I realized that not many people know financial mathematics, or just plain mathematics. It is a pre-requisite to financial independence.
Let me give you one example.
Billy the Banker downs 2 lattes a day at an upmarket coffee joint, one just before the work day starts, and another in the late afternoon. He might even throw in an extra order of fudge cake when he really deserves it. This costs him a total of $15. These are the little luxuries in life, which John has rightfully earned. There he is, sitting down with his mates, on closing a deal, or working on his very important power point presentation.
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How do you put the $15 a day habit in financial terms?
$15 a day for 20 days works out to be $300 per month or $3600 per year. So Billy needs to part with $3600 a year from his salary for this habit.
What if Billy wants to pay for this expensive coffee habit through his investments?
Billy needs $360,000 in the bank in fix deposits earning a 1% interest. This gives him $3,600 a year – just enough to fund his little luxury.
That’s it – $360,000 in capital, to fund two daily lattes in perpetuity.
What does this mean?
It means that if Billy wants to retire, and still enjoy his premium lattes with his buddies, he got to save an additional $360,000 in his retirement fund.
Alternatively, if he is satisfied with making his own coffee, which costs 5 cents a cup, this works out to be $12 a year and require an additional $1200 in his retirement fund.
If Billy is earning $100,000 a year, and assuming he saves all of it – he has to work for 3.6 years to save up $360,000 to fund his latte habit.
Are the daily lattes worth 3.6 years of John’s productive life? Or should he make his own coffee and just give up 3.12 days of his life? (1200/100000 * 52 weeks * 5 working days).