Thursday, 11 June 2015

Savings rates, compounding and cash

I’m not great at maths. A lot of FIRE bloggers seem to be in engineering or finance so presumably it comes easy to them. Unfortunately that doesn’t apply to me, I just don’t see it naturally and have to learn the hard way, so when I saw a post the other day it stuck with me and I wanted to re-iterate the point for if/when someone might actually ready this blog other than me!

Sadly I now can’t find it again to credit the author* as it’s a nice simple piece which, for me, hits on two main FIRE issues.

Firstly, savings rate. Size matters here and I'm doing okay, but the issue I had was the transition from saver to investor. Most of my savings are set to leave my account each month automatically, well done me. I'm then left with my discretionary cash until the next pay day. Following the FIRE mantra, the plan is to spend as little as possible (without being rude) and invest the rest, thus bumping my savings rate to heroic levels and earning the laurels month on month.

This moves us on to the second issue - investing it. When you read the likes of TEA, MMM or Monevator they are coolly confident when investing, with a clear route to market lying open for them. I know that time in the market is better than timing the market, but still, no one likes to see the capital value fall.

So this building bank balance leaves me feeling shameful! I might have well just spent it! My little Sterling platoon ready and waiting to earn more recruits to the cause and speed me along to my goal, locked and loaded and ready for a mission... but actually just lying idle in the barracks.

Then I saw this post. What is comes down to is this, simply by increasing your savings rate you’re giving yourself out-performance. Ta-dah!

The post assumed two people, Bob, who saves £5k pa into an account that guarantees 10% pa – pretty sweet returns there Bob, and Bill, who is terribly risk averse and only saves the cash into an account that earns no interest. Just going on the simple maths and ignoring inflation and the like, but compounding £5k per annum at 10% takes fourteen years to reach parity with Bill’s savings total, which I thought was pretty astonishing, fourteen years.

This made me feel a whole lot better. The main focus remains increasing the savings rate as a whole, cutting the unnecessary purchases but importantly not worrying so much where the savings are. Those boys will get deployed at some point, maybe just not yet, but that's not the end of the world!

*I'll carry on looking for it and edit it in later.

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