Importance of saving rate

 compares a saving rate with Return on Investment (ROI), to understand its impact on your financial goals.

Investors often focus primarily on asset allocation, expenses associated with investments (such as transaction fees and expense ratios), tax efficiency (types of account), sector allocation, active vs passive, and so on, to maximize their return on investment to reach a financial goal. The importance of saving early is also well documented.

Beyond these, though, achieving your financial goals relies on a combination of market returns and the amount you save over time (that is, your saving rate).

Saving rate
Your saving rate is the percentage of your income that you save towards a financial goal.

To put the saving rate into perspective, suppose two investors Alice and Bob each have $100,000 in income, and each saves a percentage of their income consistently for 30 years.
 * Alice saves 4% of her income ($4,000), and her return on investment on saving is 6%. After 30 years, she has $316,233.
 * Bob saves 6% of his income ($6,000), but his return on investment on saving is only 4%. After 30 years, he has $336,510. His higher saving rate has more than overcome his lower return on investments.

Increasing your saving rate is particularly important when the return on investments is low. However if return on investments is very high, then the impact of saving rate becomes relatively less important. Alternately, if your saving rate is less than 4%, the saving rate you use has a huge impact on the end balance, when compared the rate of return.

Table 1 below helps to show the relationship between saving rate and return on investment for a given saving rate. For example, with a saving rate of 1%, you need a 12% return on investment to save $241,334. In contrast, for a saving rate of 2%, a return slightly over 8% is enough to achieve the same end balance of $241,334.

When starting out, your saving rate has the most impact on increasing your portfolio value. The return on investment becomes important only after your portfolio has grown significantly, or after it achieves a critical mass.

To achieve a financial goal, you only have to control your savings rate rather than depend on market returns.

Said another way, to achieve a particular financial goal, your saving rate is more important than returns. Morningstar had recommended some suggestions to increase the saving rate.