Photo by kenteegardin on Flickr

One of my favorite personal finance bloggers, YoungAndThrifty, wrote a post titled “Take Advantage of Your Extended Health Benefits“.  In this post, she talks about using group extended health benefits, and questions why many people don’t use their benefits.  This is an very good question!

Why are so many people reluctant to use their extended health, dental, and vision coverage? People are wasting benefits that they are entitled to, which would improve their health and well-being.  Not only are they squandering their benefits, they are also throwing their money away.  Many employers deduct extended health premiums directly from employees paycheques, and do not allow for employees to opt out.  So why are employees failing to use the extended health benefits they are paying for?

Perhaps benefits go unused because many people think of extended health coverage in the same way as car or home insurance.  It is a common view that if you make an insurance claim, that your premiums may go up. Defined group benefit plans generally do not work this way.  Group benefit plan premiums are determined by “pooled risk”, not individual risk.  In plain English, the insurer looks at the average use and medical history of the type of group to determine premiums, not your individual benefits usage or medical history. For example, premiums for a group of employees in high risk groups, such as those working with hazardous materials, may be higher due to the increased possibility of health problems resulting to exposure over the years. On the other hand, office workers are typically rated lower risk. So If you’re a “desk jockey”, like so many are today, go ahead and get those teeth cleaned! It won’t affect your group health benefits premium at all!

“Compound interest is the most powerful force in the universe” – Albert Einstein

While some may argue that this is a bit of an overstatement, there is no doubt that compound interest is a powerful force in determining your long-term wealth… or lack thereof.

In my last blog post, “Double your money faster with the Rule of 72“, I presented a few scenarios showing how important compound interest is when it comes to building wealth.  The post showed approximately how long it would take for three friends to double their money, based on the interest rate each was earning on their lump sum investment.  The results were dramatic!

For those who have a pile of money sitting around, “Double your money faster with the Rule of 72” may provide a powerful incentive to invest at the best rate of return that their risk tolerance will allow.  Who doesn’t want to double their money faster?

But what about those who can only afford to invest a bit at a time?  Will the power of compound interest still work its magic?  ABSOLUTELY!!!  The key is to start NOW!!!

Even before I learned how money works, I had heard that it’s important to start saving early.  But how?  When you’re a young adult, setting aside savings often takes a backseat to school and getting established out on your own.  For those who live in places like Vancouver, where the cost of living is very high, it’s easy to go through most of your 20’s unable to save.  It’s also easy to start closing in on 30 with a bit more money in your pocket, but also a feeling of discouragement in the pit of your stomach.  Many try to alleviate this feeling by throwing away their hard-earned “disposable” income on frequent dining out, overpriced (yet beautiful!) shoes, the latest tech gadgets, and other forms of “retail therapy”.  (I know I did!)

A real eye-opener for me was seeing how much money I could end up with by the time I retired.  I could either keep throwing my money away, and find myself in retirement living CPP cheque to CPP cheque, or I could follow a simple plan to rescue my financial future.

The simple plan:  Start saving $200 a month (Age 30-65)

The goal: Become a millionaire.

Seriously!  If you’re laughing, STOP.  JUST READ.  It IS possible… thanks to the power of  compound interest!*

By setting aside $200 a month for 35 years, it is possible to build up a sizable retirement nest egg.  As we’ve seen in my previous blog post, the higher the rate of return, the quicker money doubles.  This means that over 35 years, money invested at a higher rate of return will double more times than at a lower rate of return.

Here’s what this mean in dollars and cents*:

3% interest – $148,680

6% interest – $286,370

12% interest – $1.3 MILLION

When I first saw this example, my eyes bugged out.  I was astounded by how much I could make by saving money I had been throwing away on stuff I didn’t really need.  The light switch suddenly flipped on, illuminating my  financial future.  I hope by learning the importance of compound interest that you, too, can have a brighter financial future.

Have questions on how compound interest can work for you?  Feel free to comment below, or direct message me on Twitter @KnowMoneyCA

*Figures based on investing $200 per month from the ages of 30-65, with a consistent rate of return during the 35 year period.  Hypothetical examples are used only to illustrate the effects of the compound growth rate and are not indicative of a guaranteed rate of return on any investment and not intended to demonstrate the performance of any actual investment. Unlike actual investments, the illustrations use a constant rate of return of 3, 6, 12% without and fees or charges.  Rates of return are nominal rates, compounded monthly.  Contributions are assumed to be made at the beginning of the month.  It does not take into consideration taxes or other applicable deductions.

The Rule of 72 is an equation discovered by Albert Einstein, but so easy a 3rd grader can do it. (Yes, I said a 3rd grader, not 3rd year calculus major!) It’s an easy way to approximate how long it will take your money to double.

How do we do this? Easy! All you need to do is divide 72 by the interest rate. That’s it! The result will let you know approximately how many years it will take for your savings to double.

Let’s walk through a few examples….

