Compound interest is the driver of wealth. A lot of people find it very difficult to wrap their minds around just how powerful compound interest is. After all, how could a simple and relatively easy to understand part of mathematics be so significant? Well, let me show you.

Let’s look at two middle class people, we’ll call them Sally Saver and Debbie Debtor. Both Sally and Debbie make the exact same income & hold the same investments, but Sally appreciates the importance of compound interest and shops around for a lower fee for her index fund. Sally ends up paying a slight difference of 0.72% less in annual fees  than Debbie does. Sally ended up securing a fee of 0.05% (red) and Debbie secured a fee of 0.77% (blue). Since Sally and Debbie are pretty normal and fall into the bottom 90% of people by wealth, it is likely they save between 0% and 5% of their income (which is awful). For simplicity we will assume they are going to save 3% of their income and that their income is identical to the U.S. median income of $52,250. So, what happens when Sally and Debbie start saving and investing for retirement at 30 and retire at 65?Compound interest

 

Well, what happens is that Sally, who shopped around for lower fees, retires with almost $73,000 more, or 19.9% more money, than Debbie does. The truly incredible thing is that the more they save and invest the worse the dollar value disparity becomes. For example, let’s look at what happens if our heroines Sally and Debbie decide to save and invest 10% of their income.

Compound interest_10

They are both substantially better off because they saved more money. In-fact, they are approximately 233% better off because they decided to save and invest 10% instead of 3% of their income. However, the dollar value disparity between Sally and Debbie becomes even more exaggerated. Now Sally is looking at retiring with almost $250,000 more than Debbie.

What is even more radical is to consider the difference between Sally and Debbie if Sally combines both the increased savings and lower fees while Debbie sadly forgoes both.

Compound interest and savings

As you can see, Sally finds herself in a radically different position than Debbie. Sally has nearly $1.5 million heading into retirement while Debbie has about $365,000. That is a difference of over a million dollars based off of a simple decision to save and invest more money in lower fee investments.

For those of you who enjoy tinkering and want to play around with your personal situation I’m making my excel file available to you. Please let me know if you have any questions about what I did or how you can manipulate the data yourself. Have fun!

Question: What kind of fees are you paying to your investment adviser? Do you think it is worth it? If so, why?

 

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2 thoughts on “The Million Dollar Decision

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