What is compound growth?
Compound growth is similar to compound interest. With compound interest you’re earning interest on interest. You can earn interest on the money you put in at the start, as well as the money you add later, plus on all the interest that collects over time.
This gives you a larger total amount to earn future interest on, which could lead to even more growth. Over time, you have a powerful recipe to help you grow your money.
How does compound growth work?
The idea of compound growth is like growing a forest of trees. The forest can grow in 2 ways – trees are planted by hand (like your regular investments), while others may grow on their own through seeds that fall from larger trees (like compound growth on your money). In time, a few trees planted early can grow into an entire forest without much effort.
To understand how this could affect your savings, let’s look at an example. In this fictional scenario, we’ll consider the journey of $240,000, saved 2 different ways.
If you save $500 per month with an annual return rate of 6% compounded monthly, beginning at age 25, you’d have $1,000,724 saved at age 65.
Now, if you tried to catch up on your savings, contributing $1,000 with the same annual rate of return beginning at age 45, you would only have $464,361 at age 65.
Under both scenarios, you’ve invested the same amount with the same growth rate, but in the first scenario, your money has twice as long to grow, and you end up with more than twice as much. It’s important to remember when investing that past performance isn’t an indicator of future performance, and there may be fees to consider associated with your investments as well.
The benefits of saving early
The benefit of saving early and using the power of compounding is it doesn’t take a lot of money to start.
Relatively small amounts invested regularly, especially when you’re young can make a significant difference in the total size of your savings down the road.
Those small amounts can be the difference between being confident with your investment success and having to worry about it later in your life.
It could be as easy as sitting back while your money does all the work and grows into something much bigger.
How to compound your savings
There are a few ways you may choose to start saving now to help your money grow over time:
- High-interest savings accounts – These savings accounts offer higher rates of interest on balances than regular savings accounts.
- Registered savings accounts – Money in accounts like a Tax-free savings account (TFSA) or Registered Retirement Savings Plan (RRSP) is invested to grow over time, whether you’re contributing to reach short- or long-term goals.
- Guaranteed Investment Certificates (GICs) - GICs are secured, low-risk investments. You invest your money for a specific period of time known as a “term’, and this money earns interest a fixed or variable rate. Once this term is up, you receive back 100% of the money you originally invested along with the interest accrued.
- Mutual funds - A mutual fund pools your money with many other investors in a group of investments, like stocks and bonds. A professional money manager chooses the investments for each fund with a specific objective and investment type in mind.
No matter which account you choose to start saving into, there are 3 key pillars at the heart of the strategy for compounding:
- Invest early – The longer your money is invested, the more time it has to grow. When it comes to compounding returns, time is an advantage.
- Contribute regularly – Regardless of the amount, the important thing is to start and be consistent. Even small contributions made each month will grow. You can increase your contributions as your financial situation changes throughout your life.
- Don’t take money out – As your savings grow and earn compound returns, the gains made through compounding will also help you build your wealth.