Three friends decide to try their hand at investing. Each has $10,000 in their pocket, and want to see their money grow.

Joe fancies himself a savvy consumer, so he makes sure to hit RateSupermarket.ca to look for a high interest rate savings account. He bypasses these, as he found the banks are offering as little as 0.05% to as “much” as 2% on their “high” interest rate accounts. (These are actual rates pulled from RateSupermarket.ca on May 20, 2011) Joe thinks he’s found a smoking hot deal when he’s offered a 4% rate of return. How long will it take his $10,000 to turn into $20,000? Let’s do the math:

72/4 = 18 years!

Brian thinks that Joe is a sucker for choosing to invest at 3%. Brian instead choses an investment with a 6% rate of return. How long will it take his $10,000 to double?

72/6 = 12 years… a little better…

Ally doesn’t want to wait 12 years for her $10,000 to double. Understanding the Rule of 72, and having a higher risk tolerance than her two friends, she choses an investment that has historically provided a 12% rate of return*. Assuming that her higher-risk choice does end up providing a steady 12% rate of return, when will her $10,000 turn into $20,000?

72/12 = only 6 years!

Now you know how simple the Rule of 72 is! How long will it take for your money to double?

* Past performance does not guarantee future results

You’ll need to know a few simple concepts that anyone can master. You don’t need to be an Einstein, but you do need to know the power of compound interest, first and foremost. This is absolutely key to understanding when to start saving, how to start saving, and what your results could look like.  It will also show you just how dangerous and damaging credit card debt can be – and how to minimize the overall amount your credit card debt will cost you.

The Rule of 72 is an equation discovered by Albert Einstein, but so easy a 3rd grader can do it.  The Rule of 72 will show you just how powerful compound interest can be.  It’s an easy way to calculate how long it will take your money to double.  You’ll see how important it is to “pay yourself first”… and the high cost of waiting to do so.

On the flip-side of saving is spending.  It is imperative to understand how much it costs you when you carry a balance on your credit cards.  Do you know how much that new gadget you just HAD to have, and had to put on your credit card, is going to cost you by the time it is paid off?  The Rule of 72 provides a terrifying illustration of how compound interest increases your credit card debt at an astronomical rate that the banks love!

While we’re talking about debt, let’s also introduce the concept of debt stacking.  Taking into account the interest rate and amount of debt, debt stacking determines the ideal order for you to eliminate your debts – and it’s not always what you think!  The beauty of debt stacking is that you eliminate your debts faster, without increasing your total monthly payments, while saving you tons of money in interest in the long run.

KnowMoney.ca will delve further into these important personal finance topics in upcoming posts.  Keep reading to learn the details on building your solid financial future!

Like most young people, I knew what the “cool” acronyms meant, but had no idea about financial ones. What I did know was that my minimum wage jobs were barely paying my rent, and that ramen was a college girl’s best mealtime friend. That was the extent of my financial knowledge and financial education. That and how to write out a check, courtesy of the public education system. As a young adult, I wanted to know more… How to make money, how to save money, and how to create a stable financial future for myself. I wanted the finer things in life… (like the luxury of a box of KD… made *with* milk!)

When a friend announced that we should sign up for a financial planning class, offered by a local school district’s continuing education department, I began to see hope that my aspirations could be achieved! I learned the basics… including that a Registered Retirement Savings Plan (RRSP) is a good way to squirrel away pre-tax dollars, AND reduce my tax liability doing so. (Tax refund, anyone?)

I also learned that this was only the tip of the personal finance iceberg. I wanted to learn more…. but where….how? There are a lot of books and blogs out there, but most do not address the issues unique to personal finance in Canada in general, and to residents of British Columbia in particular. That is what this blog aims to do.

What do you want to learn more about? Do you want to learn how to become debt-free? Are you concerned that your family is not properly protected? Is your goal to double your money? Do you know how long it will take? If you have any of these questions, or more, let me know! You may see your question answered in the next KnowMoney.ca blog post!

How many of us have mirrored this sentiment at some time in our financial lives? I know I have. Like Harriet, who was working overtime and seeing a bleak financial future, I paused and thought to myself, “There MUST be a way!” And there is… It’s called financial education.

Most don’t learn it in school. I didn’t… Harriet didn’t… You probably didn’t either. The School of Hard Knocks only taught us so much after our high school graduations. Now what? Fortunately, some of us have learned the secrets to saving our financial lives… and a few want to pay that knowledge forward.

That is what KnowMoney.ca is about: Sharing the financial lessons I’ve learned. As a resident of the Vancouver, BC area, the knowledge I’ve acquired is specific to BC and Lower Mainland residents, but many concepts apply to all Canadians. My hope is to help our national mantra of “…the True North, strong and free…” also apply to our personal financial freedom.

Visit KnowMoney.ca often to learn new financial lessons to strengthen your financial future and freedom. Invite your friends, share with your families and teach your children. Together, we can build a strong, financially-free Canadian future!