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What’s $50 Per Month Worth In Long-Term Savings?

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One mindset that is crucial to increasing your wealth is to stop thinking linearly and thinking in “compound” terms. Previously, I’ve discussed how it’s easy to believe that saving $50 or $100/month is not much and thus not worth doing. But that is thinking linearly. Let’s look at saving $50/m over 10 years, using a variety of investment vehicles. Fifty dollars becomes a lot more than you’d think. No amount is too small to save, and fifty dollars is a lot easier to save than a hundred, if you’re struggling. Or undisciplined.

Here’s the general plan: stop thinking linearly and save at the highest rates you can find, without paying ridiculous service fees or penalties. Pretty simple plan, right?

Sure, 10 years X 12 months a year X $50 per month is only $6,000. That’s still $6,000 you wouldn’t otherwise have saved but if you leverage your savings by using online savings accounts, money market accounts or funds, CDs, index mutual funds, and maybe later on, stocks or DRiPs (Dividend Reinvestment Plans), you’ll have more than $6,000 saved in the same time period. Or you could eat that $6,000 in extra donuts and coffee every day for the next ten years. You choose.

Online Savings Accounts

Let’s start with an OSA (Online Savings Account), where we’ll put the savings for the first three years. See the spreadsheet I’ve set up for you. With all the competition right now in the OSA market, interest rates keep changing. Which one you choose depends on whether you think you’ll be taking money out, or even adding extra contributions in. Some OSAs have a minimum balance requirement, and a long list of service fees if you don’t maintain that minimum. Here’s a list of the best high yield savings accounts.

To make it simple, let’s say that the interest rate on your OSA is 4%, compounded daily, no minimum. That means the %APY (Annual Percentage Yield) is (1 + (0.04/365)) ^ 365 – 1 = 4.08%. In other words, $50 left for a full year will be worth $52.04. Still doesn’t sound like much, but stay with me.

After 3 years, with 4% compound interest, saving $50 each month turns into approximately $1915. Nearly two grand saved, simply for cutting back on some discretionary expenses. What if you were able to add an extra $25/m in the second year and an extra $50/m in the third year? You’d have about $2845. Sounding a bit better? Almost an extra $1000 in the same amount of time, just for being a bit more spending-conscious (and thus savings-conscious).

Now that you have some significant savings – but not enough to retire on – you should consider longer-term deposits at higher interest rates.

CDs, Money Market Accounts or Money Market Funds

These are three types of investment vehicles that people sometimes confuse. Money Market Accounts (MMAs) provide a high interest rate on your balance. Money Market Funds (MMFs) are mutual funds, which are not protected by the FDIC. They tend to keep the same unit value, with fluctuating interest rates.

MMFs will often pay out higher than MMAs, but could be risky. (Although that tends to be rare with MMFs.) The interest from an MMF can usually be rolled into purchasing more units. Some MMFs require a term deposit. Here’s an article that compares money market accounts and money market funds in more depth.

Another term deposit is the CD, or Certificate of Deposit. (In some countries, these are called GICs, or Guaranteed Investment Certificates, but amount to the same thing.) CD term durations are often 90-day or 1-year multiples, and interest rate increases with duration. But because of the term commitment, not everyone likes them. It all depends on your personal needs. If you think you won’t need to spend the money soon, go for the CD. If you can afford a bit of risk, try the MMF. Alternately, you may want to split your investment amongst several choices, to reduce risk yet remain mostly liquid.

Again, if you’ve learned enough discipline after several years to invest long-term, pick a CD. For the purpose of an example, let’s pick a CD that pays at least 4.50% for a 3-year term. Remember that you have either $1915 or $2845, depending on how much you saved each month in years 2 and 3. Plus you’ll be depositing at least $50/m.

Check the spreadsheet, and you’ll see that after the second three years, you’ll either have about $4,120 or $9,020. The $410 savings is if you are depositing only $50/m. The $9,020 is if, each year, you’re increasing your monthly contribution by $25. Thus, in the sixth year, you would be saving $175 each month.

If you’ve got the hang/ habit of saving by year six, you might want to consider buying some stocks or index mutual funds, to increase your yearly return.

Index Mutual Funds and Stocks

Neither mutual funds nor stocks are insurable. So if the value of your investment goes down, the loss is gone, unless you can recoup it in the future with some luck. While you can write off your losses against your income, it’s still disheartening.

Stocks are potentially very risky, and share prices require careful watching. Index funds are less risky, but only if you apply DCA, or Dollar Cost Averaging. This is the act of buying the same dollar value each month of an index fund, thus evening out the unit-price spikes of some months.

Say that when you start, the index fund you purchased was at $21 per unit. Divide the amount of money you are investing (in this case either $4,120 or $9,020). That’ll give you the number of units you’ll own. Then, if you are investing $50/m, you’ll get $50 worth of units at whatever price they’re at in a given month. (Funds allow fractional unit ownership.) So when the price drops, you might still be investing only $50, but you’ll be getting more units. Then when the market rises, the index fund’s unit price rises, so you are getting less units for that $50/m, but your overall index fund value will rise.

It’s hard to say what percentage return an index fund will give you using DCA. In the past, it’s been as high as 11-12% over a long term of 5 or more years, especially for an index fund tied to the Dow Jones Index. Whatever the case, applying DCA on an index fund is likely – but not guaranteed – to give you a better return than a money market account, money market fund, or CD.

Simply for the sake of an example, let’s say 7%. Very conservative. You might do better. I’m making this up, because I have no idea what a fund’s unit price will be each month for the four years remaining in our example. You’ll put your savings from the end of year 6 into an index fund, and contribute at least $50/m.

Thus, with your money in an index fund for years 7-10 (4 years), you’ll end up with about either $8,225 or $24,850, depending on how much per month you are saving. So that paltry $50 a month could be worth over $8,000 in 10 years. Saving a little bit extra in later years might generate nearly $25,000.

Now do you think $50 a month is not worth saving?

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4 Responses to “What’s $50 Per Month Worth In Long-Term Savings?”

  1. raj says:

    UPDATE: Looks as if the links in the original article went missing in action. I don’t yet want to republish this article on my own site, but here is the link for the free Zohosheet spreadsheet (exportable to Excel and OpenOffice) I refer to in parts of the above article:

    http://www.zohosheet.com/public.do?fid=28387

  2. Savings are even bigger since online bank accounts are now paying 5%+ and not the 4% used in the article.

  3. raj says:

    Agreed. I was just being conservative, but you are right :)

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