{"id":763,"date":"2020-11-15T17:50:42","date_gmt":"2020-11-16T01:50:42","guid":{"rendered":"http:\/\/www.mitchelljoe.com\/blog\/?p=763"},"modified":"2020-11-15T17:50:42","modified_gmt":"2020-11-16T01:50:42","slug":"money-101-15-do-the-math","status":"publish","type":"post","link":"http:\/\/www.mitchelljoe.com\/blog\/2020\/11\/15\/money-101-15-do-the-math\/","title":{"rendered":"Money 101 (#15): Do the math"},"content":{"rendered":"\n

DISCLAIMER: I am not a financial advisor and this should not be taken to be financial advice. You should consult a financial professional for advice. I am a financial amateur. These are my thoughts and opinions on money that I have recorded here for my children, with the hope that my thoughts might help them. They are responsible for the results of the advice they choose to follow. Always worth keeping in mind: Past performance is no guarantee of future results. Your mileage may vary. The map is not the territory. Keep your eyes open. Smell it before you take a bite. <\/strong><\/p>\n\n\n\n

To my children: <\/p>\n\n\n\n

Money matters are mostly math. And it\u2019s not hard math. It\u2019s addition, subtraction, multiplication, and division. That\u2019s all you need to succeed. Let\u2019s practice. <\/p>\n\n\n\n

Which coupon is better?<\/strong><\/p>\n\n\n\n

I have one Bed Bath & Beyond coupon for 20% off a purchase and another for $5 off any purchase of $15 or more. Which one is better? Well, it depends on the price of what you\u2019re buying. $5 off of $15 is 33% off the purchase, so that\u2019s better than 20% off but as the price of the goes up, $5 becomes a smaller percentage of the purchase price. For example, if you buy something that\u2019s $20, then $5 off of $20 is only 25% off, not 33% off. The coupons become equivalent when you buy an item that is $25, because $5 is 20% of that price. So that\u2019s the math of that. You\u2019re better off using the $5 off coupon buying something that is $15-$25, and if it\u2019s over $25, then you\u2019re better off using the 20% off coupon. <\/p>\n\n\n\n

Should you pay for a car in all cash?<\/strong><\/p>\n\n\n\n

When you make a big purchase, like a car, a house, a TV or a mattress, you may be offered a loan so that you don\u2019t have to pay the lump sum all at once up front. You might not have the money to pay up front. The loans are sometimes free (0% interest) for a while, and sometimes they charge interest the whole time, so you end up paying more than the price of the item because you are paying for the item plus the interest on the amount you took out as a loan. You might think that it\u2019s better to pay all cash so that you don\u2019t have to pay any extra money, which is the interest on the loan. But if the loan is free (0% interest) or is a very low percentage rate, then it might make more sense, math-wise, to take out a loan, if you plan on investing the money in something that grows at a pace that outpaces the loan. <\/p>\n\n\n\n

Consider the following two situations. Let\u2019s assume you have $10,000 saved up in cash. In Situation 1, you buy a car for $10,000 and pay in cash. You now have a car, $10,000 less than you used to, and no debt. But what is your money doing? It\u2019s in the car, and the car will slowly lose its value over time. Now consider Situation 2, where you buy a car for $10,000 and take out a loan, let\u2019s say it\u2019s a 5% annual interest rate. In this situation, you have a car, $10,000 in debt plus the interest that you\u2019ll pay for the loan, and you still have your $10,000 cash (minus the first monthly payment that you\u2019ll probably have to pay up front. Where is your money? It\u2019s mostly still in your hands. If you invest that nearly $10,000 in a stock index fund, then your money can grow and if it grows at its usual 9%, then you don\u2019t need to worry about the 5% you’re paying on the loan, because 9% is more than 5%. You\u2019re making money if you can borrow it at 5%, pay back the 5% and keep the other 4% that you\u2019ve made for yourself. That\u2019s very different from what happens when you pay cash for a car, where your money is in the car and the car\u2019s value is slowly going down instead of up. <\/p>\n\n\n\n

Which is a better investment, real estate or stocks?<\/strong><\/p>\n\n\n\n

Real estate vs stocks? Let\u2019s say you have a friend, Real Estate Rachel, who bought a house in cash with no mortgage for $100,000 and 7 years later, she sold it for $200,000. That sounds pretty good. And let\u2019s say you have another friend, Stock Market Stan, who makes a steady 10% every year investing in stock index funds. Which is better? Well, you have to do the math. Let\u2019s say Stan started out with $100,000 just like Rachel. After 7 years, he would have $100,000 x 1.1^7, or $194,871.71, which is pretty similar to Rachel\u2019s real estate result. <\/p>\n\n\n\n

Now let\u2019s add some complexity. You don\u2019t have to pay for a house in cash, you can take out a loan and often pay only 20% of the price as a down payment and then pay the rest off slowly. You can rent it out and sometimes the renter\u2019s rent will cover the mortgage payment. Let\u2019s say that you pay 20% as a down payment and that the income you receive from renting it out exactly covers the monthly mortgage payment. After 30 years of mortgage payments that were paid for by the renter\u2019s rent money, you own the house with no loan. You paid 20% as a down payment, and also benefit from 30 years\u2019 worth of its appreciation in value. Let\u2019s say it went up 4% every year. The house that was $100,000 is worth $324,339.75 after 30 years. ($100,000 x 1.04^30), and you only put in $20,000 of your own money. So your $20,000 grew into $324,339.75 after 30 years. That sounds pretty good. But how good is it? Using a compound annual growth calculator<\/a> that does the math backwards for you, you can see that it\u2019s 9.73% growth per year. That is very similar to the historical growth rate of stock index funds, so in this example they are about the same. <\/p>\n\n\n\n

Different money growing opportunities will be different but this is the type of math you should do when considering a investment option. <\/p>\n\n\n\n

Should you rent or buy a house? <\/strong><\/p>\n\n\n\n

You will meet people who will tell you that you should buy a house because when you pay rent, you are just throwing your money away and you have nothing to show for it, whereas when you buy a place and pay a mortgage you get a place to live and also, after 30 years of paying a mortgage, you own a house. After 30 years of paying rent, you own nothing. What should you do? You should do the math. It\u2019s not true that you get nothing when you pay rent\u2014you get a place to live. Just like when you rent a car, you get a vehicle to drive. It is true that you don\u2019t get to own anything after the renting is done but the owning part of paying a mortgage isn\u2019t free. The monthly mortgage payment on a house is often more than the monthly rent payment would be to rent that same house. And usually you have to pay a significant down payment up front when you buy a house. So part of the math and the tradeoff is to ask yourself if paying that extra money is worth eventually owning a house for you. <\/p>\n\n\n\n

There are a lot of pros and cons to think about when considering buying or renting (owners can\u2019t get kicked out of their house by a landlord, renters don\u2019t have to fix their own refrigerator, etc.) but for the math part of it, some of the moving parts to think about, money-wise, are that: <\/p>\n\n\n\n

(1) Homeowners have to pay property tax and other expenses that renters typically don\u2019t have to pay. <\/p>\n\n\n\n

(2) Renters could invest the extra money (the difference in savings between paying rent vs a monthly mortgage payment, and the money they held onto by not making a down payment to buy a house), while homeowners do not have that amount available to invest. <\/p>\n\n\n\n

(3) Homes appreciate in value. This is good for the homeowner and makes no difference to the renter. <\/p>\n\n\n\n

There\u2019s a lot to consider and they have rent vs buy calculators<\/a> that you can check to help you make a decision. It\u2019s complicated but it\u2019s definitely not true that when you rent, you are throwing your money away. <\/p>\n\n\n\n

What\u2019s the math good for?<\/strong><\/p>\n\n\n\n

Math is good for helping you decide between multiple options. You always need to consider at least two options. You can\u2019t decide if something is a good option in isolation. If it\u2019s the only option, then it\u2019s the only option. If there\u2019s more than one option, then do the math. <\/p>\n\n\n\n

Bottom Line: Whenever you are trying to decide what to do with your money, you should consider at least two options, do the math, and then let the math point you in the right direction. <\/strong><\/p>\n","protected":false},"excerpt":{"rendered":"

DISCLAIMER: I am not a financial advisor and this should not be taken to be financial advice. You should consult a financial professional for advice. I am a financial amateur. These are my thoughts and opinions on money that I have recorded here for my children, with the hope that my thoughts might help them. … <\/p>\n

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