An Extra $205,701 - the Power of Getting 1% Better
Just 1% better. In his book Atomic Habits, James Clear sums up perfectly the impact getting just 1% better each day can have on our personal selves (I love the example he shares in this article). In the beginning, a 1% improvement is barely noticeable. As a result, some may see a 1% improvement as meaningless – not worth the effort – while others see it as an easy opportunity to get better. But for those that focus on a 1% daily improvement, the small changes made today drive tremendous improvements down the road due to the impact of a single variable – the compounding effect.
Last week I was privileged to speak with students from two college economics classes about their personal “Investment Journey.” In preparing to speak with them, I was pulling together notes related to items I thought would be most helpful for those just beginning life’s journey and one of the key items was the importance of starting to save early in their careers. It’s common wisdom to harp on those just starting out to “get started early” as, over the course of a 25 – 30 year career, small amounts put away today compound and grow into large nest eggs at the end of careers. However, as I was speaking to the class about the power of compounding and the importance of getting started early, the thought dawned on me that the same 25 – 30-year career time horizon these students will have is also about the same amount of time that a person typically spends in post-career, retirement. So perhaps the adage “get started early” should be reframed as “get started now” knowing that even those in retirement have 25 – 30 years to reap the benefits of what is sown today!
Coming back to the concept of a 1% improvement, I wanted to run some numbers to see just how impactful a “measly” 1% may be over a 30-year time horizon. And the result? Consider this:
the difference between a return of 6% per year and 7% per year equates to an additional $205,701 over the course of 30 years!
If you want to start now in getting an extra 1% return on your financial life, consider the 3 areas below as a great place to begin:
1. Excess cash in your checking account – even though interest rates have started to increase in most areas of our lives, there is one place most individuals have yet to see any change – our checking accounts. For most, interest rates on checking account balances are still hovering near 0%. For those holding excess reserves in such accounts consider using a money market or high yield savings account to improve your return. Still FDIC insured (so you retain the same banking insurance that you have on your checking account), companies like Ally and American Express offer savings accounts that will pay you 1.9% interest on your reserves – an improvement of $190 per year for every $10,000 you have “just sitting there.”
2. Investment Fees – according to research from the Investment Company Institute (“ICI”) while investment fees tend to be trending the in right direction over time (down), there is still a large gap between the expenses charged by “actively” managed mutual funds and those that track an index. The ICI reported that in 2017 the average actively managed mutual fund charged 0.78% whereas the average index fund charged 0.09%. Independent of differences in investment performance, the fee savings alone can add an additional $690 per year for every $100,000 you have invested.
3. Investment Performance – in addition to their higher costs noted above, actively managed funds are notorious for underperforming. Data from Dow Jones/S&P500 (“SPIVA”) reports that over the previous 5 years 76.49% of actively managed funds underperformed the S&P 500 and did so by an average of 0.52%. Accordingly, in addition to the fee savings that can be realized as noted above (0.69%), by layering in the performance improvement that could have been realized over the previous 5 years (0.52%), all of a sudden, we’re talking about real dollars – 1.2% or $1,200 per year on every $100,000 invested.
By focusing on getting just 1% better in our lives and in our finances, we ensure that small, subtle shifts today can have tremendous, lasting impact for us down the road – get started!
Footnotes:
1. $205,701 calculated based on return differential of 6% and 7% compounded annually over 30 years at a starting balance of $100,000.
2. 0.69% performance differential calculated by comparing average 5 year return of the S&P 500 to the average return of All Large-Cap Funds based on data reported in SPIVA U.S. Scorecard Mid-Year 2018. Past performance does not guarantee future results.