Positive Savings Rates Make a Huge Difference Over Time
September 25, 2009
Which Side of the Saver vs. Borrower Divide Are You On?
MoneyRates recently posted an compound rates infographic entitled "One Percent Makes all the Difference." This shows that retirement savers can accumulate a significantly larger nest egg just by adding one percent to the interest rate they earn. It's a compelling study--the example shows a couple earning an extra $205,000 just by shopping around for the best savings account interest rate--but as a practical matter, there may be even more to the story.
Shopping for higher bank rates is only one of the smart savings habits people need to acquire. It's also important to start saving early, because as a practical matter, very few people spend exactly what they earn. They tend to fall on one side of the line or the other--they are either accumulating savings or accumulating debt. Falling even slightly to one side of the line or another can make a huge difference over time.
Is Your Savings Rate Positive or Negative?
Take an example from each side of the savings vs. borrowing dividing line. One couple manages to save $100 a month for ten years. The other increases credit card debt by $100 per month. The difference is not huge--$2,400 per year. A little budget discipline on a day-to-day basis, or slightly more modest choices of automobiles or housing, could easily make that difference. For the couple that didn't make those smart choices, though, that little divide could grow into a gaping canyon.
Suppose the savers earn 2% on their money, and the borrowers pay 14% on their credit card debt. Those are representative annual bank rates and credit card rates, respectively. At the end of ten years, the savers would have accumulated $13,259.68 in principal and interest. The borrowers, meanwhile, would have built up $24,658.51 in total debt, including principal and interest. The $200-per-month difference in savings habits between these two couples would have grown to a total gap of $37,918.19. Clearly, falling just a little on one side or the other of the line between borrowers and savers can make a huge difference.
One other interesting thing about this analysis. Given today's low bank rates, in their first month of earning interest, the savers would have earned a grand total of just 16.5 cents in interest. Such a low reward for their good behavior might seem discouraging at first--and a target for derision by the less responsible couple. However, over time, these same good habits would earn them $1,259.68 in interest. More importantly, they would avoid the $12,658.51 in debt interest being accumulated by the other couple.
In short, even when bank rates are fairly low, the difference between interest on savings and interest on debt is still quite wide. Factor in some compounding over time, and the gap just gets wider.
Conclusion: Work on that Savings Rate!
As the above example shows, developing a steady savings rate is a habit that will pay off. Even with CD rates, money market rates and savings account rates on the low side, the difference between interest compounding on positive or negative balances is huge. You want to do all you can to be on the positive side of that divide.
Source: CardRatings.com: http://www.cardratings.com/
