On occasions when I discuss interest rates or investments expenses, I get comments saying that rate chasing is not worth it. To show you that rate chasing is worth it, I am going to show you some math. One percent may not seems like much, but given enough time, 1% is much bigger than you imagine.
Many of you are saving your money in a traditional savings account. Let’s assume you have $10,000 in savings and your bank pays a generous 1.00% APY. You’ll have $10,100 after the 1st year, and $13,478 after 30 years.
On the other hand, if you put $10,000 in Ally Bank which currently pays 2.00% APY, you would have $10,200 after the 1st year, and $18,114 after 30 years — almost 35% better returns over 30 years!
Now, let’s assume you add $2,500 to your savings at the end of each year. You will have about $100,000 at 1% interest rate and almost $120,000 at 2% interest rate. Personally, I think the extra $20,000 is not a bad price to pay for being a rate chaser.
One of the most important factors I consider when investing in the stock market are the expenses I incur. Why? A expense as a percentage of overall portfolio value, or expense ratio, is the only guarantee performance you will get in the stock market.
What does that mean? Consider two mutual funds, one with an expense ratio of 1.21% and another with 0.21%. There is no guarantee that the more expensive fund will outperform the cheaper fund; however, you are guaranteed to have 1% better return on investment with the cheaper fund.
Assuming both funds have an average return of 8% per year before expenses, fund A will have average net return of 6.79% and fund B will have 7.79%. After 30 years, your $10,000 investment I fund A would grow to approximately $72,000 and money in fund B would grow to approximately $95,000!
Now lets’ assume you add $10,000 to your portfolio at the end of each year. After 30 years, your $10,000 investment I fund A would grow to approximately $981,000 and money in fund B would grow to approximately $1,185,000!
If you have been ignoring your interest rates or expenses, consider doing something about them now. Here are a few things you can do: