Financial success revolves around understanding time and money – but these concepts make our eyes glaze. Throw in math and it’s off to cat videos on YouTube. The elite and savvy take an interest in this stuff and they outpace everyone else by miles – and millions. You can be forgiven for hating math. Most people hate math, even simple elementary school math – which is all you need for budgeting and financial planning. Unfortunately, because of this aversion we fail to understand the very real consequences for our finances over varying time frames. Do you avoid thinking about and prioritizing this stuff?
The wealthy and financially stable understand time and money consequences and take action but they’re in the minority. After all, only about 41% of Americans have a budget, though that doesn’t mean they stick to it. Most Americans live paycheck to paycheck and can’t afford a $1000 emergency without going into debt. The majority also have little to no savings for retirement. Unfortunately our economies and lives run on money and this inability to think long-term or mathematically sets us up for failure – all thanks to the inherent weakness of the human mind toward numbers and conceptualizing time.
Where do you fall on the spectrum? If you could save $20 a month by paying say an extra $4000 on your mortgage, would you do it? Chances are, you wouldn’t even if you had the money. Twenty bucks for $4000? Seems like a lot for very little gain (and most don’t even have $1000 lying around). But let’s see how that $20 a month works on long time spans – which has consequences for anything from retirement planning to interest on debts or being able to take awesome vacations.
The Inherent Human Weakness for Numbers and Time Frames
Somehow I was born with the bizarre nerd gene that loves math and thinking about time. Which means I love to crunch numbers and think long-term about my finances. That said, I’m still prone to human weaknesses about numbers over time. Noticing that my interest amounts have lowered by $20 dollars on my mortgage over six months thanks to extra payments really didn’t impress me. It’s sort of like, I’ve paid that much extra and all I get is a crappy $20 savings each month? That’s not even enough for a Starbucks addiction if I had one! Why bother?
But catching myself being long-term dumb, I became curious about how that $20 a month works out long-term. I did quick math. $20 a month savings yields a paltry $240 a year, not even a dollar a day in savings. Those are small numbers over a relatively immediate time frame. Again, why bother? But over 30 years that equals $7200. That number, while rough, definitely caught my attention. After all, there are many things I can do with $7200 and it’s also an immediate display of how small numbers make big impacts over time.
Another fun tidbit – doing those extra payments knocked 18 months off the life of my loan, which equals even more money saved in terms of payments not having to be made and the interest not accruing over that time span – we’re talking roughly $15,000 in interest saved thanks to $4000 in prepayments. How does that sound now?
But we aren’t wired to want to calculate those financial consequences. We just see the immediate $20 difference.
Think about it another way and for a different situation – can you spare $20 bucks a month? Probably. Over 30 year that would grow to $7200, excluding interest earned. You could use that towards all sorts of things. $40 over 15 years would again equal $7200. To get the same value in a year? $600 a month put away. How comfortable are you with these numbers and their time frames? Probably the immediate numbers have the biggest impact – $600 a month, $7200 in a year. These are big and immediate numbers but small and distant numbers impact us to our detriment or benefit on large scales that are in some ways far more important.
The visible consequence of my $4000 extra payments was a mere $20 reduction in interest accrued each month. Hidden behind all that was the interest taken out completely over the life of the loan thanks to lowering the outstanding principal. Which then lowered the number of payments I’d make over the course of the loan, saving me tens of thousands of dollars in interest. This is the key detail but one that only the nerdy and financially astute look for.
Everyone else goes, “What?” and their brains hurt and they move on to watching cat videos on YouTube. My brain hurt too until I grew comfortable with the math, the concepts and the time frames. But once I did, my financial priorities began to shift and my net worth began to grow.
Seeing a financial opportunity and acting on it saved me over $15,000 in interest. That’s a significant chunk of change, especially coupled with the 18 payments I won’t have to make. And it only required some simple multiplication on a calculator and some subtraction using my amortization schedule.
Interest Makes Normal Brains Glaze Over but Excites the Wealthy
Interest is a horrible little creature – whether on mortgages, car loans or student loans, or credit card debt. Lenders count on our human weakness when it comes to calculating small numbers versus long time frames and understanding their consequences. We gladly accept 3-7% numbers because 3 to 7 are small numbers. Hey, we can count that on our hands! The banks and lenders rarely show us the big numbers except buried in small print along with a lot of other big numbers spread over long time horizons. For instance, take Mortgage Calculator, a handy online tool for estimating loan payments. It doesn’t even show the full numbers unless you’re savvy enough to see the small print for “amortization”, click on it, then understand the drop downs to find the proper numbers to include. Your eyes will glaze over quickly looking at them.
See we instinctively go back to the percentage numbers. Again, countable on our hands and made in a near-term and easy format of monthly payments. We don’t really consider that 3% interest on a $100,000 debt is $3000 a year, a not unremarkable sum as this is the average tax refund most people will receive this year. But it’s also small. 7% interest for a year? $7000. That’s more eye-opening. What about that whopping 16.99% interest on credit cards? That would be $16,990 at the end of the year but few people have that kind of credit card debt. The average credit card debt is $5700 so interest works out to $968 over the year, fantastically high given the debt.
We humans, when we process $3000 to $7000 to $16,990 over a year, start getting uncomfortable with the debt we’re taking on when before, thinking only of 3% or 7% or 16.99% as concepts, not their real-life generating interest fees, we were more lackadaisical. When it comes to a 30 year time span for mortgage or student loans, we can’t conceptualize the numbers and default to the percent figure like 3-7%, which seems small. And manageable. But that mortgage at today’s rate of around 5% comes out to $93,255.78 over the life of the loan – almost the same amount as we borrowed! But we don’t really understand it enough, other than abstractly, to change our behaviors.
Bankers do to the fattening of their wallets. The wealthy and financially stable take keen note of these numbers to protect their wallets and build their wealth. The rest of the populace… Well, they live paycheck to paycheck and can’t save $1000 to provide for an emergency, let alone retirement.
This is human weakness at work when it comes to numbers. It is milking us for all we have and crushing our financial stability.
Financial Stability Takes Understanding Time Frames and Multiple Liabilities
Student loan debt, credit card debt, mortgage and car loans, and medical debt… Paying these off is like fighting a horde of blood-sucking vampires we didn’t realize we had inadvertently invited into our house. Now we can’t get rid of them. When we got the loans, it all seemed so manageable. But we didn’t understand interest and numbers working over time. Now those numbers are draining our spending potential and quality of life.
The average per capita income in America is just over $48,000. But that is gross, not net. And everyone is trying to sell us something, usually by subscription or installment plans (get the latest phone for $20 a month!), because they know they’ll reap a lot of dollars since we don’t understand the consequences of those small payments over time. The average new car loan hit $31,099 while used car loans hit $19,589 this year – both records. People think that since their salaries are greater than the loan, they’ll be able to afford it. The payments? $515 a month for a new car, $371 for a used car. The interest doesn’t seem bad either at roughly $1250 a year for new, and $785 for used.
Students taking on debt think they’ll be making enough money to pay off their loans easily and quickly, not realizing that the interest will make it hard to ever dig out, particularly since lenders always offer the longer terms first which means longer payment terms and larger interest (they know where their bread is buttered). It’s the same for a mortgage loan.
Not only do we not understand the values of this interest over time, we can’t add the various liabilities together. By this, I mean their cost in interest or lost spending power. People may know their house payment is $800, their car payment $500, their student loan payment $350 for a total of $1650 in payments but not the sum of all the interest generated that month by those liabilities. It runs in the hundreds each month but we don’t see it or think about it. That’s lost earning and spending potential. Hundreds of dollars lost each month? That’s a vacation, a monthly retirement contribution or so many other things.
The financially wise see this and they calculate it and make plans because of it – whether not taking on the debt, finding favorable terms, or prioritizing its payoff.
You Should Know How Much You Pay in Interest Each Month
When I do my monthly financial tracking, I always look at the interest paid on liabilities like my mortgage and remaining student loans (I stopped carrying credit card debt years ago). I imput them into my Quicken account ledger so that I regularly see the numbers and get a visceral stab in the gut at how much money I’m wasting until they’re paid off. Do you know how much you’re paying each month on interest?
