Importance of saving rate
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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. Further, importance of saving early is also well documented to reach the individuals financial goals. In this article, role of savings rate is presented to understand its impact on an investors financial goals. Role of savings rate effect is compared with return on investment.
Savings rate is defined as percentage of income saved by an individual or entity towards a financial goal.
To put the savings rate in perspective, let us say two investors A and B make $100,000. Investor A, saves 4% of income ($4000) 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. 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. 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. Below chart will help visualize the relation between savings rate and return on investment for savings.[]