Difference between revisions of "Importance of saving rate"

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In '''{{PAGENAME}}''', ''savings rate'' is compared with an investor's Return on Investment (ROI) in order to understand its impact on an investor's financial goals.
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In '''{{PAGENAME}}''', ''saving rate'' is compared with an investor's Return on Investment (ROI) in order to understand its impact on an investor's financial goals.
  
 
Investors often focus primarily on [[asset allocation]], expenses associated with investments (such as transaction fee, [[expense ratios]]), tax efficiency (types of account), sector allocation, active vs passive etc, to maximize the return on investment to attain a financial goal. Further, the [[importance of saving early]] is also well documented.
 
Investors often focus primarily on [[asset allocation]], expenses associated with investments (such as transaction fee, [[expense ratios]]), tax efficiency (types of account), sector allocation, active vs passive etc, to maximize the return on investment to attain a financial goal. Further, the [[importance of saving early]] is also well documented.
  
Achieving an investor's financial goals is a combination of not only market returns, but the amount saved over time (the ''savings rate'').
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Achieving an investor's financial goals is a combination of not only market returns, but the amount saved over time (the ''saving rate'').
  
==Savings Rate==
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==Saving Rate==
Savings rate is defined as percentage of income saved by an individual or entity towards a financial goal.<ref>{{cite web |url= https://www.investopedia.com/terms/s/savings-rate.asp|title= Savings Rate|author=Jim Chappelow |date= May 15, 2018 |website= |publisher= [https://www.investopedia.com/ Investopedia]|access-date= |quote=}}</ref>
+
Saving rate is defined as percentage of income saved by an individual or entity towards a financial goal.<ref>{{cite web |url= https://www.investopedia.com/terms/s/savings-rate.asp|title= Savings Rate|author=Jim Chappelow |date= May 15, 2018 |website= |publisher= [https://www.investopedia.com/ Investopedia]|access-date= |quote=}}</ref>
  
To put the savings rate in perspective, let us say two investors A and B make $100,000. Investor A, saves 4% of income ($4,000) consistently for 30 years, with return on investment on savings at the rate of 6% will have $316,233 at the end of 30 year period.
+
To put the saving rate in perspective, let us say two investors A and B make $100,000. Investor A, saves 4% of income ($4,000) consistently for 30 years, with return on investment on saving at the rate of 6% will have $316,233 at the end of 30 year period.
  
However, investor B saves 6% of income ($6,000) but the return on investment on savings was only 4% will have savings of $336,510 at the end of 30 year period.
+
However, investor B saves 6% of income ($6,000) but the return on investment on saving was only 4% will have saving of $336,510 at the end of 30 year period.
  
The increase in savings rate is crucial particularly if the return on investments is low. However if return on investments are very high, then the impact of savings rate become relatively less important.
+
The increase in saving rate is crucial particularly if the return on investments is low. However if return on investments are very high, then the impact of saving rate become relatively less important.
  
Alternately, if the savings rate is less than 4%, the savings rate has huge impact on the end balance over the rate of return.
+
Alternately, if the saving rate is less than 4%, the saving rate has huge impact on the end balance over the rate of return.
  
Table 1 below will help visualize the relation between ''savings rate'' and ''return on investment'' for given savings rate.
+
Table 1 below will help visualize the relation between ''saving rate'' and ''return on investment'' for given saving rate.
  
For example, with a savings rate of 1%, a 12% return on investment is necessary to save $241,334. Whereas, for a savings rate of 2%, a return slightly over 8% will suffice to achieve the same end balance of $241,334.  
+
For example, with a saving rate of 1%, a 12% return on investment is necessary to save $241,334. Whereas, for a saving rate of 2%, a return slightly over 8% will suffice to achieve the same end balance of $241,334.  
  
 
'''Table 1: Saving Rate (SR) Vs Return on Investment (ROI) for Savings.  
 
'''Table 1: Saving Rate (SR) Vs Return on Investment (ROI) for Savings.  
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In the initial phase of accumulation of wealth, savings rate has the most impact in increasing the nest egg. The return on investment becomes important only after the nest egg has grown significantly or after it achieved a critical mass.<ref>{{cite web|author=|title=Your Savings Rate is More Important Than Your Rate of Return|url=https://www.biglawinvestor.com/savings-rate-important-rate-return/|publisher=Biglaw|date=April 3,2019}}</ref>
+
In the initial phase of accumulation of wealth, saving rate has the most impact in increasing the nest egg. The return on investment becomes important only after the nest egg has grown significantly or after it achieved a critical mass.<ref>{{cite web|author=|title=Your Savings Rate is More Important Than Your Rate of Return|url=https://www.biglawinvestor.com/savings-rate-important-rate-return/|publisher=Biglaw|date=April 3,2019}}</ref>
  
 
To achieve a financial goal, investor only have to control the savings rate rather than depend on market returns.<ref>{{cite web|author=|title=Savings Rate vs. Investment Return: Which is more important in wealth creation|url=https://www.thorwealthmanagement.com/savings-rate-vs-investment-return/|publisher=Thor|date=September 10,2018}}</ref>
 
To achieve a financial goal, investor only have to control the savings rate rather than depend on market returns.<ref>{{cite web|author=|title=Savings Rate vs. Investment Return: Which is more important in wealth creation|url=https://www.thorwealthmanagement.com/savings-rate-vs-investment-return/|publisher=Thor|date=September 10,2018}}</ref>
  
Thus to achieve a particular financial goal, savings rate is more important than returns.<ref>{{cite web|author=David Blanchett|title=A Closer Look at the Cost of Retirement: Savings, Not Returns, Are Key|url=https://www.morningstar.com/articles/793326/savings-not-returns-key-to-secure-retirement|publisher=Morningstar|date=February 11,2017}}</ref> [https://www.morningstar.com/ Morningstar] had recommended some suggestions to increase the savings rate.<ref>{{Cite web|author1=Jason Stipp|author2=Christine Benz|title=Three Simple Ways to Bump Up Your Savings Rate|url=https://www.morningstar.com/articles/680306/3-simple-ways-to-bump-up-your-savings-rate|publisher=Morningstar interview|date=January 16, 2015}}</ref>
+
Thus to achieve a particular financial goal, saving rate is more important than returns.<ref>{{cite web|author=David Blanchett|title=A Closer Look at the Cost of Retirement: Savings, Not Returns, Are Key|url=https://www.morningstar.com/articles/793326/savings-not-returns-key-to-secure-retirement|publisher=Morningstar|date=February 11,2017}}</ref> [https://www.morningstar.com/ Morningstar] had recommended some suggestions to increase the saving rate.<ref>{{Cite web|author1=Jason Stipp|author2=Christine Benz|title=Three Simple Ways to Bump Up Your Savings Rate|url=https://www.morningstar.com/articles/680306/3-simple-ways-to-bump-up-your-savings-rate|publisher=Morningstar interview|date=January 16, 2015}}</ref>
  
 
==See also==
 
==See also==

Revision as of 00:15, 9 January 2020

In Importance of saving rate, saving rate is compared with an investor's Return on Investment (ROI) in order to understand its impact on an investor's financial goals.

Investors often focus primarily on asset allocation, expenses associated with investments (such as transaction fee, expense ratios), tax efficiency (types of account), sector allocation, active vs passive etc, to maximize the return on investment to attain a financial goal. Further, the importance of saving early is also well documented.

Achieving an investor's financial goals is a combination of not only market returns, but the amount saved over time (the saving rate).

Saving Rate

Saving rate is defined as percentage of income saved by an individual or entity towards a financial goal.[1]

To put the saving rate in perspective, let us say two investors A and B make $100,000. Investor A, saves 4% of income ($4,000) consistently for 30 years, with return on investment on saving at the rate of 6% will have $316,233 at the end of 30 year period.

