Tag Archives: compounding

Do You Have a 50% Credit Card Rate?

If that sounds insane, it really isn’t. Millions of Canadians have it – they just don’t know it!

Numerous surveys over the past few years show that one quarter of Canadians are cashing in some of their RRSPs before retirement. That’s more than 1.8 million people. Say it ain’t so as the old expression goes.

Two of the most common reasons for you to consider cashing in all or part of a retirement plan are to purchase a home or to pay off debts. Let’s assume you want to cash in $5,000 to pay off a credit card. The first thing you pay is a 10% penalty right off the top. So you’re actually getting $4,500. Then this amount is taxed, as if you made that money as income. In a 30% tax bracket, that’s another $1,350. So the bottom line is that the $5,000 you cashed in is really only $3,150 of net money going on your credit card. Sure, it’ll save you 20% interest on the card, but that’s not the whole story.

That money is no longer growing in your RRSP (or your Tax Free Savings Account). At a 10% return, that $5,000 would have doubled every seven years. If you’re in your 30s, you’re now missing around $160,000 at retirement. If you’re in your 50s, that $5,000 still would have doubled three more times, which is $40,000 now gone.

While you’ve now been able to pay just over $3,000 on your credit card, it likely didn’t pay off the balance. That’s bad enough with what it’s cost you in foregone investment income. Now to make things worse, the majority of people keep using that credit card again! Odds are, you’re in the majority where you’ll be back to an average $7,000 balance within two years.

That puts you back to paying 20% on your card while you’re out at least $40,000 in savings for the next 20 years. The bottom line: Your credit card is then costing you more than 48% interest. While you were hoping to make things better – they got worse – a lot worse.

On the plus side, how would you like a zero risk 28% return on your money? It’s easy: Just pay off your credit card. The 20% interest rate you pay is with after-tax money. So the real rate is over 28% if you carry a balance. That’s the biggest reason trying to save at the same time you’re trying to become debt free doesn’t work!

Graduate As a Millionaire

85% of teenagers never take a course on credit or finances. That means they haven’t got much of a hope of being financially successful from the get-go.

The first thing most teenagers do when leaving the home is to take on a car payment, get a credit card, pay rent, and often have a student loan. But if you have teenager that’s about to leave the home, here’s a deal you can make that’ll insure their financial freedom for the rest of their life.

The only thing your teenager has to do is to save $8,000 by their 20th birthday. Nothing more – nothing less. After that, without getting into debt, or touching these savings, they can literally spend every dollar they make.

It’s the magic of compounding and works with something called the Rule of 72. Simply take your rate of return and divide it by 72 – that’s how long it’ll take for your savings to double. So at a 7% rate, it’ll double every 10 years, while a 10% rate will double it every seven years.

Do some lateral thinking of how you can help them achieve this. Maybe you can charge them rent and keep that in a savings account. Some parents match whatever the teenager saves to a certain amount – there are all kinds of ways.

Then your 20-year old just has to watch his or her savings double again and again until it reaches $1 million at age 67, using a 10% rate, and it all started with a one-time saving of $8,000.

Oh, if only we had done this when we were their age. But one more thing: Because they’re teenagers, I’d recommend there’d be two signatures on the account – just in case they get the urge to take some money out…

The Rule of 72:   At 10% it’s 72 divided by 10 = money doubles every 7 years

At 11% it’s 72 divided by 11 = money doubles ever 6 ½ years

At age              Amount now saved through compounding interest at a 10% rate

20…                 8,000

27…                16,000

34…                32,000

41…                64,000

48…                128,000

55…                256,000

62…                512,000

67…                1,014,000

THAT is the best graduation present I can think of, and it’s not hard to do at all. It works with any starting amount. Even if it’s $5,000, it’ll turn to $640,000 and that’s not a bad deal for a year of two of savings at an early age!

Adults can get there, too. If you want to have $1 million when you retire at age 67, for example, you just need to work backwards.

So at age 60 you’ll need half a million because it’ll double when you reach 67. At age 53, you’ll need $250,000 and at age 46 you’ll need $125,000, and age 39 you’ll need $63,000. When you reach any of those amounts, at whatever age, it’ll double and double until you reach a million at age 67. But, depending on your age, you may want to use a more conservative 7%, depending on your age in order to lower the risk of your investments.

However, there’s a big proviso: It’ll never happen if you’re also in debt and making a bunch of payments. Sorry, can’t be done. You need to be debt free to have some serious money to put away for investments. I know the world has taught you that you can have it all – it’s not true. There’s no chance you can save a little, pay a little here and there and still have a life with your normal rent, mortgage, utilities, gas, etc. I know you think you can and it’ll be another five, 10, or 20 years of finding out that you were really wrong and wasted another decade.