Why you can’t “save” a million…

But how you can still retire rich

You may as well face facts: You can’t “save” a million dollars. A recent survey of the market showed that the highest rate paid in a standard, plain-vanilla deposit savings account (the kind that most banks and large financial institutions offer as a place to put your cash) was around 2.8%, while the lowest was, believe it or not, one tenth of 1%. Believe me, with this kind of return, you will not be able to “save” a million dollars. But another fact is that you can still retire rich, possibly with much more than a million dollars in your nest egg, once you unshackle yourself from the savings account trap. Here’s how.

The “money losing” account

Let’s say you decide to put your money in a typical bank savings account, at an interest rate of, say, 2% annually. Starting at age 30 with $1,000 and adding $200 per month for 35 years, you’ll wind up with a total of about $168,000. That’s a long way from a million bucks. And only about $47,000 of that would be the interest you’ve earned. Factor in inflation, currently running about 2%, about 30% tax on the interest income, and the monthly fee the bank charges you just for keeping your money on deposit, and you’re actually losing money – plenty of it – on every dollar you’re allegedly “saving.”

So how do you actually manage to retire rich if you can’t “save” a million?

It’s not easy. But with the right guidance, there are ways to invest your money with a much higher return, at a risk level that lets you sleep nights, with a decent return to boot. Stocks, bonds, mutual funds, exchange-traded funds open up a universe of investment alternatives. As a simple example, take the venerable mutual fund. These are still the investment of choice for hundreds of thousands of investors, who at last count, have put over $1 trillion into mutual funds in Canada. Some of these funds have been around for 20 years and more. And some have posted an average annual compounded rate of return of 9% or more over those 20 years.

Let’s be conservative and defensive and use an even lower rate of return. At an average annual compounded rate of return of 5%, that same initial $1,000 with a $200 monthly investment you would have put in a savings account for 30 years would grow to about $170,000, with nearly $100,000 of that coming from investment return. It beats a “savings” account hands-down. And if you use a Tax-Free Savings Account to invest, you’ll never pay a cent of tax on any of that income!

Raise the monthly deposit amount (which most people do as they advance in their careers) and the rate of return, and you’ll soon be closing in on that million-dollar nest egg. Starting with, say, a $5,000 deposit, investing an additional $400 per month (increasing at a 2% inflation rate), at an average annual compounded rate of return of 9% for 35 years, will give you a nest egg of about $1.4 million.

I think you get the point by now. Getting to a million isn’t easy. But with a little common sense and a few basic rules, you can make a good start on meeting that objective of financial security by the time you retire.

Don’t start with a marathon. Even before you start researching stocks, mutual funds, or ETFs as potential investments, you have to start with the basics. First, remember that there is no free lunch. If you are serious about investing, then you will need to start from ground zero and build from there.

Apply money basics. It’s all about getting a grip on your income and your outgo. Live within your means, and do not spend more than you earn. Simple advice, and something you’ve probably heard a thousand times. Yet, many people just seem unable to follow it. That’s where planning comes in. Most people benefit from a written plan – somehow that makes your goals seem more “real.” You do not need to make a six-figure salary to become a successful investor, but you do need to set out a diligent savings goal and investment plan that will span decades.

Make it grow. Understand the power of compounding. As we’ve seen, this is the principle that any earnings from an asset will in turn generate their own earnings. Compounding allows your original investment amount to grow faster when earnings are reinvested than when earnings are paid out. Most people will have heard about “compound interest,” which is simply the principle of compounding applied to risk-free interest-bearing assets, like Guaranteed Investment Certificates and those so-called “savings” accounts, where the interest earns interest. Apply it to an investment portfolio and the compounding machine really goes to work.

Cut taxes. This is perhaps the most important rule of all, because tax efficiency accounts for a large chunk of investment return – as much as 28% according to research. So make full use of tax-free, tax-deferred, and tax-efficient investment plans and products. It’s what I call the “The Wealth Effect.” While the type of securities you hold (asset mix) and the choice of securities (security selection) are important, tax-efficiency is absolutely critical for building wealth, and it’s the one element over which you have the most control.

The best route to tax efficiency for most investors is to use a Registered Retirement Savings Plan (RRSP) and a Tax-Free Savings Account (TFSA).

With an RRSP, contributions are tax deductible, a feature that could earn you a tax refund every year. However, investments grow in the plan on a tax-deferred basis – in other words, you won’t have to pay tax on interest, dividends, or capital gains on investments in an RRSP until you withdraw funds from the plan – at which time withdrawals are treated as ordinary income and taxed at your full marginal rate. Still, there are various “maturity options” and strategies you can take advantage of to mitigate the tax impact when it comes time to collapse your RRSP.

In a Tax-Free Savings Account, contributions are made with after-tax dollars (you don’t get a tax deduction). But investment growth accumulates within the plan completely tax-free, and withdrawals are totally tax-free. The other difference from an RRSP is that the annual contribution limit is much lower.

Good advice is crucial. For those of us who want to do more than “save” our money, getting the right kind of financial planning and investment advice is crucial. The kind of counsel that is cool, objective, balanced, and highly disciplined. Once you understand the rules, the rest falls into place. Create an investment plan that matches your risk-tolerance level. For example, it makes absolutely no sense to say you’re a conservative investor and then jump into trading penny mines on the TSX Venture Exchange. Once you’ve set your investment plan in motion, track it weekly or monthly. You’ll be surprised how fast your investable assets can grow when you take control, and get out of the savings account trap.

Robyn Thompson, CFP, CIM, FCSI, is the founder of Castlemark Wealth Management, a boutique financial advisory firm specializing in wealth management for high net worth individuals and families. Contact her directly by phone at 416-828-7159, or by email at rthompson@castlemarkwealth.com for a confidential planning consultation.

Notes and Disclaimer

The foregoing is for general information purposes only and is the opinion of the writer. Securities mentioned are illustrative only and carry risk of loss. No guarantee of investment performance is made or implied. It is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice. Please contact the author to discuss your particular circumstances.