Don’t let the title- mathematics for business and personal finance scare you. In this article, the mathematics involved are very simple yet so important to know if you want to improve your financial outlook.
To make this more useful and fun, I enlisted the help of my personal finance blogger friends. We will be going through 7 favorite almighty financial formulas.
Let me open the floor.
Table of Contents
1. The Finance Twins – Personal Savings Rate
Your personal savings rate is easy to calculate, but its impact is profound. To calculate your personal savings rate you simply need to divide the amount of money you were able to save or invest over a period of time (typically monthly or annually) and divide it by your take-home pay over the period of time.
So for example, if you saved or invested $1,000 in a month (include contributions to retirement accounts) and your after-tax take-home pay was $4,000, that means that your savings rate was 25% since $1K / $4k = 0.25.
The reason this simple calculation is so powerful is that it can mean the difference between retiring when you’re 60 or working until your last days on Earth. The more you save, the more you’ll have for retirement.
At the same time, the more you save, the less you need to live off of (since you are able to live off of a smaller amount), which means you will need to save less for retirement. A win-win. Curious what a good personal savings rate is? You’ll have to read the related article to find out – Personal Savings Rate
2. Your Money Geek – The 4% Rule
The 4% rule has become part of the foundation of retirement planning. In essence, the 4% suggests you can withdraw 4% of your retirement savings each year and feel reasonably assured you will not outlive your savings.
The advantage of the 4% rule is the math is convenient. Want to know how much money you must save to quit the workforce? Simply multiply you designed spending by 25 and you will know how large your nest egg must be before turning your resignation.
However, all is not perfect with the beloved 4% rule. Several studies have been published suggesting that given today’s low interest rates and comparatively high stock valuations, the 4% rule should be revised and that retirees should withdraw even less.
Some academics suggest rates as low as 2.9 or 1.9, at these rates it may feel like you may never retire. Luckily, those that prepare can sidestep some of the uncertainty with the 4% rule.
Starting a side business or purchasing investments with guaranteed annual income can help you sleep easily during retirement. Even with its limitations and the disagreement over whether 4% is too high.
Most of the financial elite agree that exceeding 4% should be avoided. It’s better to plan for the worst and hope for the best, of all goes well then you will have extra money to enjoy when you are retired.
3. Time In The Market – The Rule Of 72
The rule of 72 is a cool way to easily estimate how long it’ll take your money to double given an interest rate. I found this concept in some of the best financial books I have read.
You divide 72 by the annual rate of return and get a rough estimate of how long it’ll take that investment to double in size.
For example, if your money is sitting in a bank account earning 2%, it’ll take around 36 years to double(72/2). That’s a long time!
However, if you invest that money and get 7% in the stock market, it’ll take about 10.2 years to double(72/7). That’s a big difference!
It’s not exact but a good enough estimate and gives you an idea as to why investment returns really matter when trying to grow your wealth.
Let me interject here and say that I also love the rule of 72. In fact, I went through how to derive the rule of 69 (as that was the actual derived number, it was approximated to 72 to look cooler ) in our post – The bizarre truth about the rule of 72 in investment.
4. The Money Mix – Success formula: Productive Time
When it comes to professional success, one thing we learned is that few things are more important than hard work and determination.
There are 168 hours in a week. If you sleep 8 hours per night, you have 112 waking hours. If you work 40 hours a week, you are still left with 72 hours. Give or take some time for dinner and getting to work and you still have 60 hours of “free” time.
The math here is more simple than some of the other formulas but few are as important.
What are you doing with those 60 extra hours to make your dreams a reality? Are you starting a business? Spending time with your loved ones? Learning new skills? Picking up a hobby? Networking?
If you’re filling it up with reality TV, then you are simply wasting a lot of time.
Read more to see the other habits of people who’ve achieved wild success in their careers.
I have to be honest with you, at first, when I got this reply back, I was wondering if the money mix misinterpreted my questions or something. However, the reply made sense and it is unique.
You can also read about the 7 habits of highly successful people (millionaire next door) on our blog too.
