They match up well, like wine and cheese. Preferably low-cost wine and cheese, as would be more in line with responsible spending. We’re all about increasing net worth here 🙂
Anyway, back to money and math. Some of this is very straightforward. For example, the more money we have, the better! Pretty simple math there.
More involved but still simple concepts are those that involve computation. For example, the power of compounding is very clear. Also, concepts can be combined. A recent post on three important financial numbers highlighted this as well.
I was thinking of a few other ways that we can use math to think a little bit more about money, and to revisit some assumptions that we might have about it. Nothing complex, but just simple ways of looking at things that we can keep in mind to make sure we’re making the right moves. Here are 4 such examples:
A Penny Saved is Not a Penny Earned
Let’s say you got a bonus of $1,000 next week. Wouldn’t that be great! If you’re like me or similarly like-minded people, you might want to throw that straight into savings. The thing is, you can’t. Why?
We can’t forget about taxes, that’s why. Lets say you will end up paying 30% in taxes. In that case, the $1,000 earned resulted in $700 saved. Flipping it around, a penny saved required more than a penny to earn it.
That might not have been the exact meaning of the saying, but you get the idea: taxes take a bite out of what we can take home, much less save. Depending on the tax rates in different countries, it could be small amount or a much more significant factor.
Losses Require Extra Work to Get Back to Even
Take another example of $1,000. Just to make it easy, you know. This time, after-tax income. If you lose 20% of it, you’re down to $800. That’s no fun!
If you want to get that $200 back, you have to do better than gain 20% back. You have to grow that $800 by 25% in order to get back to $1,000. Losing money requires some work to recover, so be careful with certain risks!
We Need to Do Better Than Save our Entire Raise
It’s often mentioned in the personal finance blogosphere that a good way to save money is to set aside your annual raise. In other words, simply save your raise – on top of whatever else we’re saving.
I think we need to do better than that.
Here is what I’m thinking. Tacking on a few zeroes to that $1,000 example from the past two situations, let’s say a person makes a $100,000 salary. With an annual raise of 3%, that’s a nice $3,000 increase! The thing is, those taxes might take away a fair amount of it. For simplicity let’s say one-third of the increase disappears via tax, leaving us with $2,000 extra.
However, that remaining $102,000 won’t have the same purchasing power as it did the prior year. With 1% inflation, it would have about the same purchasing power as $101,000 did the prior year. Thus, our raise won’t get us too far ahead of where we were last year. Which is crazy, since raises aren’t guaranteed, and jobs aren’t a sure thing either.
A Million Dollars Might Be Enough For Retirement, or It Might Be Way Too Little
I picked a million dollars as just as a random number to use in this example, just to illustrate. Here’s what I’m thinking:
Let’s say a 50-year old person has $1 million, and wants to retire. If that person spends $5,000 per month on expenses, it means she has 200 months of living expenses that are covered. That’s over 16 years, and probably not enough.
If her twin sister has the same exact amount of money, but only spends $2,500 per month, that’s over 32 years of expenses covered. Clearly, a very different situation. An example of how spending habits and liabilities can impact one’s ability to retire, as well as an example of how thinking through the math can help us make better decisions on using financial resources.
Do you think of money in these terms, with respect to the above 4 examples?