1%, it seems so little and potentially, a regular person may think that it is very immaterial. However, when you apply it to your finances, this one percent makes a big difference!!
The Effect on Your Savings
Have you ever heard of the Rule of 72? It is a simple estimation to determine the number of years your money would double given a certain rate of return. The concept is that if you divide 72 by the rate of return on your savings, the resulting amount is the number of years your money will double. Remember, these are just estimates so you can see the effect of the rate of return on your investment without using a financial calculator.
For example, if the rate of return on your retirement account is 3%, and you put in a one-time lump sump of $100,000, then using the rule of 72, it would take 24 (72 Ã· 3) years for your investment to reach $200,000. Now, if we increase your rate of return by just 1% to 4%, it would take only 18 (72 Ã· 4) years for your money to reach $200,000. In this scenario, a one percent increased means 6 less years.
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Now letâ€™s look at it this way and these assumptions are just for illustrative purposes. Â Assuming that you want to retire when your retirement account reaches $1,000,000 and you have $500,000 lump sump to invest. And letâ€™s pretend that youâ€™re not going to put in any more in that account and you just want to let it grow by itself. Also, letâ€™s pretend that you have a choice between an investment that would give you a guaranteed 3% return or take a little risk on an investment that would yield a 4% rate of return. The rule of 72 estimated that you can retire 6 years earlier with the 4% return than with the 3% return. You see in this scenario, the 1% difference means six years of your retirement life.
Rule of 72 Table
|If the interest rate is||Your money will double in|
rule of 72
The Effect on Your Debts
When it comes to debts, the 1% difference affects your purchasing power. Letâ€™s assume that you want to purchase a house and you can pay $1,500 per month on your mortgage (or PITI). Using the table, with a 5%, you can purchase a house for $279,000. Now if the interest rate decreases by just 1% to 4%, then you would be able to purchase a much more expensive house for the same monthly payment with 30 years to pay. In this case, it is around $35,000. You see in this scenario, the 1% difference could be your down payment, upgrades on kitchen or floorings, or an extra bedroom!!
|Interest Rate||Home Prices|
rule of 72
Thus, you should always fight for every percent that you can get because even a little percentage could mean a lot of money down the road!!
Money Cone says
Love the way how you’ve explained the magnitude of percentages and interest!
This was a fantastic explanation! 🙂
The $60K Project says
This is a great reminder – I know that some investments in my 401(k) have much higher fees than others. I need to become more aware and take a closer look at these fees. Your explanation gave me a good kick in the pants!
Wow, I hadn’t thought about what a difference 1% makes in savings. I should have realized, since of course it makes a difference in debts, but I hadn’t seen it laid out that way before.