What matters more – your personal savings rate or your investing rate of return?
Your instinct is probably to say the latter, as that is what gets far more attention. We are often thinking about how we can make a higher return; we rarely think about saving more. I shudder to think of the impact one will realize if they simply try to “ear” their way to retirement security. Here me. One cannot control returns but one can control how much they save. So which is more important?
In reality, though, saving is far more important for the majority of Americans.
If we assume various savings rates on this $49,300 (1% to 5.5%) and various returns (1% to 10% annualized), where does this leave the average household after 30 years (to simplify, we’ll assume no taxes and no inflation)? Was it more important to earn a higher return, or to save more?
The answer may surprise you.
If the average household saves 1% per year and earns a 10% rate of return, they are left with $81,096 after 30 years. If they instead save 5.5% per year (the national average) and earn only a 1% rate of return, they are left with a higher balance: $94,319.
Source: Pension Partners
Note: Table Assumes No Taxes/Inflation
To further illustrate, let’s compare a 1% increase in your rate of return versus a 1% increase in your savings rate:
- If the average household saves 1% per year and earns a 5% return per year, after 30 years they are left with $32,754. A 6% return would bump this up to $38,976, a 19% increase.
- By comparison, if instead of earning 1% more on their money they were able to save 1% more per year, they are left with $65,509 after 30 years. This is a 100% increase.
Clearly, savings seems to trump investing returns for the average American household. This is good news, for saving more is something you actually can control, whereas earning a higher rate of return is infinitesimally more difficult.
That’s not to say that saving more is easy. Far from it, especially when the median household income has struggled to keep pace with inflation over the past 20 years. It takes discipline, hard choices, and saying no to a lot of things. This doesn’t sound like very much fun, but if you want to build wealth, there is no other way.
What if you are already retired?
While savings is something those who are still working can control, for those who are retired the same can be said for spending. This idea works in reverse. Instead of saving more, you simply spend less and allow your savings to grow accordingly.
Focus on what you can control.