Retirement and compound interest ‘magic’

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  • All adds up: a screenshot showing the accumulating total and interest when $300 is saved monthly with interest of 2 per cent allowed to compound. By the end of 40 years the total is $220,330.69, of which $76,330.69 is interest earned (Graphic from free-online-calculator-use.com)

    All adds up: a screenshot showing the accumulating total and interest when $300 is saved monthly with interest of 2 per cent allowed to compound. By the end of 40 years the total is $220,330.69, of which $76,330.69 is interest earned (Graphic from free-online-calculator-use.com)


Starting when you are young and saving consistently can lead to a comfortable retirement. Our monthly Bermuda Realistic Retirement Reviewer Series continues today with this great retirement success story from a Royal Gazette reader.

The reader wrote: “I’m just an ordinary person with an ordinary life. Never made it to the top of the working food chain, but that was never my life goal. As I begin retirement, I look back proudly on a good working career, and at what I have earned, learnt, and contributed in my 45-year career.

“When my kids were young we sent them to daycare. It cost $300 per month in those days, if my memory is correct. It was tough going; my paycheque took a real hit because I was just starting a first-rung-on-the-ladder-level job. Anyway, as children do, before I knew it they were in school all day. Whew, I thought at least, that expense is done with.

“Then, I had another crazy thought. Why don’t I pretend that our childcare expense still exists, but put the money into a savings account each month instead? Deposit rates weren’t great, but I figured it will add up in the end. At least, it will be a rainy-day fund.

“That’s how it started. Mind you, this wasn’t a strategy, but more of an impulse. There was little opportunity or available help in those days to explore terms such as financial planning, securing your future, and all those investment superlatives, such as long-term appreciation and the like.

“Life went on as month after month that old childcare money was automatically deducted from my salary. I received numerous raises over these years. One day, I suddenly realised that I never even missed this little daycare savings nest egg and it was starting to add up. So I set up another account using my latest raise, and further on another and another and another. I became more careful managing amounts into longer-term, higher-paying fixed deposits, rolling them over each time they matured.

“Eventually, I even got up my courage and invested in a couple of passive index funds. I didn’t dare invest too much as I understood so little about investments and capital markets. That became an interesting challenge too, as I tried to learn as much as I could about stocks and bonds, because by then Bermuda had the National Pension Scheme plan for employees.

“Did I ever cash in? Well, no, even though I was so tempted one time especially — there was this gorgeous watch. But, you know, I just couldn’t — it had been so hard for the family at first to get the savings programme started.

“Good thing, too. I’ve just retired and I’m happy to report that my retirement is worry-free, comfortable, not luxurious, but just fine financially. All those small consistent savings plans growing for 40 years have paid off. You can do it, too. Take my advice, just start!”

All right readers, how did our retiree contributor manage to do this?

1. Consistency.

2. The power of compounding — a math certainty.

3. Long-term passive capital appreciation.

4. Perseverance. The willpower to forego instant gratification.

The compound interest effect on savings is a magical math reality, even when interest rates are very low.

Compounding interest means that every bit of interest is added to the principal, and the next interest earned computation pays interest on both the principal and the added interest. This is the magic ingredient — interest grows exponentially. Let’s do a bit of math here.

Simply put, we take our reader’s $300 a month savings, interest compounded on a monthly basis, while adding in an additional $300 each month, compounding that additional interest and adding to the total, and repeating each month again for 480 months — that’s 40 years.

After only year it begins to get very complicated. However, there is a free online calculator that can work it out for you. A link to the Free-Online-Calculator-Use.com website is included at the end of this article.

The future value annuity calculator might seem to be a confusing title, because you just thought you were calculating some savings and interest, but this is in fact what our reader was doing.

The tedious method to check your work (and the calculator) to determine a rough final savings estimate is to:

1. Multiply annual principal deposits of $3,600 times 40 years = $144,000

2. Multiply 2 per cent interest rate per year of $72 times 40 years = $2,880

3. Multiply 2 per cent interest rate per year of $72 times 39 years = $2,808. Why? This is for the second saved annual $3,600.

4. Multiply 2 per cent interest rate per year of $72 times 38 years = $2,736. Why? This is for the third saved annual $3,600.

5. Multiply 2 per cent interest rate per year of $72 times 37 years = $2,808. Why? This is for the fourth saved annual $3,600.

6. And so on, run through each subsequent year until you get down to the last $3,600 saved.

7. Now add up all the interest and add it to the principal amount deposited of $144,000.

Computing with the free use calculator shows that the future value of 480 monthly deposits of $300, deposited at the end of each period and earning an annual interest rate of 2 per cent would be $220,330.69. That total consists of $144,000 in payments made, and $76,330.69 of interest earned. Not a bad start to a retirement, and this is only one savings plan.

So, do you still think 2 per cent is a lowly, non-significant interest rate? Imagine if the deposits were earning more.

Next time, we will share more of this retiree’s determined self-advised financial planning story.

Readers, please share your planning for retirement and retirement stories with me. We want to hear from you. Any data published will be on an anonymous basis by changing identities, certain facts, etc — keeping reader confidentiality.

Sources:

• Free-Online-Calculator-Use.com website at: https://tinyurl.com/yces9j9o

Martha Harris Myron CPA CFP JSM: Masters of Law — international tax and financial services. Dual citizen: Bermudian/US. Pondstraddler Life, financial perspectives for Bermuda islanders and their globally mobile connections on the Great Atlantic Pond. Finance columnist to The Royal Gazette, Bermuda. Contact: martha.myron@gmail.com

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Published Jun 23, 2018 at 8:00 am (Updated Jun 22, 2018 at 11:50 pm)

Retirement and compound interest ‘magic’

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