How Much Is 1% Really?

By Pinyo, on June 23, 2009

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.

Earning 1% More For Your Savings

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.

Reducing Your Investment Expenses By 1%

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!

Get Better Interest Rates Today

If you have been ignoring your interest rates or expenses, consider doing something about them now. Here are a few things you can do:

• Check this list of savings banks with highest interest rates and move your money
• Switch to investments with lower expense ratio
• Switch to an investment broker that charges lower trading fees
• Transfer your credit card balance to a lower interest rate credit cards
• Refinance your home mortgage
• Lower your household expenses
• Increase your savings rate — i.e., contribute more to your 401k and IRA, or simply add more money to your savings.
• Improve your credit score so you can take advantage of lower interest rates

Pinyo is the owner of Moolanomy Personal Finance and an entrepreneur with over 20 years of business experience. He is interested in business management, investing and wealth management. He has written for many online publications, including American Express Currency and U.S. News Money. You can follow him on Facebook and Twitter.

Add Your Question or Comment (8 Comments)

1. Mike Piper:

   June 24, 2009 at 7:42 am

   Indeed. This is what John Bogle refers to as the wonderful magic of compound returns and the powerful tyranny of compound costs.

   I’m nothing short of miserly when it comes to my investment costs.
2. My Journey:

   June 24, 2009 at 12:35 pm

   Pinyo,

   Regarding the rate chasing for saving accounts – I couldn’t disagree more. You think the headache of rate chasing, having how many bank accounts open, the tax documents, etc. is worth an extra $166 a year (or $13 bucks a month)?! Not to mention the bank can change their terms at any time.

   As far the investment fees, I agree. It may sound counterintuitive but I view them differently
3. Cat:

   June 24, 2009 at 2:03 pm

   I love compound interest, but my main concern is that rate chasing hasn’t paid off for me in the past. I started an HSBC account. They dropped their rate, so I switched to ING. They dropped their rate, so I switched to Etrade. Now I’m looking at Ally and wondering if after I go through the hassle of changing they’ll drop their rate after a month and I’ll be right back where I was, but with one more account to keep up with. I think I’ll wait for things to stabilize before I go back to my rate chasing ways.
4. Ryan Smith:

   June 24, 2009 at 6:59 pm

   You are very right about improving you credit score to get better rates. A half percent rate difference adds up on a 15 or 30 year mortgage.
5. Jim:

   June 25, 2009 at 4:37 pm

   When I hear “rate chasing” generally it seems to be applied to frequently moving your savings around to keep it in the online account that has the highest interest rate at any given time. And generally I don’t think its applied to moving from 1% to 2% but more like moving from that Ally account at 2.0% to a Bank of Internet account at 2.06%.

   I certainly think getting 1% more interest over the long term is worth it.

   But constantly moving your money around high yield savings accounts to chase a 0.0x% difference every month or week is really not worth it.

   Jim
6. DDFD:

   June 28, 2009 at 10:50 am

   Ah! The magic of compound interest! Great post!
7. 1percenttrader:

   June 30, 2009 at 6:00 pm

   1% is awesome, especially when you control your own investments and are able to get it once a week. I dumped my broker long ago and haven’t looked back since. Compound Interest is even sweeter when I am not wasting money paying someone to handle my cash.
8. defiscalisation:

   October 19, 2009 at 8:36 am

   yes, sometimes 1% represents a lot! funny we don’t realize that!