This graph emphasizes why compounding interest works and why it does not pay to wait to begin saving. Compound Interest strategies can really make a difference in your retirement lifestyle. A person who begins saving at age 21 and saves a total of $24,000 by age 41 and assuming an 8% return on the investment which is reinvested will yield a total savings of $471, 358 by the age of 67. That is a lot of money and only based on savings of $24,000 by age 41. In reality, this person will probably continue saving all his or her life and accumulate much more than this already large amount.  However the point of this post is really about what someone who begins later in life and how much money they will actually have at age 67.

The graph above assumes someone begins saving much later in life at age 47, which unfortunately is when many people begin saving. This is the time when they suddenly realize that retirement is not far away and they do not have enough money saved for retirement. If this person began saving at age 47 and saves the same $24,000 by age 67. Including the average 8% annual return, this person will only have %59, 295 saved. Not very much for retirement and they are already 67. They are looking at many more years of working unless they have a pension to make up the income they need.

Starting to Save for Retirement Late is Scary – Compound Interest

For those of you who are reading this post and fit into the latter category, it will be a scary thought to wonder how you are going to survive on so little savings. It is going to be tough unless you can continue to work for many more years. Let’s face it, most of us do not want to work that long unless we really love our jobs.

In both cases, both parties saved $24,000 over a period of 20 years. However, the younger person began saving much earlier and so compounding continued for many more years and created much more wealth!

This is the main reason why we are so strong in suggesting that people begin early to save. There will be many market fluctuations along the way and some investments might not do so well, however, when you combine the growth of value for your investments combined with the income they generate, you will be much further ahead and closer to your retirement goals. The income should always be reinvested to earn additional income.

How difficult is it to Save $24,000 over Twenty Years?

Just doing the simple math i.e. dividing $24,000 by 20 to get the amount you need to save per year and then dividing by 52 to obtain the amount you need to save each week brings us to the huge sum of $23 a week. This is not a huge amount. Most people will spend much more than this amount on whatever vice they have.  Whether it is cigarettes, fancy coffees, drinks at the local bar, or whatever happens to be your particular interest, you can easily set aside $23 a week to save this kind of money by the time you are 67.

Imagine< $451 thousand by the time you are 67 and all you had to do was save $23 a week for twenty years beginning at age 21. chances are you will be able to save much more than that by saving a great deal more as your jobs pay more and your income grows. If you save 10% a year, or 10% a paycheck you will quickly be able to achieve these large numbers. You should be able to retire much younger than perhaps you have planned.

But I am too young to even Think About Saving for Retirement!

This is what most people say. They have too many other bills to pay. They are having too much fun. Also, they can worry about retirement later if they make it that far. Many people do make it that far. They also find that they have to work much longer than they planned just to live.

It is so simple. Just start saving now. Figure how much you need or want. How many years you have left before you want to retire? Use a number like 8% return on average to calculate how much money you need to save for retirement each week. If you do not know how to make this sort of calculation, sit down with a financial adviser. Ask him or her to do the calculation for you. You might be surprised how little you need to get started and save every week.

Once you start, it will quickly become a habit. You will not even miss the money and your future will be assured! And compounding interest will help you achieve your goals! Just aim for compound interest solutions!

Does interest rate fluctuations mean that  interest rates going up? One of the good things about the past recession or depression as some people would call it is that the interest we pay on loans and mortgages have been at historical lows. Many people would say this might be the only thing good thing about this  recession. If you lost your job, or your home or have gone further in debt you probably are not interested in what is occurring with loan and mortgage interest rates.

Interest Rate Fluctuations – Will they Change

However many of the worlds governments are letting their constituents know that interest rates are about to begin rising.  How much and exactly when interest rates will begin to rise is not yet known, yet most informed sources feel that they will begin to rise in the second half of 2010. There are various strategies that one should consider depending on whether you are an investor or a borrower.

Note that any suggested advice we discuss in this blog is just that advice. We do not have a crystal ball and we really have no idea what will occur, however it is one writers opinion. Make your own assessment , read lots of material and make your own independent decisions.

Investor Strategies

If you are an informed investor, then you probably have a diverse investment portfolio with blue chip investments distributed among stocks, mutual funds and bonds across the various market sectors. That’s a big mouthful, however the message is do not ever put all of your eggs in one basket!

Typically when interest rates go up, existing bond values fall to maintain the overall yield, while new bonds being issued will have to offer higher interest rate yields to match the market interest rate. Dividend paying stocks also will decline so that overall yields will match the going interest rates on the market.  Of course many other events can influence the value of the stock, such as corporate earnings and other market issues which will impact the overall value of the stocks value.

So what should you do when you see that the government is about to increase interest rates. If you are betting that the increases will be relatively minor, that they will not need to fight serious inflation, then you can take your time and be somewhat more careful about your plans.

Most people are long term investors, aiming at generating income and growth of their portfolios. With this in mind, fluctuations in interest rates and their corresponding impact are less troublesome. However there are some things you can do to make sure you take advantage of increasing interest rates and avoid the loss of income as interest rates decline.

Interest Rate Fluctuations – Bond Ladders

Creating a bond ladder allows you to invest in bonds with maturities over various years. For example if you have $100,000 , then investing $10,000 with a maturity in subsequent years lets you take advantage of bonds maturing every year instead of all at once when interest rates are low. You may not be able to invest all of your money at the highest interest rates, however your overall average will be higher than the lowest market interest rate.

As interest rates drop, you may find that bond lenders may call their bonds early. With this option, which many bonds have, the bond owners can pay off their bonds early. They issue new bonds at a much lower interest and save thousands of dollars. This is not a good situation for many investors who might be counting on this income. As you invest in bonds, always inquire whether the bond is callable or not and when. You will need to make your decision to purchase a callable bond, based on your assessment of where interest rates are headed.

We really like bond ladders with non callable bonds when interest rates are declining and especially when they are rising. We also like keeping approximately 5 to 10% of our portfolio in cash. If interest rates are headed up we can take advantage of the increasing rates.  By cash we mean money markets or GICs with early maturity dates. You will not make much money, but every little bit counts. You will be ready when a good deal comes along.

What to do If you are Borrowing Money

Interest rates are currently expected to rise. What should you do if you have a mortgage? Or a loan, or planning to borrow a large sum of money?

If you believe interest rates are going to rise significantly, it may be time to lock in your mortgage or loan so that you will not be hit by a financial shock when they do increase. You may find that there are hundreds of dollars added to your monthly payment when interest rates do rise.

If interest rates stay low for some time, you can actually save money by staying with an open mortgage. The interest rate will be tied to the bank rate. There is some risk to this approach because you could get caught if interest rates increase rapidly.

Bottom Line

If you are a risk taker, then you will take a more aggressive approach. You will be avoiding locking in your mortgage or loan for up to 5 years or more. On the other hand if you worry a lot or cannot withstand a financial shock, take a different approach. Locking in interest rates will protect you from fluctuations in monthly payments as interest rates change! At least you will not lie awake at night worrying about this issue.

Comments are welcome as are suggestions about what to do in this current situation.