« Cheap or Free Entertainment Ideas | Home | Friday Finance Reads »
August 18, 2005
How Much is One Percent Worth?
When choosing a savings account or CD, it's obvious that one of the things to look for is a high interest rate. But sometimes it's not clear exactly how much that extra point of interest will be worth.
If you save $10 a month, how much difference will an extra point make? If you don't really have a good idea of how much that is, the table below will show you!
Saving $10 a month, interest compounded monthly:
| 3% | 4% | 5% | |
|---|---|---|---|
| 1 year | 121.66 | 122.22 | 122.79 |
| 5 years | 646.47 | 662.99 | 680.06 |
| 10 years | 1,397.41 | 1,472.50 | 1,552.82 |
| 20 years | 3,283.02 | 3,667.75 | 4,110.34 |
| 30 years | 5,827.37 | 6,940.49 | 8,322.59 |
| 40 years | 9,260.60 | 11,819.61 | 15,260.20 |
You can see that after one year, the difference is not so great -- less than one dollar per point. So how is it that after forty years, the difference is $2,259 from 3% to 4%, or $3,440.59 from 4% to 5%? That's a lot more significant than $1 a year!
Even an extra $1 the first year, $2 the second year (since you've saved twice as much), and so on would only add up to $820 after forty years. What accounts for such a dramatic difference?
Our old friend, compound interest
The answer, once again, is compound interest. Not only are you earning interest on the money you save, but you get to earn interest on the interest that gets added to your account!
It doesn't seem like that would add up to so much, but after forty years, saving $10 a month, you have deposited $4,800. If you'd stuck the money in a jar, that's all you'd have. But at 4% interest, you've more than doubled your total investment.
And if you could manage to get a 5% interest rate, that's another $3,440, nearly as much as you contriubted in the first place. That's what one percent is worth.
A word about inflation
Note: this does not take inflation into account, which at about 3% a year, would wipe out any gains from a savings account with 3% yield. You want to shoot to earn a higher interest rate than inflation! The idea here is just to illustrate the difference one point of interest can make in the long run.
Posted by Frank at August 18, 2005 8:04 AM
