1% more interest doesn't matter? Think again!

in money •  5 months ago

People tend to think that one percent doesn't matter when it comes to investing. We think that if we have 4 or 5 percent interest, it really doesn't make a difference. Therefore, we don't stop to think how much a 1% investment fee will set us back in the long run. One percent from a hundred dollars is only 1 dollar, what's the big deal? Let me explain. But first I want to thank @scaredycatguide for the idea, he recently made a post about how 1% kills your investment, even though I don't think that is quite the case, it is still crucial to understand how much 1% can influence your investments!

Why should I care about the difference between 5% and 4% when investing. It is only 1% right?

Let's start of with a figure:

fourorfive.JPG

In the figure you see how an investment of $1000 a month for 40 years grows. Notice how the difference starts to show clearly after 20 years. I'm using 40 years as an average amount of years one person might work, to show how much they could potentially build up their wealth by saving $1000 a month. By the time they retire they would have approximately $1 449 000 if they were to get 5% interest, but if they only got 4% interest they would "only" have approximately $1 140 000. Now, this is why I think one percent doesn't kill investing, you still end up with over a million dollars, even if you only manage half of what the market grows. However, just by making 1% more in 40 years, you end up with a whooping $300 000 more.

So how much does 1% affect at each different percent per year?

Ok, so lets examine how much the difference is when we look at realistic percentage growth each year, again investing $1000 each month for 40 years:

Percentage differences.JPG

Wait, where did that 4% go? Oh, there it is! You see that small line at the bottom colored in pink?

So, if the difference between 4% and 5% didn't make you wonder if you should care, I hope the difference between 4% and 10% at least makes you think.

Now, lets look at the differences. They are rather small on the scale of things for the first 20 years or so. Of course, don't let the scale fool you. The difference between 4% and 10% in 20 years is already about 34 thousand. But by the end of 40 years it is over 4 million. Anyway, that isn't my main point in this post. My main point is that when you're investing long time. A difference of 1% or 2% might not seem like much, but actually the longer you invest the larger the difference becomes! The difference between 9% and 10% in 40 years for example is already over a million dollars. Unfortunately the difference between 9% and 8% is also about $900 000 dollars. But don't let that discourage you, even if 8% is what you can realistically manage, as I like to think. The amount you end up with 8% interest over 40 years with investing 1000 a month is approximately $3 100 000. Now tell me that you ain't smiling at that sum :)

What is this sorcery?

This is what Albert Einstein allegedly called "the eight wonder of the world" meaning of course compound interest. He also allegedly added: "He who understands it, earns it ... he who doesn't ... pays it."

Compound interest is my favorite thing in investing. By compounding your interests, you always build up more interest on top of your interest and that starts to build up quickly and goes to the moon! Ok, getting a bit too excited here. Anyway, if you're interested, have a look at some of my earlier posts about it. Haven't written one in 7 days so don't bother upvoting them, but you can still have a read :)

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great post, I love Rule 72, been using it for years.

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Thanks. I rather use online compound interest calculators than manual calculation with rule 72. The one I mostly use is in Finnish so I won't share it here. But there are a ton online.

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ya i use ones that i program myself, but easy one to use is calculator.net, easy calculations on there.

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this is interesting. still lots to learn from you.

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It is a very cool effect. When one visualizes it on a chart the effect becomes more clear :)

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yes, if not by the chart i also wouldnot notice how big is the difference.