Albert Einstein was a great scientist, but first, he was a great mathematician. I tell my kids that most everything in the world, including those amazing video game graphics or high tech fight scenes in the latest mega movie, or even the waves crashing on the beach, comes down to math. As a mathematician, Einstein reportedly said about interest: “Those who understand it, earn it…Those who don’t, pay it.”
A current example of the value of understanding math can be found in the Utah legislature which is considering a bill to raise the individual income tax rate by 7/8ths of one percent. The argument claims that it is just a small increase. Politicians routinely speak in tiny percentages as a way of minimizing the cost in the voter’s mind. Since Utahns currently pay a flat 5% income tax, increasing that amount to 5.875% is actually a 17.5% tax increase. If politicians campaigned on a plan to raise income taxes by 17.5%, I suspect they would face a tough challenge. (Now you who are anxious to slam me on tomorrow’s opinion page, hold your keyboards. I am not giving an opinion on these tax issues, just showing the importance of correctly understanding the math as you evaluate them).
Investors face a similar math challenge with investing. An example may be upfront bonuses offered to purchase certain investments, that are often presented at free dinner seminars. I have seen some products that offer what they claim to be a 10% signing bonus. That seems great but the fine print points out that you may need to hold it for ten years in order to collect it. So that bonus is actually just 1% per year. With this understanding, an investor can more clearly decide if it is worth 1% per year for the liquidity they are giving up, among other things. In making decisions during one of these dinner seminars it may be wise to consider another Einstein quote. “To obtain an assured favorable response from people, it is better to offer them something for their stomachs rather than their brains.” I guess Einstein understood more than just math.
As with taxes, in investing, small percentages can mean very large dollars over the course of time. Never discount the value of squeezing out a few more fractions here and there, nor should you ignore the potentially dramatic cost that losses play in the final result. Just as many painfully learned in 2008, the math of investing requires you to protect against unreasonable losses that take years to recover. A few percentages gained or lost can make a huge difference over time.
There is a science and an art to assembling a successful investment portfolio, but both begin with an understanding of the math involved. Einstein was a great mathematician, which is why he is credited with calling compound interest the 8th great wonder of the world. Unfortunately, that “wonder” can work for you or against you, depending on how well you understand and use it.
Hi, I'm Dan. I'm a CFP® Professional.
Securities and advisory services offered through Commonwealth Financial Network®.
Member www.finra.org / www.sipc.org , a Registered Investment Advisor. Wyson Financial, 1173 S. 250 W. Suite 505, St. George, UT 84770.
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