We have already written several times in this blog about the importance of the highest possible savings rate and the need for regular deposits into the custody account. The savings rate is particularly important in the early years of investing. At the beginning of an investment process, a high savings rate can allow the portfolio to grow quickly and increase the potential for the compound interest effect. However, as the size of the portfolio increases, the influence of monthly deposits on total assets decreases.
In this article, we shed light on the reasons for this effect and explain why the size of the custody account itself eventually becomes the driving force behind wealth accumulation.
The beginning: high savings rate, high influence
At the beginning of every investor’s career, the portfolio is still small – you are just starting to discipline yourself and regularly save automatically in shares or ETFs in order to get a feel for what the daily fluctuations on the markets mean. Due to the small size of the portfolio, regular deposits are very important.
Let’s take the example of an investor who has EUR 5,000 starting capital and saves EUR 500 per month. The securities account grows by 6,000 euros in the first year through deposits alone. Assuming a return of 7 %, the portfolio could therefore be worth around EUR 11,350 after one year – the majority of the growth is due to the deposits, not the return generated. In the second year, around 44% of the portfolio value comes purely from the deposits.
In this phase, the savings rate has a considerable influence on the growth of the portfolio, as the returns on the small capital are still relatively low. The more money flows into the custody account, the faster the capital grows and the stronger the compound interest effect, which is crucial for asset accumulation in the long term.
Growing portfolio size: Decreasing importance of the savings rate
Over the years and with a positive return, the assets in the custody account grow faster and faster. At some point, the income from the funds already invested will exceed the monthly deposits. In our example, the custody account could already contain around EUR 94,000 after ten years, whereby the deposits “only” account for EUR 60,000. The remaining 34,000 euros come from the returns generated.
As the size of the custody account increases, the savings rate contributes less and less to the total assets. In a custody account with a volume of 100,000 euros, for example, monthly deposits of 500 euros account for only 0.5 % of the total value. The annual return of 7 % on the securities account is already considerably higher at 7,000 euros than the 6,000 euros paid in annually. The return on the invested capital significantly exceeds the savings rate.
The compound interest effect takes the lead
As the size of the portfolio increases, the compound interest effect increasingly becomes the main driving force. It ensures that interest is paid not only on the original capital, but also on the returns already achieved. In theory, this means that the capital grows exponentially in the long term. The higher the deposit volume, the higher the annual returns and the lower the monthly deposits.
If you manage to invest EUR 300 every month, you will have exceeded the magic threshold of EUR 100,000 in your custody account after around 15 years, given the historical returns of a global equity ETF such as the MSCI World. Anyone who does not rest on their laurels, continues to pump their EUR 300 per month into the market and also earns an average of 7% per year on their previous savings will only need half as long – around seven years – to reach the next EUR 100,000. To reach a deposit volume of 300,000 euros and thus the next 100,000 euros, you will then only need just over four years – provided you do not change anything in your previous approach.
After not quite 32 years, which is a realistic time that every employee spends at work until retirement, you would have reached half a million euros and thus have a good cushion to at least cover the pension gap or lead a carefree life in old age.
When is the savings rate negligible?
The question of when the savings rate has little influence on total assets depends on individual factors such as the investment amount, the savings rate and the return. As a rule, it can be said that from a custody account volume of EUR 100,000, the influence of the return on growth predominates. The larger the securities account becomes, the less significant the regular deposits become, as the existing capital increasingly generates more return than the investor can add through deposits.
This is also the reason why we consider assets of EUR 100,000 to be important and recommend that everyone comes as close as possible to this amount by the age of 30. You can then take a more relaxed approach.
What the savings rate means for investors
This knowledge has some practical implications for investors:
– Saving early pays off: As the savings rate has the greatest impact at the beginning, it is advantageous to start making regular deposits as early as possible in order to benefit from the compound interest effect.
– Adjust the savings rate: As the value of the deposit increases, investors can consider reducing the savings rate in order to use the disposable income elsewhere or invest in other asset classes. You already have a good capital stock working for you.
– Ongoing optimization: A greater influence in the long term lies in optimizing the existing portfolio, e.g. through better diversification or a favorable cost structure. Continuous optimization of the investment strategy can also support portfolio growth and is often more important than constantly increasing the savings rate.
– Planning for retirement and the withdrawal phase: A larger portfolio often leads to more flexibility in retirement, as it stands on its own two feet and is no longer dependent on regular contributions. Investors can therefore expect a stable return during the withdrawal phase.
Conclusion
The monthly savings rate has a considerable influence on portfolio growth, especially at the beginning of the investment phase. However, the larger the portfolio volume becomes, the more the income and the compound interest effect take over the leading role. The savings rate becomes less important as the capital share increases, which has the long-term effect that the portfolio grows on its own.
This dynamic illustrates the importance of a long-term perspective: investing early and continuously creates the basis for a portfolio that later generates solid returns regardless of the amount invested each month and paves the way to financial freedom.
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