Why low rates benefit new savers: The story of Joe and Jane

Earning interest is supposed to be one of big incentives for saving money. So wouldn't today's low bank rates take the wind out of a new saver's sails? Believe it or not, it's the other way around. Low interest rates for savings accounts, money market accounts and CDs actually make a stronger case to start a savings program.

From a historical perspective, sometimes interest rates are high, and sometimes they're rock-bottom. While high interest rates might seem like a better incentive for new savers, you'd actually be better off with interest rates at a low point when you start your savings program than to encounter that low point later on.

Joe vs. Jane: A tale of two money market accounts

Let's take the case of two savers, born 20 years apart.

Joe, born first, starts saving when money market rates are at 5 percent, and sets aside $10,000 at the beginning of each year. Over the next 19 years, he sees money market rates gradually decline, by a quarter of a point per year, until they are at 0.25 percent in the 20th year that Joe is saving.

That's when Jane, born later, reaches the age where she starts saving. She also sets aside $10,000 per year, and over the next 19 years she sees money market rates rise by a quarter point a year, until they reach 5 percent in the 20th year that she is saving.

Over 20 years, Joe and Jane each put the same amount into their money market accounts, and over time they each experience the same range of money market rates. The only difference is that, in Joe's case, those rates went from high to low, whereas Jane saw them go from low to high.

Who comes out ahead ? Surprisingly, at the end of 20 years, Jane would have $287,366, and Joe would have $245,069, or more than $40,000 less than Jane.

Why higher money market rates later is better

Why the difference?

Joe experienced high interest rates in his early years of saving, when he had very little money in the bank earning interest. By the time his deposits accumulated, interest rates were already slipping lower and lower.

Jane, on the other hand, experienced low interest rates early on, when she had little money earning interest anyway. Her deposits accumulated in time to make the most out of the high money market rates that prevailed later.

In a perfect world, you'd have high money market rates all throughout your prime saving years. But it's a fact of life that interest rates rise and fall over time, and if you have to encounter a period of low rates at some point, it turns out that you come out ahead if you have high money market rates come later in your saving years.

Whether you've just started saving or are saving to catch up, the temptation with a low-rate environment is to tell yourself you wouldn't be earning much interest anyway. Although the dismal bank rates today seem like a disincentive to save, the lesson that Joe and Jane can teach us is that it's better to have the money market account stocked up in the lean years to take advantage of a steady upswing in rates when it happens.

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