A TALE OF TWO BROTHERS: Compound interest demonstration
Bruce and John are twin brothers but with very different personalities. Bruce is a serious student focused on achievement who excelled at university and was accepted at a prestigious law firm. John is a happy-go-lucky fellow who quit university after first year, became a plumber, and enjoyed hockey and beer with his buddies. They both decided to contribute to RSPs each following their own instincts.
John was single in his twenties with a well-paying job so could easily afford to contribute 12K per year to his RSP and did so for 12 years while the market was doing fairly well such that his average compound rate of return was 8%. After those first dozen years, he got married, bought a house and lost interest in his RSP so declined to contribute another dime for the next 33 years until he was 65.
Bruce dealt with student loans and the challenges of an early career so did not contribute anything to his RSP until he was 32. However, he was disciplined and continued the same 12K per year every year for the next 33 years for a total of almost 400k in contributions as compared to 144k for John.
The compound interest calculator shows that at age 65, John had almost one million dollars in his RSP, while dutiful, careful Bruce who contributed over 250K more than John ends up with 850K or significantly less even though he contributed much more. Obviously, the point here is not to claim that plumbing is a better choice than a legal career or some other conclusion, but simply to illustrate that:
Key Points
Time is an enormous factor. Any delay in starting to invest will heavily impact expected returns.
Luck also matters as illustrated by the effect of investing in an 8% as opposed to a 4% market.
The compound interest calculator is a useful tool to show how even minor changes can have a very significant impact; inputting varying rates of return by even a few percentage points will help you to understand the negative impact of high management fees and below market returns.
To access an easy to use compound interest calculator, please click here