Taking control over your financial future is just as important and empowering as achieving academic and career milestones. Understanding how to invest your money so it grows on its own is critical information to have, especially as you graduate and begin making a salary. Investing isn't just a way to grow your wealth—it's a step toward long-term financial independence.
What Does It Mean to Invest?
Investing involves using your money to purchase financial products that have the potential to grow in value over time. The idea is you are taking calculated risks to achieve higher returns. Think of it as a strategic plan to make your money work for you, with the ultimate goal of selling your investments for more than you bought them at some point in your future.
The Magic of Compound Interest
Albert Einstein calls compound interest the eighth wonder of the world. Unlike simple interest, which is calculated only on the principal invested, compound interest builds on both the principal and previous interest. The earlier you start investing, the more you benefit from the growth of compound interest. As you can see in the below graph, the final years of the compound interest are really where the value is created.
Time Value of Money
The time value of money is a fundamental financial concept stating that a dollar today is worth more than a dollar in the future. This principle underpins most investment and financial decision-making processes.
For example: Money today can be invested to earn returns in the future. For example, $100 invested today at a 5% annual return will grow to $105 in a year, whereas $100 received a year from now will still just be $100.
The Importance of Investing Early
Let’s consider two investors, Emma and Trinity investing in a fund that gives them a 10% annual return:
If Emma begins investing her money at age 25, investing $200/month for 30 years, her investment will be worth $1.26 million by age 65
If Trinity begins investing her money at age 35, investing $200/month for 30 years, her investment will be worth $451,000 by age 65
Starting 10 years earlier makes the difference between retiring with $451k in savings or $1.26 million in savings. Emma’s money had more time to compound, and those 10 extra years make the compound effect much more drastic. What is most important to remember is that when it comes to investing, the most impactful decision you can make is starting early.
Risk vs. Reward: Diversification
Different investments come with varying risks and rewards:
Lets consider you invest $10,000 in each of the following investments:
Tesla Stock (High Risk/High Return):
Potential for $100,857 over 10 years with a 26% average return
Risk of losing the principal investment of $10,000 if the company fails
Index Funds (Moderate Risk):
Potential for $25,937 over 10 years at 10% return
Represents broader market performance, the economy would have to fail to lose the principal investment
Government Bonds (Low Risk):
Potential for $14,380 over 10 years at 3.7% return
Minimal risk as the country’s economy would have to fail to lose the principal investment
When investing in equities, there is always a small chance that the company will go bankrupt, then your investment will be worth -$10,000. The question is, what is the probability that this will happen? Investing your money well involves finding a solution that maximizes return and minimizes risk. The best way to find this balance is through diversification. Depending on your goals and timeline, you can determine where you want to allocate your money and how much.
Other Investment Options:
Mutual Funds: Medium risk with pooled resources
Real Estate: Tangible assets with steady returns
Crypto: High risk and volatile but offers potential high rewards
Precious Metals: Low-risk options for preserving value
Invest in Yourself
Remember, you are your greatest asset. When you are a student with minimal capital, you can still invest in your future by finding ways to invest in yourself such as:
Relationships: Keep people around you who will encourage your personal growth
Education: Always continue to expand your skills and knowledge
Health: Invest time into physical and mental well-being
Perspective: Travel or read to learn more about the world around you
These "investments" can have the potential to yield infinite returns over time.
Budgeting and Planning
When you decide you are ready to start investing your money, think through the following steps to help guide your decisions:
Determine Your Goals: Tailor your strategy for where you are in life and what you would like to achieve. For example, if you are a student, you will most likely have very different near-term financial goals than if you are a parent.
Calculate Costs: Evaluate the recurring minimum expenses you need to live your life. This would consist of items like rent, utilities, food, transportation, insurance, phone bills, etc…
Choose Investment Accounts: There are several options in Canada that allow you to maximize your returns when investing, two of the most common accounts for long-term investing are the RRSP and TFSA. Both are investment vehicles in which you don’t pay taxes on internal investment growth, and you can invest in opportunities mentioned previously such as bonds, equities, index funds, etc… Some of the key differences include:
RRSP (Registered Retirement Savings Plan)
Primarily saved for retirement savings
Annual contribution limit of 18% your previous annual salary
Contributions are tax-deductible - they reduce your taxable income
Withdrawals are taxed
TFSA (Tax Free Savings Account)
Suitable for retirement savings, can be used for various financial goals
Annual contribution limit of $7,000*/year and can be carried over (*as of 2024)
Contributions do not reduce taxable income
Withdrawals are not taxed
Set Monthly Goals: After deducting recurring expenses, evaluate how much is left of your income and determine how much you would like to invest every month. When investing for retirement, your goal is to save enough money so you can withdraw from your savings for a long period of time without the money running out. You can use the 4% rule to guide your thinking in terms of determining how much money you need to save: If you draw 4% of your retirement savings each year, there is a very high degree of probability you will not run out of funds for 30+ years. Say you decide you want to live off $100,000 a year: 100,000/ 4% = $2,500,000 should be your savings goal. Investing is amazing because you only need to save a fraction of this amount to reach this goal.
Set Up Automatic Payment: Have your investments removed directly from your account every month, almost as if you never saw it in the first place. Once you have paid your recurring costs and your investments have been taken, the difference remaining can consist of your spending budget for the month. This can be “fun” items that you can purchase guilt-free knowing your necessary costs and investments have already been paid.
Final Tips for your Financial Independence Journey
· Always live below your means
· Be extremely aware of lifestyle inflation
· Remember that it does not matter how much you make, it matters how much you keep
· Start working on your credit score from an early age
· The younger you are, the more room you have to take risks with your investments, so take them
· Take time to determine what things actually make you happy and put your money towards them
By Emma Saganowich
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