by Stephan Desbiens, Partner & Associate Portfolio Manager at Exponent Investment Management Inc. | June 2019
Einstein described “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”
Here’s a fun lesson to share with your grandchild on compound interest (or growth). Make your grandchild a summer job offer. The job is for a 30 day term and the starting pay is 1 cent for the first day, with the pay doubling every day for the duration. “Do you want the job?” you ask. What follows is an expression on the child’s face similar to a confused face emoji ? and “NO WAY! I’m not taking that job!” to which you’ll respond: “That’s too bad, you just turned down a $10,737,418.23 payday!”. (Save the tax lesson for another day or as Comic Bill Murray once said, “The Best Way to teach your kids about taxes is by eating half of their ice cream.”)
Don’t believe it? Do the math together on a single sheet of paper. On left side of the page list the numbers 1 through 30. Starting at .01, hit x 2 on the calculator (as the pay doubles daily) and write the number down as you go through the days. Repeat 30 times. The summer job of a lifetime indeed!
That, in a nutshell, is the power of compounding growth and the reason it’s important to start teaching finance to young adults and even children as soon as possible. In The Wealthy Barber, the financial planning book franchise by Canadian author David Chilton HTTP://www.wealthybarber.com/ he explains the magic of compound growth with an example of twin brothers who start saving at age 22. “One opens an RRSP, invests $2,000 a year for 6 years, and then stops. The second twin procrastinates and doesn’t open his RRSP until the 7th year, the year his brother stopped. The second twin then contributes $2,000 a year for 37 years.” Both earn 12% per year on their savings. “At age 65, they go out for dinner to compare their RRSP holdings… they both have approximately $1,200,000”. Starting to save early and letting the compounding effect take over works, and the younger one starts the more it works!
Whether saving in an RRSP, TFSA or a Registered Education Savings Plan (RESP), it’s never too late for grandparents and parents to teach a child the valuable lesson of saving and compound growth.
P.S. One last thing, before offering the job, please be sure to cover yourself with proper disclaimers in case your grandchild accepts the position, or you may end up in court with a breach of contract claim filed by your grandchild.
A Brief Outline About RESPs: A Registered Education Savings Plan is an excellent savings vehicle for a child’s education. The Canada Education Savings Grant (CESG) is provided by the government of Canada to complement RESP contributions, wherein the government contributes 20% of the first $2,500 in annual contributions made to an RESP. That’s $500 per year of free money! These savings can grow tax-free and are available for withdrawal from the RESP by a post-secondary recipient. https://www.canada.ca/en/services/benefits/education/education-savings/resp.html
About RRSPs: https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/rrsps-related-plans/registered-retirement-savings-plan-rrsp.html
About TFSAs: https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/tax-free-savings-account.html