Grey Matters: A little math can add up in your retirement savings

calculator with chart and pen

WANDA MORRIS | POSTMEDIA | 10.30.2017

 

When I was little, my dad used to sit my two sisters and me at the kitchen table and play the Smarties game. He would ask us questions and we’d get a Smartie when we got one right. When we got one wrong, he’d get a Smartie — or two or three. The Smarties game taught me my times tables and combined two loves that shaped my life: math and chocolate.

Because of this early positive exposure, I always saw math as fun. In my University of Calgary days when I was, admittedly, somewhat obnoxious, I took great joy in pointing out math errors in textbooks and leaving exams early to show how easy they were.

I understand that many people find no joy in math at all. That’s too bad. Not only are they missing out on the fun, but understanding math is fundamental to our financial security. To miss the first is regrettable; to miss the second can endanger your retirement.

The good news is that there is one single specific mathematical concept that anyone can learn to greatly help increase financial security: compounding.

Imagine you receive a bequest of $100,000 and decide to invest it for 25 years then use it to fund your retirement. You don’t know how much of a return you’ll make on your windfall, but let’s say either four per cent, six per cent, eight per cent or 10 per cent.

You decide you need a financial adviser to draw up a financial plan (an excellent idea) and make and monitor your mutual fund investments. You find one you like who will do all this by investing you in mutual funds which include an embedded commission of two per cent of your assets a year (mutual fund fees typically run between 1.5 per cent and 2.5 per cent annually).

Depending on the gross return on your mutual fund investment, after 25 years, your $100,000 would be worth:

• Mutual funds earning four per cent will grow to $164,000

• Mutual funds earning six per cent will grow to $267,000

• Mutual funds earning eight per cent will grow to $429,000

• Mutual funds earning 10 per cent will grow to $685,000

Imagine that instead you visit a fee-for-service financial planner who provides you with a financial plan; you then invest your money into index funds. Let’s assume you pay $2,500 for your financial plan and your index fund costs you one per cent a year. You start out with $2,500 less but pay one per cent less per year in fees every year. What happens to your investment over time? Again it depends on the return you earn. Here are the returns after 25 years on $97,500 at different rates of return:

• Index funds earning two per cent will grow to $204,000

• Index funds earning six per cent will grow to $330,000

• Index funds earning eight per cent will grow to $529,000

• Index funds earning 10 per cent will grow to $841,000

The extra return, whether $40,000 for an investment earning four per cent or $100,000 for one earning eight per cent, is the compounded effect of the one per cent difference in investment fees. (Note that many exchange-traded funds have an even lower investment cost, but they typically require a minimum investment and attract trading costs, so I’ve used index funds for this example).

Now you may be thinking, nothing I’d love better than an extra $40,000 in my retirement fund, unless of course it’s an extra $100,000, but how do I know if this applies to my situation?

The good news is that CARP has partnered with ex-banker Larry Bates to give everyone this information through a tool he developed to help you understand how compounding affects you.

Go to carp.ca/TREX to get your own T-Rex score (an investor’s total return efficiency index) and find out how big a bite fees and commissions are taking out of your savings.

And when you’re done, why not treat yourself to some Smarties? Because math can save you money and be fun, too.

 

25 Years On

What’s the difference in value between an investment of $100,000 in mutual funds (two per cent annual fees) and an investment of $97,500 in index funds (one per cent annual fees)?

• At a four per cent return, the savings from the lower commission index funds are $40,000.

• At a six per cent return, the savings from the lower commission index funds are $63,000.

• At an eight per cent return, the savings from the lower commission index funds are $100,000.

• At a 10 per cent return, the savings from the lower commission index funds are $156,000.

 

 

Wanda Morris will be speaking on Nov. 22 at 1:30 p.m. at Triwood (in N.W. Calgary). For more information or to register, please contact calgary@carp.ca

Grey Matters is a weekly column by Wanda Morris, the VP of Advocacy for CARP, a 300,000 member national, non-partisan, non-profit organization that advocates for financial security, improved health-care for Canadians as we age. Missed a week? Past columns by Wanda and other key CARP contributors can be found at carp.ca/blogs.