5. Debt Discipline – Compound interest
Compounding interest separates the rich from the broke.
“Compound interestis theeighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.” – Albert Einstein
I’m a big fan of compound interest or compounding interest. It is one of my favorite mathematical formulas in personal finance.
The sooner you understand its power, the better position you will be able to build wealth. Think of it as interest on interest. For example, a $100 initial investment compounding annually at 5% will yield $5.
So after one year, you have $105. After three years the balance grows to $115.76. Consider if you have interest compounding monthly at the same 5% rate the same $100 initial investment will increase to $179.58 in year one and $579.18 after three years.
Now imagine if you added additional money to that investment periodically, the growth will be more significant. The only downside to compound interest is that there are no guarantees to the interest percentage rate you will receive.
Smaller guaranteed interest rates like say a savings account will yield less, then say a riskier investment in the stock market. The key to remember is to take advantage of compound interests magic, you will need to be in it for the long term. The sooner you can begin investing the sooner you can enjoy the benefits.
Check out our compound interest calculator and play around with it to know when you will reach your first million dollars. Or 10 million, the sky is the limit.
6. Wealthy Nickel – Retirement Savings By Age
There’s a rule of thumb I like to use to estimate how much you need in retirement savings by age. Did you know that the number one method people use to estimate how much money they need for retirement is guessing? And who’s to blame them? The financial industry really overcomplicates things with fancy retirement calculators and obscure financial products.
If you plan to retire at the full retirement age of 67 and maintain a similar standard of living, you should have at least 10X your income saved for retirement. So if you back that up, at age 30 you’d need 1X your income, 3X by age 40, 6X by age 50, and 8X by age 60.
By using this simple formula, you can easily see if you are on track for retirement. Even if you’re behind, it helps you have an idea of what you need to do to catch up, so you can make a plan. I think so many people fail to plan for retirement simply because they don’t know what they need.
While I love that this is a simple rule of thumb, of course, everyone’s retirement situation will be different, and you will need to tweak it for your own needs.
The main disadvantage of this formula is that it is really TOO simple to be the only gauge of whether or not you’re on track for retirement.
But as a baseline target to aim for, I think it allows you to at least have a goal so you are not stumbling in the dark when it comes to saving for retirement. And of course, you can tweak it along the way.
7. Dr. Breathe Easy Finance – Time Value Of Money
Time value of money is essentially the formula that tells you that the money in your hand today is worth more than the same amount in the future. This formula is very simple, yet, it has many applications.
Growing up, a common proverb in Nigeria is – A bird at hand is worth thousands in the bushes. This is kind of the fancy version of that proverb.
This concept can work for you or against you. If you keep your money under your mattress due to fear of the market, the time value of money is working against you. If you are investing your money right now, it will work in your favor.
In our highly ranking blog post – the importance of time value of money, we detailed this rule and its application. We went through various calculations to decide whether you should take 10,000 today or 100,000 in the future. The answer is simple when you know the formula.
The formula for future value of money
FV = PV X (1 + r) ^n
FV = Future value
PV = Present value
R = rate of return
N = the time period the money is invested.
There you go. 7 formula to help you go farther in your financial journey. Please share and comment to let us know what you think.
Adebayo
Website
I am a pulmonary and critical care doctor by day and personal finance blogger/debt slaying ninja by night.
After paying off close to $300,000 in student loan debt in less than 6 months into my real job, I started on a mission to help others achieve the same. There is no magic to this than to strap up and get it done. Some of the ways we achieved this include side hustle, budgeting, great negotiation skills, and geographical arbitrage.
When I was growing up, common knowledge in Nigeria is that there is one thing you cannot trust anyone else with, and you guessed it – your money.
Being frugal came easily to me based on my background. However, the concept of building wealth did not solidify in my mind until when I finished medical school. I wish I knew what I know now when I was 14. Still, I don’t know enough and I am constantly learning to improve my knowledge.
My goal is to reduce financial illiteracy among young professionals. I am catering to the beginners – babies and toddlers in financial literacy.
