Ask Nanci: Should I Wait Until I’m Rich?

When To Start Investing

Curious-Almost-Thirty asks Nanci:

(BIG FAT Q.) I recently left a stable job at a nonprofit, where I was making about $28, 000 a year. It was my first “real” job, and I was pretty stoked to be earning a steady income with paid vacation and sick days, with enough money left over after rent and food for restos, movies and clothes. Unfortunately, caught up in the glitz and glam as I was, I didn’t do much about putting my some of my salary away to create a nest-egg or start building my financial portfolio. While I did eventually start transferring money to my savings account from each pay cheque, I didn’t actually save that money for long. Instead, I used it for larger purchases, birthday presents, and vacations. A guess a part of me thought that I wasn’t making “enough” to invest in longer-term financial planning.

After 4 years in that job, I left for some soul-searching and to shift gears a bit. I am now working as a freelancer, and make closer to $20, 000 a year. I am starting a 2-year masters program next year, which will hopefully qualify me for some more ballin jobs. I will likely be taking out a student loan of about $10,000 in order to complete this degree.

What is the minimum money you need to invest in order to make an investment worth it? And when is the right time to start investing?

Enough context, and now on to the question. I have a tax return of about $650 on its way. Do you think it is wise to invest that money in something, and if so, what? I currently have a chequing account, a savings account, and tax-free-savings account, with no investments.

Which, in turn, brings me to my more meta questions:  What is the minimum money you need to invest in order to make an investment worth it? And when is the right time to start investing? Should I wait til I am “rich”?

(BIG FAT A.) OMG, I am so glad you asked this question.  The best time to start investing?  10 years ago.  The next best time?  Today.   It could not be further from the truth that you need to be rich to start investing.  It is the absolute opposite.  Real wealth is often build slow and steady, over decades.  

It’s fine that you did not manage to keep any of your savings from your first job. Really. And the fact that you are still under thirty and are asking this question? Awesome.

What would a plan look like if I was allowed to give financial advice? 

Hypothetically, I would consider investing $400 or $500 of your tax refund. The remainder you can put in your savings account for a rainy day. (you know, because every girls needs good boots and a new lipstick for a rainy day!)

For many, many years your only low-cost option would be to have bought a mutual fund. Mutual funds have been sold for decades to investors with a “deferred sales charge” (DSC), which allowed your financial advisor to be paid between 4% and 5% the day you bought the mutual fund, but you did not pay anything. Instead, you were “locked-in” (aka: hog tied) for up to seven years while the mutual fund Manager collected annual fees on your total investment of up to 3%. And of course, you could have bought a single stock or two, but there would – and still is – a commission to both buy and sell stocks.

But don’t worry about all that – quite a bit has changed in just the last few years.

You can now buy ETFs though Questrade commission free for purchases. What exactly does this mean? It means you can buy monthly purchases of kick-ass, low-cost well-diversified index funds (did I mention low-cost?) for free. The catch (if you can even call it that) is you would pay a regular commission when you sell all or part of your position.

For example: (yes, I am now going to do yet another example of basic math. Come on, it is the only math I am good at!)

If you were to purchase:

$250 of VDY (Vanguard Canadian Dividend)
$250 of VUN (Vanguard Total U.S. Dividend)

That is $500 today at no fees.

» and then, $50 a month for the next two years, while you are in school (if you can afford it)  

» and then, $100 a month for the next 3 years while you pay your student loan off (yes, I want you to keep investing – even just a little bit – while you are paying off your student loan!) 

» and then, $500 a month for the next 2 years because your student loan is completely paid off, and because now you have a super, amazing job that you love. 

That would be: 

$500 + $1,200 + $3,600 + $12,000 =  $17,300 with no commissions or high fees! 

If for any (smart!) reason you decide to sell the funds (either you wanted to sell to purchase another investment within your Questrade account, or you wanted to use it as a downpayment on a home, or similar), you would pay a commission at that time.  Which I think is (wait for it) $5.99.  I am not making that up.  

If you were to invest your $500 today, and then only $100 a month for the next 40 years, at 6% compounding interest you would have $202,000!  Tax free

The above example is for illustrative purposes only, I did not take into account the minuscule annual management fee, nor did I factor in any capital gains or dividends.  What I do not need to take into account is taxes, because I want all of these investments to be in your Tax Free Savings Account (TFSA). So if the current TFSA that you have does not allow for commission free purchases on ETFs, run (don’t walk!) to Questrade where it is free to open the account and to purchase Vanguard ETFs. 

I hope I answered your question: What is the minimum money you need to invest in order to make an investment worth it?  

Because every $10 counts! If you were to invest your $500 today, and then only $100 a month for the next 40 years, at 6% compounding interest you would have $202,000! Tax free

So do it!  And then you will be an investor and have an investment portfolio. Fun!

Have a question? Ask Nanci


Three Answers

understanding compound interestThe Wall Street Journal published a blog a few weeks backa three question test of financial literacy (which of course unleashed fury in the comments on financial literacy – or lack thereof – in North America.)  But what I did notice was that while the answers to the three multiple questions were provided at the end of the post, no one took the time to explain why the answers are the answers. Which I think is not so great because if you didn’t get all or any of answers right, you might feel not-very-smart and that’s not allowed here on The Money Coach.

No stupid questions, just an industry that is most profitable when financial literacy is at a minimum. 

So let’s do this!  The first question was: 

1. Suppose you had $100 in a savings account and the interest rate was 2% per year. After five years, how much do you think you would have in the account if you left the money to grow?

A. More than $102
B. Exactly $102
C. Less than $102

The answer to this lies in understanding the concept of compound interest.  You can click that for the Wikipedia definition, but here is mine:

If you have $100 and you put it in a savings account that pays 2% per year, at the end of the first year you will have $102.  (100 x 2% or 100 x 1.02 = 102).  So that is after one year.  The questions asks how much you will haver after 5 years.  

Working this out from day one: 

Year one: 102 x 1.02 = $102
Year two: 102 x 1.02 = $104.04
Year three: 104.04 x 1.02 = 106.12
Year four: 106.12 x 1.02 = 108.24
Year five: 108.24 x 1.02 = 110.40

After five years, you would have $110.40 which is more than $102, therefore the answer is A.

If you break this down, the magic of compound interest is that not only does your original amount (in this case, $100) earn interest, each and every year,  but so does your year-on-year interest.  So in the second year, your $2.00 of interest (from the first year) is also earning 2% interest. And then in year three, your $4.04 is earning 2% interest, and the $$ and the years go by.

A common (and understandable) mistake is to take the 2% per year and multiply by it by 5 (the five years in the question) which is 10%, and so $100 x 10% is $110.  This however, is not correct because when your interest is paid annually (once every year), your interest payment then becomes part of your original amount (so at the end of year one, $100 because $102) and then also earns interest for each and every year thereafter.  

The concept of future value/compound interest/time value of money is one of the top three of this blog.  It is so important to understand, both in how earn money, but also in how you owe money (i.e. debt – mortgages, car loans, etc. work in the same way, against you – being, you have to pay interest on your interest.  More on this in the coming weeks.) 

 I will answer Questions two and three from the WSJ blog in the next few days.