Most people I talk to – even “nerdy” peers – don’t. They just make the payments by either sending in the check or automating the payment. They don’t look at their statements (which rarely show how that payment is broken down across principal and interest) and they never log into their accounts to look at their payment history which will clearly show the breakdown. I made a friend do this once and she was horribly shocked and appalled. It was a real eye-opener on her student loan situation – and why the balance really wasn’t budging despite years of consistent payments.
To be financially stable, you must track these interest numbers – and preferably monthly. Everyday, self-made millionaires and the financially free do this. They are avid about knowing these numbers and mitigating them.
Why does this matter?
You can’t problem-solve a problem you don’t know you have. Secondly, seeing the numbers can light a fire in you to take financial action – like restricting your spending and prioritizing paying down debt rapidly. Without that fire, you’re likely to remain mired in the status quo.
Light that fire.
Small Numbers Cost Us Big Returns
In a similar vein, not understanding small numbers and big time frames costs us tons of money in our pockets. Warren Buffett constantly talks about how much he loves compound interest. Considering that he is one of the richest people in the world, this should make you stop and wonder what he’s going on about.
It’s bad enough that small numbers cost us huge amounts of interest over our lifetimes, like $93,000+ per $100,000 in loans over 30 years. Most people have mortgages and students are rapidly racking up higher and higher debt for college. $200,000 in total debt when car loans, credit cards and medical debt are added in can easily exceed this figure, which means nearly $200,000 in interest paid in addition to the $200,000 originally borrowed amount. That’s $400,000, half of which gets you nothing and what’s even worse, prevents you from using that money toward your retirement, lifestyle goals, and building any lasting wealth.
After all, your hard-earned money is going to interest, not your IRA, your 401k, a holiday in the Bahamas, creating your business or investing in myriad other opportunities that make you money.
Small numbers and large time spans are again our weakness. After all, most people’s eyes glaze over what 7% annual returns in the stock market means over 30 years or how $20 a month can make them a tidy nest egg over decades. Here’s why it matters though.
That 7% means your investment doubles after 10 years. Put $5,500 in your IRA and never invest again and you should have roughly $11,000 in 10 years, a heck of a lot more if you did that every year for ten years. It’s really large after 20 years, supremely hefty after 30 years. But we can’t conceptualize that. We think short timeframe. To invest $5500 in a year means roughly $458 a month put into that account. That’s a BIG number for most people in a SHORT time frame. That’s basically a new car loan payment. No way Jose are they going to do it. Unfortunately, they can’t grasp that done yearly at 7% a year for 30 years will net them $519,534.
Meanwhile, they’ll spend far more on non-essential expenditures because they are usually small and done daily without an easy tally going on in their heads. Don’t believe me? A recent report found that millennials spend $838 per month on unnecessary expenses, while Gen Xers spend $588 and baby boomers $683. This is wasted money but since the expenditures are small, usually not related to one another and done across a month, it goes unnoticed. This non-essential (i.e. investable money) could easily go toward that $458 monthly IRA contribution or other investments. Or at least be extra payments to escape debt and its vampiric interest.
Savvy people understand this like the self-made millionaires and others who are financially free. Check out my article on the true spending habits of self-made millionaires.
Get Comfortable With Small Math and Large Time Frames
The takeaway from all this? We need to evolve to meet the demands of today’s economic realities. Many of us have and are doing just fine. Most are living paycheck to paycheck and can’t save $1000 for an emergency despite spending $588-$863 in non-essential expenditures each month. Where do you fall?
To get ahead and live the lifestyle you desire requires understanding the drip drip drip of your lifeblood wasted in interest or small expenditures over time. It also requires familiarity with how small numbers over that same time period can save you or grow your worth by incredible amounts. If you’re 30, how does having that $519,534 in your IRA when you’re 60 sound? Depending on your answer, you’re going to be financially motivated or indifferent enough not to act. Your bank account will be greatly different in 30 years depending on that answer too.
Light your own fire. Get interested in this stuff. Track it. See how it impacts you. We all should live financially secure lives but it takes action. Even if you start with $20 a month, that’ll grow over time. Start with $20 today and see where it takes you long-term.
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