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| One Percent Makes All the Difference |
Submitted by:
Ray @ Tip Hero 09/30/2009 7:23 PM
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MoneyRates has an interesting info-graphic on the difference one percent can make over the long run when it comes to your investment returns. It illustrates the power of compounding, even when dealing with small differences like one percent.
To illustrate, they take two fictional couples, the Zinns and Wynns, who both start out with a retirement account of $60,000 in their thirties and add $10,000 to it each year until they reach 70. The only difference between the two is that one couple, the Zinns, gets a return of 4% and the Wynns get a return of 5.13%. This small difference in returns results in a $205,000 difference between the two couples' nest eggs upon retirement. Here's the info-graphic.
This graphic illustrates that small differences over long time-frames can have a huge impact on returns. I wrote an article late last year on the hidden impact of mutual fund fees. The difference in fees between an actively managed mutual fund and an index fund can easily be over one percent. I modeled out a hypothetical retirement account over 30 years taking into account the increased fees for actively managed funds, and discovered that the biggest impact comes not from the fees themselves but the lost compounding opportunity of those fees. Here's a link to the article: Hidden Impact of Mutual Fund Fees.
The power of compound interest is one of the most important concepts you can learn in personal finance. It's also important to realize it can work both for you (e.g., when investing) and against you (e.g., with credit card interest or mutual fund fees). It's such an important concept that even legendary investor Warren Buffett supposedly used to carry around a card in his wallet with compounding rates.
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