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How I think about interest rates and growth

Recently, I made a post on social media encouraging people to teach their kids growth and interest rate mathematics as early as they can to give them an edge growing up and throughout life.  Pro tip: if they aren’t big on math and crunching numbers, talk to them about furry animals having babies… how many bunnies will you have in 3 years if you have 8 today and 2 bunnies make 5 babies a year? Kids love furry animals and “grown up” talk!

Growing up, my family was careful with spending and money, but lacked the experience with credit and interest to really drive home the point of how powerful interest really is into my teenage head, even after I got my first credit card at 18, maxed it out and started paying interest out of my minimum wage job.

As an adult who’s been through quite a bit of financial and economic education by now, I’ve made it a habit to calculate what things cost and are worth with interest almost as a hobby.

For instance, if I have a 1,000$ tax return, one of the first things I will do is go through different investment vehicles currently available and compare interest rates and dividend yields.  This is why when the topic comes up, I know instinctively that the truth is somewhere along the lines of:  with a great promotional rate on a savings account in my bank, this 1,000$ will be worth 1173$ in 5 years (promotional rate of 3.2%) a profit of 173$ over 5 years or 34.60$ per year, but the same money used to purchase shares of this same bank will yield a dividend return of 269$ for the same period of time (4.78% dividend yield) and while the stock could definitely go down in price, a Canadian bank is generally considered a safe investment so I can reasonably expect the share price to remain steady or grow.  In fact, the way I would calculate it, is that I’d look at the average yearly growth rate of the value of the bank’s stock over the last 5 years (in my example, the stock appreciated 6$ or 1% over 5 years, which adds up to about 0.2% per year) and figure that my 1000$ with the historical growth rate should be worth 1100$ in shares plus 269$ in dividend payments for a total of 1369$.

Now compare my 369$ of profit with the 173$ of profit the savings account would generate.  We’re looking at over twice as much money from essentially the same starting point, just a few different clicks with online banking, as long as you know where to look. Information is power. Just from knowing this, I can reasonably expect to make 2.13 times more money than someone who doesn’t.

I gave you a 1,000 example, but what if you’re dealing with a more serious amount of money, for instance 10,000$ you get from selling your company stock options?  The stock and dividend strategy would have gotten you 3690$ over the course of 5 years; a whopping 1960$ more than the 1730$ the savings account would have given you.

How’s that for a treat?

On the other hand, say that you have your 1,000$ and you’ve decided to put it as a down payment on a 10,000 used Honda Civic, because it’s reliable and you could use the upgrade from your old car that’s starting to look embarrassingly dated.

10,000$ with the sales tax will add up to 11,300$, less the 1,000$ of money you’ve got in your hand for a total of 10,300$ that you’ll have to finance over 5 years through your bank, which will usually charge you an 8.99% interest rate these days. The nice rep at the bank will be very happy to tell you that the car is all yours for an easy monthly payment of 213.76$, every month for the next 5 years.

Would you instinctively know how much that car will end up taking out your pocket in those 5 years?  My thought is that you wouldn’t, but you should.  You should know, even if only approximately, that you’ll end up paying 12,825.60$ for that car after your down payment, that’s 2,825.6$ over the ticket price of the car, that means you’re actually paying, factoring the 1,000$ you spent when you got the car, 38% over the value of the car.

How likely were you to buy anything if at the register, they charged you 38% more than the price on the tag?

Yet so many of us never even think of things this way.

Why does this matter? Well, say you decided to stretch your old car’s life out a bit and instead, slapped 1000$ and then 213.76$ per month into some growth strategy, what would happen then?

Well with the simple, savings account strategy we discussed earlier, you’d have all of 15,077$ in your bank account to buy a nice car with on the 5th year.

With the dividend stock strategy, that amount would be 15,828$.

Now I understand that maybe you need that car really band and you don’t have a choice, and I can relate, I’ve been there more times than I’d like to admit and have paid way more interest than what’s reasonable.

My point is, having these numbers, even roughly rounded in your head when making that decision of whether or not to buy the car, make the investment, spend the money will empower you to make better decisions for yourself and will keep salespeople and loan peddlers from taking advantage of you.

In the end, it’s up to you to decide whether you want a car worth 10,000$ today or one worth almost 16,000$ in 5 years… or maybe you like that money in your account growing and figure maybe taking the bus isn’t so bad after all, especially when you think long term and say “hey, I’m planning on retiring in 30 years, if I just keep putting aside 214$ per month until then, I’ll have 181,887$ in my account, and of that, 75,686$ will be money I didn’t get to spend and saved instead, but 106,201$ will be money that I’m just being given “for free” for having saved instead of spent.

Well, if you’re living pay check to pay check, that 214$ can make a huge difference, but if you’re in the Canadian average, chances are that 214$ is something you could easily save if you skipped a handful of drinking nights at the bar every month.

Please understand, this isn’t financial advice; I’m not telling you what you should and shouldn’t do with your money. This is thought advice. I want you to know how big of an impact a few simple facts can have on your life and on your decision making, and most importantly, that you don’t need to go back to school for another degree to understand how these things work and act accordingly.  You just need to develop the habit… and then you’ll start realizing things you never thought of before, like for instance that if you saved that 600$ a month you spend on partying every month, that’ll be an extra half a million dollars in your retirement account, you know, in case such things matter to you.