As someone who always loved math growing up (not embarrassed to admit that I was a mathlete in high school, just like in Mean Girls), I found it extremely frustrating that all these finance folks spoke so fluently in numbers and I had no idea what they were talking about. They were excited when something grew 12%, devastated by a 20% loss or hit with a 28% credit card interest rates. In my experience, those tiny percentages were, well, tiny.
So what do all these numbers mean? Below, I’ve contextualized examples of the impact of these tiny percentages and shared some examples of the impact of each percentage range. It’s important to call out that these percentages show up as interest rates, stock market increases, rate of return, etc.
Hopefully, this will decode these numbers for you as it did for me.
Why should I care so much about such small interest rate numbers and what in the world does all of this mean?
I finally understand how those tiny little numbers can make a disproportionately large impact on your journey to financial freedom.
If you’re in the same boat as I was and are looking for some guidelines on how to think about the meaning of these percentages, I’ve shared my thoughts below on interest rates. I’ll qualify this by saying these are not industry standard, but merely my perception and an oversimplification.
If you’d like to explore the power of tiny percentages, I highly encourage you to explore numbers with this interest rates calculator and figure out all the ways you can use the power of compounding interest to amass a fortune.
~0% Return
Well, this is exactly what it sounds like, your money is not growing one bit and you might think that’s the end of this conversation. Not quite! If your money is sitting in a checking account or a traditional savings account (not a high-yield savings account), then your money is actually losing value! What?
Inflation sneaks up and diminishes the value of your hard-earned savings. It’s just like when your sibling sneaks a few dollars out of your piggy bank every month. It’s also why grandma always tells you about how gas was a nickel back in her day.
While it’s not ideal to have your money lose value, there are plenty of times where it makes sense to have your money sitting in a 0% account. The money you pay your bills with should be fluid and a checking account is a great place to park your money so you can easily access it when you need to pay the bills.
1-2% Return
This is such a teeny weeny increase from 0%, so why does this number matter? 2% growth rate is the average rate your money needs to grow so 10 years from now, you can still buy the same amount of stuff as you can today. 2% is the target inflation rate set by the Federal Reserve.
Sticking with the previous metaphor, it stops your sibling from swiping anything from your piggy bank. Maybe you’re thinking that this is so small that you should just ignore this silly number? Well, go plugin 2% interest in this interest rates calculator over 20 years and see if you want to ignore it.
If you start with $15,000 in total savings, after 20 years of 0% growth, the 2% inflation rate will reduce the spending power of your original savings. That $15,000 will end up being worth the equivalent of $10,000. No thank you.
On the bright side, there are plenty of extremely safe options (meaning you don’t risk losing money along the way) in order to easily get a 1-2% return. Check out high-yield savings accounts or certificates of deposit (CDs).
5-8% Return
Now your money is actually starting to go to work for you if you’re averaging a 5-8% return.
You’ll often hear that the market (or specifically S&P 500 index) returns on average 5-8% every year over 10 years, and this is a really healthy return. If you average this return over several decades, pat yourself on the back because you did quite well.
What does this actually look like in practice? Let me ask you this – what lengths would you go to to get $45,000 added to your savings account right now? Sign me up for whatever that job is because I’m going on a nice vacation!
If you start with $10,000 and hit an 8%/year return on average for 20 years, you’d have just over $46,000. Shoot, if you hit 9% a year, your account has $56,000 sitting right there for your retirement.
12-15% Return
Holy smokes you’re going to be a millionaire in no time with these numbers (ok, it actually will take some time). So yes, this is really really amazing! But how amazing?
If you invest just $5,000 at age 30, invest an additional $1,000 every year, and hit an average return of just 15% every year (compounding each month)…yes, 3 nickels for every dollar, less than 20 years later you’ve hit the million-dollar mark.
Don’t get me wrong though, these are really, really hard numbers to hit consistently, even for the professionals, but if you can, my god you’re doing amazing!
18-24% Return
You’re putting Warren Buffet to shame with these numbers (just kidding, he puts us to shame). If I haven’t already made my point at 15%, I just want to emphasize, you will not have any money worries if you are hitting these rates of return.
On the flip side, these numbers might also look unpleasantly familiar because this is the interest rate that most credit cards will charge on any balance you carry.
This negative return is just as powerful at moving you in the opposite direction exponentially faster. I cannot emphasize how important it is to avoid credit card debt because it’s that little number that will steal your hard-earned money and take the peace of mind you’ll need at retirement.
The bottom line is to get rid of credit card debt at all costs!
100% Return
If 15% was an incredible return, then obviously 100% is freaking unbelievable. What if I could tell you an easy way to guarantee a 100% return?
Some of you lucky folks out there have employers who will match your money, dollar for dollar, in your 401K retirement plan (usually up to a certain percentage). Holy moly!! If this is you, and you are not taking advantage of 401K matching, you march your butt into HR and figure out how to get this set up ASAP. If you don’t, you are putting yourself and your family at a huge disadvantage as you grow older and rely on your savings.
I can not emphasize this enough – and if this article and future posts (because there will be more on this topic) can inspire one person to either contribute more or open a 401K, then my job here is done. Will it be you?
Hopefully, this was helpful to provide some context to what these interest rates mean and the implications they have for your savings goals. Do you still have questions? Let us know because we love to hear from you!
Check out additional topics to make personal finance SLIGHTLY EDUCATIONAL on our Personal Finance page.
