Young People Want to Protect Their Financial Futures
May 12th, 2021
When it comes to savings, most people have heard “it’s never too early to start.” And while this is absolutely true, it can be difficult to put into practice, especially for those of us who see retirement as a distant concern.
But pandemics, it would seem, have a way of changing people. Routines are interrupted, values and beliefs are challenged and maybe, the way we do things no longer makes sense. Being laid off and facing job insecurity also has a way of rearranging peoples’ priorities. Stability and comfort have, for many, been replaced with instability and uncertainty and naturally, this type of shift begets change.
There has been such a shift among young people – Millennials and Gen Z – who are reportedly, more concerned now about their financial futures than they were before the pandemic.
Findings from a Sun Life survey published on March 11, 2021 indicate that 60% of Millennials and 74% of Gen Z say the pandemic has made saving for the future difficult. This is unsurprising given that as of April 2020, Statistics Canada reported: “one-in-five Canadian businesses had laid off more than 80 per cent of their staff.” [1]
Due to the uncertainty and instability COVID-19 has wrought, 80% of Millennials and 89% of Gen Z reportedly want to protect their financial futures now more than ever.
As difficult as the world is right now, and as many barriers as there may be to young people (read buying a house, paying off student debt, feeling like they can afford to have children, etc.), they do have at least one thing going for them: time.
All young savers should know about compound interest and that, above all else, it takes time to really be beneficial. With younger people expressing an increased interest in protecting their financial futures, now is a good time to introduce this concept and inspire action. It is also a good time for older millennials to capitalize on an opportunity they may not have known about or acted on in their early twenties. Remember, while it’s never too early to begin saving, it is also never too late.
Compound interest is “the interest on a loan or deposit calculated based on both the initial principal and the accumulated interest from previous periods.”[2] Unlike simple interest, which is only accrued on the original amount invested, compounding interest applies to the principal amount and the interest it collects. Put simply, it is interest on interest.
So, what is the difference between simple and compound interest and why does it matter?
Let’s say a 20-year-old Gen Z who works part-time in retail decides to start saving money for retirement. They save up for a few months and deposit $1,000 into a regular savings account at a big bank that has a monthly interest rate of 2%. Their goal is to start saving consistently for the long-term but still have enough money to save for more immediate needs (and have a bit of fun). Going forward, they plan to save an additional $100 every month.
Simple interest – 45 years
Banks tend to offer low interest rates, often less than 1%, due to historically low interest rates.[3] In this example however, we’re going to use 2% interest that applies monthly to the principal amount (so we’re comparing apples-to-apples). In reality, this rate would likely be lower. After 45 years of saving, this is what the now 65-year-old Gen Z individual would have:
$1,000 principal investment + $100 saved every month for 45 years = $79,185
Let’s say the Gen Z part-timer decided to seek professional advice instead and opened a TFSA account. They now have an opportunity to grow their savings by investing in the same manner however, they will earn compound interest because there are no taxes applied to their earnings unlike in the savings account. Note: compound interest is only achievable when investing in a tax advantaged account.
As an investor, it is important to understand that not all compound interest is created equally. “The rate at which compound interest accrues depends on the frequency of compounding, such that the higher the number of compounding periods, the greater the compound interest.” [4]
Basically, the faster your interest collects interest on itself, the quicker your investment grows. A compounding period can be daily, monthly, quarterly, semi-annually or annually. This explains why the amount of compound interest accrued on $100 compounded at 10% annually will be lower than that on $100 compounded at 5% semi-annually over the same period of time.[5]
Compound interest – 45 years
Now in this example, the Gen Z investor adds $1,000 to their TFSA which has a 2% interest rate, and they plan to invest an additional $100 every month. After 45 years of saving, this is what the now 65-year-old Gen Z individual would have:
$1,000 principal investment + $100 saved every month for 45 years = $90,069
With more young people than ever interested in safeguarding their financial futures, it’s important they receive sound advice so they can effectively leverage one of their greatest assets – time.
For more information about compounding interest and how to make your money work for you or a young person in your life, connect with us.
[1] https://betterdwelling.com/nearly-1-in-5-canadian-businesses-laid-off-more-than-80-of-staff/#_
[2],4,5 https://www.investopedia.com/terms/c/compoundinterest.asp
[3] https://www.investopedia.com/articles/personal-finance/062315/how-interest-rates-work-savings-accounts.asp