before, then you absolutely should do so, because your money is able to compound over a longer period of time, to your advantage.
With respect to saving for retirement, a Registered Retirement Savings Plan (RRSP) is one of the best tools to use for retirement because it allows you to defer taxes on your money while also receiving a deduction for your contributions. A Tax-Free Savings Account (TFSA) is another great tool that you will want to use for saving. TFSAs are not tax-deductible, but the income and the capital gain earned will grow tax-free, and they afford the person the ability to take out money without any tax consequences. We will explore RRSPs and TFSAs in further chapters.
Generally speaking, a priority that most Canadians should have while they build up their retirement is to max out both their RRSP and their TFSA, and also to pay off their mortgage. With regard to which one to max out first, or when is the best time to contribute to them, it all depends on your individual situation. In particular, it means looking at the potential interest rate you will earn in both your TFSA and RRSP, the interest you pay on your mortgage, the amount of your income, and the tax deduction you will receive from your RRSP contributions, among other things.
While you are saving for retirement, you also want to keep track of debt. If you ignore debt, you will not be on track for your retirement even if you have a lot of investments. As mentioned above, compound interest can work for you or against you: it works in your favour where you are able to invest and receive interest, and it works against you where you are paying interest for your outstanding debt.
If you have debt, there are a few things you should start to consider doing, especially as you approach retirement. Start by assessing all required payments, and determining if they are manageable for now, and sustainable in the future. You should also look at your current debt, to see if there are opportunities to pay it off sooner, either through lump sum payments or by increasing the frequency of payments. Before you do so, always review the terms and conditions associated with such debt, to see if there are any penalties arising from paying off the debt sooner than scheduled. You should also look at the terms and conditions of the debt to see if the interest rates attached to the debts can increase in the future. In any event, you should consider reaching out to the institution who you borrowed from to see if you can negotiate a lower interest rate. Where you have debts that are jointly owned with someone else, you should know that if the person does not contribute their share, you may be exposed to financial risk and become liable for their payments; keep an eye out, and make sure they are paying their dues.
A person may have debt for different reasons, and there may be instances where debt makes sense. For some individuals, holding debt for an appreciating asset is one of the instances where it is logical to keep the debt. Nonetheless, you should always make sure to have a plan in place when dealing with debt; in some instances, that means liquidating assets with a lower interest rate than the debt. Generally speaking, this is not always a straightforward decision and in many instances this may mean you have to consider prepayment penalties, potential tax issues of the sale, and tax deductibility of the debt to name a few things to consider when planning to eliminate debt.
“Compound interest is the eighth wonder of the world. He who understands it, earns it… he who doesn’t… pays it.”
