Read on as we break down how investing even a small amount early on can lead to far greater rewards than waiting to invest. But the biggest takeaway if you stop reading now? Regardless of your age, there’s literally no better time to start than right now. Not tomorrow. Not next week or month or year. Now (or yesterday if you figure out time travel).
To understand why investing early matters, it helps to understand interest.
What is interest?
You invest money by sending it off into cyberspace. But then what? It’s not as mysterious as it seems. That money goes to companies that use your investment to grow their business.
Interest is the money you’re paid for letting those businesses use your money. There are several ways interest is calculated. Simple interest calculates interest only based on the original amount of money that you invested or borrowed, also known as the principal. To calculate simple interest, multiply the interest rate by the principal by the given time period, usually in days or years. This type of interest usually applies to automobile loans or short-term loans.
Let’s say you invest $1,000 in a one-year GIC with a simple interest of 3% per year. The interest you earn after one year would be $30, growing your total investment to $1,030. Let’s say you decide to keep your money invested in the GIC for a total of 5 years, then you would make $150 in interest over that period.
Here’s where interest gets more interesting…
Introducing compound interest
Compound interest is like an avalanche only far more positive: your money may start small, but as it rolls down the hill (in this case, the hill is time), it becomes bigger and bigger.
When it comes to your money, you want the biggest hill. And the earlier you start, the bigger your hill.
Unlike simple interest, compound interest is calculated based on your principal and the interest earned from previous periods. In other words, it includes interest on interest.
Let’s use the same example above except this time you invest $1,000 in a 5-year GIC with a compound interest rate of 3% per year. After the first year, your investment will gain $30 in interest. However, by the fifth year your investment will have gained $159 in interest, making you $9 more than with a simple interest investment.
That $9 may not seem like a huge difference, but the more money you invest (your principal) and the more time you let it sit (your hill), the more opportunity you have to earn interest and for that interest to grow. It can mean the difference of thousands of dollars, or more.
It’s worth remembering that compound interest can also work against you in certain situations, such as when you carry credit card debt, but it’s all upside when it comes to investments. Compound interest and your investments are a match made in heaven.
Do the math (or let a calculator do it for you)
Unless you liked math growing up, you may be tempted to skip over this. But trust us: you’re going to wanna see how compound interest shakes out.
One of the best ways to visualize the power of compound interest is through the classic checkerboard math problem. Take a checkerboard and place one penny on the first square. Then two on the second. Four on the third, so on and so forth, doubling the amount of pennies on the square each day. How much money would you have by the last square?
It’s more than you may think. By square 64, you’d have: $184,464,625,987,328,000.00. We’re not even sure what the heck that number is.
Now, we’re not suggesting you double your pennies every day. But, you can use a compound interest calculator like the calculator from the Ontario Securities Commission to see how time and consistently saving can exponentially increase your money.
Say you start with a $100 investment and decide to add $10 to your account each month beginning at age 25. And then you wait to use that money until you’re 65 years old. Using a 5% interest rate compounded annually, you’ll have earned $10,629.24.
If you make these same investments, but start at 35 (so, you have 10 fewer years for your money to grow), you’ll have earned only $4,885.95 in interest.
Let’s be clear: it is never too late to start investing. Putting aside money for your future is smart, no matter when you start. However, do a little math and you’ll quickly realize that it pays to start as soon as you possibly can.
Increasing the amount you’re contributing to your investments can also have a major impact on your money’s growth.
If you feel strapped for cash, you may want to dig in a bit deeper. What would it mean to pay $10 less per month on your debt and invest that $10 instead? You’ll have to do a bit more math to see if it makes financial sense for you. It may, especially if you have a loan that has a lower interest rate than the expected average annual returns of wherever you’re investing your money.
Just think: you owe $1,000 on a loan that has 4% interest. That may mean you owe $40. But if you can invest $1,000 in an investment that has an average of 10% returns? You can make $100. Which covers the cost of interest, plus $60.
And when your avalanche gets moving, it gets moving. You’re going to need an avalanche beacon to locate your principal. “I invested this and it’s now this?” Yup, a little now can go a long way by the time you’re set to tap into that sweet, sweet cash avalanche.
Moka can help you start investing with your spare change. Download the app to get started and Moka will round up your purchases and invest the difference.
Get ready to watch those pennies add up.