Thursday, August 5, 2010

Interest Rates: 3rd Grade Expert

Which would you rather have $2000 at 1% or $500 at 5%? Well, I don’t know about you, but I would rather have the two grand. The kicker is that some of you are yelling at the monitor right now:

“BUT ANDREW, YOU’RE MISSING OUT ON 5%!” (even if you didn’t yell it, you probably thought it)

percentageHerein lies the problem.  You see, from the time we are but wee children, interest rate concepts are repeated to us over and over.  Higher interest rates on your savings is better, lower interest rates on loans is the sweet spot… and by the time we reach high school  - time to give out the gold stars you’re an expert. But somehow in all of our expert wisdom we missed the larger, more important concept.

You can’t earn interest on the money you don’t have and time is more important than rate.

I may have just dropped a scud missile on everything you once new and loved, I’m sorry.

It feels so good to be able to complain about how low interest rates are. After all, the expert wisdom that Ms. Williams shared with me in 3rd grade tells me that higher is better! Most of the time the folks that are complaining about rates are those with the $500. Do you know what the annual difference between 5% and 1%  on $500 is?  - 20 bucks (duh, Andrew I’m an expert). So who cares!?

Guys, we have got to start focusing on what matters. Cash balances matter, saving while you are young matters and paying down debt sooner rather than later matters. We have a tendency to forget these things and we make excuses as to why we are not doing this. Almost everyday I talk with someone who is taking cash equity out of their house because interest rates are so low. Or someone who is putting saving on hold because after all, what’s the point? Interest rates are so low!

The point is that increasing your debt and taking on 5 more years to your mortgage will cost you more in real dollars over the long term. Postponing your saving will drive you toward credit card debt and keep you awake at night. I look at this journey up the tall mountain of financial independence as a race, not a hike. What’s going to get me there the fastest? I’ll give you a hint, it’s not more debt.


  1. interesting, so what you're saying is that having more cash is better than having more interest?

  2. Interest doesn't matter if you don't have anything for it to work on. We should focus on accumulating wealth before analyzing interest rates. Often times people focus so much on the APY that they never bother to save. Conversely people spend so much analyzing their debt interest rate and trying to constantly re-finance to a lower rate that they never pay down the balance.

    Thanks for the feedback!