1 August 16
Some little things make a huge difference – the beats of your heart, the number of carats in a diamond… With money, it’s worth paying attention to even small fractions of a percentage point.
But it’s easy to get lost in those percentages. What dollar amounts do they translate into?
Bip… bip… bip… Back in the day when I sold mortgages for a living, it was all about counting the “bips”. A bip, or basis point, is one hundredth of a percentage point, or 0.01%. That sounds more complicated than it is – basically, if something goes from 1.0% to 1.25%, it’s gone up 25 basis points. If it’s from 1.0% to 1.50%, it’s gone up 50 basis points. You get the idea.
Bips are especially meaningful when we’re talking about interest rates, since, as we’ll see here, small tweaks have big implications.
Many of us might not think that a single percentage point in returns would make much of a difference to our end results in KiwiSaver. But what if we thought of that as 100 basis points? That might be more helpful, because actually, a jump like that will be substantial.
For example, these days we project returns for a KiwiSaver growth fund – after fees, taxes and inflation – to be around just 2.9%. Doesn’t sound like much. But let’s say someone is starting out their career at age 20 earning $40,000, and contributing 3%. After 20 years, they already have $66,085 stashed.
But what happens if those returns drop 100 basis points, to 1.9%? Their 20-year result drops $6,192 to $59,893. That’s a significant hit to the cash flow – that extra amount would have certainly come in handy down the line (perhaps when it came time to replace the car).
Conversely, a rise in 100 bips on that original rate – from 2.9% to 3.9% – would see their results in 20 years jump even more because of compound interest, to $73,069, or $6,984 more. (And that would buy a decent car.)
We all need to look beyond the percentages to see what they mean to our very real dollar results. Have a look at Sorted’s KiwiSaver fees calculator to see how these tiny numbers can matter so much. And if you find yourself paying more than you think reasonable for the results you’re getting, you can sort through to ones that suit better.
What about debt? The same thing happens: small changes in percentages mean big differences over time, usually to our costs.
For example, on a $500,000 loan, let’s say rates rose just 25 bips, from 4.25% to 4.50%. You’d need to come up with an extra $31 each fortnight to cover the repayments. But much more importantly, you’d end up paying $16,075 more in interest over the 20-year life of the loan. So those 25 bips mean $16,075 of difference. (Or a much better car!)
While rates stay that bit lower, it’s a good idea to take advantage and pay down debt. Who wouldn’t want to save $16,075? But what if you could save even more? If rates dip even further, keeping repayments steady – or even increasing them – lets us shave off even more interest and get debt-free that much more quickly.
This is one of the reasons that Sorted’s mortgage calculator is its most popular tool – every time rates move a few bips, thousands of people jump on to find out how their payments will change. Hopefully they see how much they could save by avoiding interest, too.
Those bips mean a lot over time when they translate into real money.