• Posts
  • RSS
  • ◂◂RSS
  • Contact

  • The high impact of the real interest rate

    July 18th, 2012
    money  [html]
    If you're a young person trying to decide how much to save for retirement, a big thing to consider is how much the money you invest now will be worth then. I've heard wildly different claims about this, from it being worth twice as much to twenty times as much! If I'm trading off between spending money now and spending money in 40 years, a big consideration is how much my saving helps my 40-years-older self.

    A key number here is the real interest rate. That's how much money you expect to earn after subtracting inflation. If you're earning 7% that means $100 today is nominally $107 [1] next year, but if inflation is 3% then that $107 is really only going to be worth $104 [2] in today's money. So the real interest rate is 4% [3].

    Small changes in the real interest rate have a large effect on how much money you have at retirement. I have about 40 years of working life ahead of me, which means money I invest now has about 40 years to grow before I need it. So how much money does $100 invested now bring me in 40 years? It depends on the real interest rate:

    real interest rate    money after 40 years
    -1% 0.67x
    -0.5% 0.82x
    -0.2% 0.92x
    0% 1.00x
    0.2% 1.08x
    0.5% 1.22x
    1% 1.49x
    2% 2.21x
    3% 3.26x
    4% 4.80x
    5% 7.04x
    6% 10.29x
    7% 14.97x
    8% 21.72x
    9% 31.41x
    10% 45.26x
    x x^40
    At low interest rates there's some advantage to investing now instead of just saving money near retirement, but at higher ones the advantage is very large. It's worth it to put in a lot of effort on figuring out what you the real interest rate will be instead of just choosing the first number you find that looks plausible. The value of information here is high.

    Over the course of your career the money you save for retirement has less and less time to grow. This same table computed for 20 years growth, is:

    real interest rate    money after 20 years
    -1% 0.82x
    -0.5% 0.90x
    -0.2% 0.96x
    0% 1.00x
    0.2% 1.04x
    0.5% 1.10x
    1% 1.22x
    2% 1.49x
    3% 1.81x
    4% 2.19x
    5% 2.65x
    6% 3.21x
    7% 3.87x
    8% 4.66x
    9% 5.60x
    10% 6.73x
    11% 8.06x
    12% 9.65x
    x x^20
    If you expect a high interest rate it makes sense for you to try really hard to save money now, and save somewhat less as you approach retirement. While if you expect a low interest rate it matters much less when you save.


    [1] 7% * $100 + $100

    [2] (7% - 4%) * $100 + $100

    [3] 7% - 4%

    Comment via: google plus, facebook

    Recent posts on blogs I like:

    The Gift of It's Your Problem Now

    Recently a security hole in a certain open source Java library resulted in a worldwide emergency kerfuffle as, say, 40% of the possibly hundreds of millions of worldwide deployments of this library needed to be updated in a hurry. (The other 60% also …

    via apenwarr January 1, 2022

    The container throttling problem

    This is an excerpt from an internal document David Mackey and I co-authored in April 2019. The document is excerpted since much of the original doc was about comparing possible approaches to increasing efficency at Twitter, which is mostly information tha…

    via Posts on December 18, 2021

    Experiences in raising children in shared housing

    Sometimes I see posts about people’s hope to raise children in a group housing situation, and it often seems overly optimistic to me. In particular they seem to expect that there will be more shared childcare than I think should be expected. Today I talke…

    via The whole sky October 18, 2021

    more     (via openring)


  • Posts
  • RSS
  • ◂◂RSS
  • Contact