However, investor B saves 6% of income ($6,000) but the return on investment on saving was only 4% will have saving of $336,510 at the end of 30 year period.

The increase in saving rate is crucial particularly if the return on investments is low. However if return on investments are very high, then the impact of saving rate become relatively less important.

Alternately, if the saving rate is less than 4%, the saving rate has huge impact on the end balance over the rate of return.

Table 1 below will help visualize the relation between saving rate and return on investment for given saving rate.

For example, with a saving rate of 1%, a 12% return on investment is necessary to save $241,334. Whereas, for a saving rate of 2%, a return slightly over 8% will suffice to achieve the same end balance of $241,334.

Table 1: Saving Rate (SR) Vs Return on Investment (ROI) for Savings. Assumptions: Annual income: $100,000. Future value calculated assuming money invested at the end of period for 30 years.

ROI SR SR SR SR SR SR SR SR SR SR
1% 2% 3% 4% 5% 6% 7% 8% 9% 10%
1% $34,785 $69,570 $104,355 $139,140 $173,924 $208,709 $243,494 $278,279 $313,064 $313,064
2% $40,568 $81,136 $121,704 $162,272 $202,840 $243,408 $283,977 $324,545 $365,113 $405,681
3% $47,575 $95,151 $142,726 $190,302 $237,877 $285,452 $333,028 $380,603 $428,179 $475,754
4% $56,085 $112,170 $168,255 $224,340 $280,425 $336,510 $392,595 $448,680 $504,764 $664,388
5% $66,439 $132,878 $199,317 $265,755 $332,194 $398,633 $465,072 $531,511 $597,950 $664,388
6% $79,058 $158,116 $237,175 $316,233 $395,291 $474,349 $553,407 $632,465 $711,524 $790,582
7% $94,461 $188,922 $283,382 $377,843 $472,304 $566,765 $661,226 $755,686 $850,147 $944,608
8% $113,283 $226,566 $339,850 $453,133 $566,416 $679,699 $792,982 $906,266 $1,019,549 $1,132,832
9% $136,308 $272,615 $408,923 $545,230 $681,538 $817,845 $954,153 $1,090,460 $1,226,768 $1,363,075
10% $164,494 $328,988 $493,482 $657,976 $822,470 $986,964 $1,151,458 $1,315,952 $1,480,446 $1,644,940
11% $199,021 $398,042 $597,063 $796,084 $995,104 $1,194,125 $1,393,146 $1,592,167 $1,791,188 $1,990,209
12% $241,333 $482,665 $723,998 $965,331 $1,206,663 $1,447,996 $1,689,329 $1,930,661 $2,171,994 $2,413,327

In the initial phase of accumulation of wealth, saving rate has the most impact in increasing the nest egg. The return on investment becomes important only after the nest egg has grown significantly or after it achieved a critical mass.[2]

To achieve a financial goal, investor only have to control the savings rate rather than depend on market returns.[3]

Thus to achieve a particular financial goal, saving rate is more important than returns.[4] Morningstar had recommended some suggestions to increase the saving rate.[5]

See also

References

  1. Jim Chappelow (May 15, 2018). "Savings Rate". Investopedia. External link in |publisher= (help)
  2. "Your Savings Rate is More Important Than Your Rate of Return". Biglaw. April 3,2019. Check date values in: |date= (help)
  3. "Savings Rate vs. Investment Return: Which is more important in wealth creation". Thor. September 10,2018. Check date values in: |date= (help)
  4. David Blanchett (February 11,2017). "A Closer Look at the Cost of Retirement: Savings, Not Returns, Are Key". Morningstar. Check date values in: |date= (help)
  5. Jason Stipp; Christine Benz (January 16, 2015). "Three Simple Ways to Bump Up Your Savings Rate". Morningstar interview.