As we get older, a high personal savings rate becomes increasingly important, dare I say, more important than compound interest? I know, I know – everyone talks about compound interest as the 8th wonder of the world and while it is extremely important, I’m talking to Gen-Xers that are playing “catch-up” with their retirement savings. Give me a chance to prove my point – 

First, we need to understand both terms:

A personal savings rate is how much of your disposable income you save, expressed as a percentage. The higher your percentage, the bigger the impact on your financial independence timeline. Calculating your personal savings rate involves dividing the amount saved by disposable income (income after taxes). This helps you to understand your propensity to save rather than consume.

Compound interest is the interest calculated on the initial principal and also on the accumulated interest from previous periods. It’s the interest on interest, which can significantly grow the initial sum of money over time. This concept is usually discussed when we look at financial products like savings accounts, investments and loans. When you earn compound interest on savings or investments, the interest is continually added to the principal, allowing your investment to grow faster than simple interest, which only accrues on the initial principal amount.

Now, why do I think a high savings rate is more important for those of us that have less than 15 years before retirement? Simple, time in the market.

Individuals with 20, 30, 40 years to retirement will benefit greatly from the magic of compound interest, potentially resulting in substantial wealth accumulation with lower contributions. The best of both worlds are ideal, just not reality for “most” Gen-Xers! 

Let’s look at Monica, 52 and her baby sister Brandy, 40 (yes, I’m showing my age and music taste :). Neither has anything saved for retirement but they both want to retire at age 65. This hypothetical illustration will show the impact of a high savings rate vs. compound interest on your retirement savings¦ no tax or inflation consideration is used in this example. Let’s also assume they are both receiving a healthy 9% market return through investing in index funds. 

Monica can invest $2,000 per month as she used her budget to get a handle on her spending and in the process, eliminated all her consumer debt. Brandy has just started tracking her spending but is still making student loan payments, so she can only invest $400 every month.

Monica’s $2,000/monthly investment for the next 13 years will yield her a portfolio worth $588,788 – very nice! 

Brandy’s $400/monthly investment for the next 25 years will yield her a portfolio worth $448,448 – not too shabby! 

This example shows how Monica’s higher savings investment is really helping her money grow over the next 13 years. Her contributions total $312k which is significantly higher than Brandy’s contribution of $120k. Brandy’s additional 12 years in the market will substantially grow her portfolio with lower monthly contributions. 

Ideally, having a higher investment contribution and longer time in market is extremely beneficial but this blog is geared toward the sandwich generation, Gen-X. Most of us are getting a late start as we are taking care of older family members as well as our own family. We are paying down debt while helping our adult children pay for college, however, most of us are in our peak earning years, so we can save a bit more for investing.

It’s the combination of good savings habit and wise investment strategies that can lead to significant wealth accumulation over time but if time is not on your side, start today, right where you are and look for ways to increase your savings rate!

Thanks for reading and remember, our story is far from over, let’s keep Enjoying the Journey!