Principles of Macroeconomics- Personal Finance and Compound Interest

Summary

This macroeconomics lesson emphasizes the importance of personal finance, advising viewers to save 3-6 months' expenses, invest in low-cost index funds, avoid credit card debt, and start saving early for retirement. The power of compound interest is highlighted through simulations showing how early savings can significantly increase wealth by age 65.

Takeaways

• 💼 Regularly review your personal finance habits to ensure you're making sound financial decisions.
• 💰 Aim to save three to six months of expenses in a liquid account for emergencies or ethical dilemmas at work.
• 🚗 Avoid unnecessary expenses and prioritize saving over instant gratification.
• 📈 Invest in low-cost index funds that track the market rather than trying to beat the market with individual stock picks.
• 🚫 Stay away from high-interest credit card debt as it can significantly hinder your financial growth.
• 💹 Start saving for retirement early and take advantage of the power of compound interest.
• 📊 Use tools like Excel to simulate and understand how much you need to save to reach financial goals.
• 🔢 Even small annual savings can grow significantly over time due to compound interest.
• 🎓 Start saving early in your career to maximize the benefits of compound interest over a longer period.
• 👴 If you start saving later, you'll need to save more to achieve the same financial outcome as those who started earlier.
• 💼 The script emphasizes the importance of personal finance education and continuous learning for financial health.

Q & A

What is the main focus of the video script?

The main focus of the video script is to provide an overview of personal finance principles, emphasizing the importance of saving, investing in tracking funds, avoiding credit card debt, and the power of compound interest in retirement savings.

Why is it recommended to save three to six months of expenses?

It is recommended to save three to six months of expenses to provide a financial cushion for unexpected job loss or unethical demands from a boss, ensuring financial security and the ability to leave a job if necessary without ruining one's career or facing severe consequences.

What is the suggested approach to investing in the stock market for long-term gains?

The suggested approach is to invest in low-cost tracking funds, such as those that follow the S&P 500, rather than trying to beat the market through individual stock selection or market timing, which is often less effective due to fees and market unpredictability.

Why is it advised to avoid credit card debt?

It is advised to avoid credit card debt due to the high interest rates associated with it, which can significantly increase the cost of borrowing and hinder one's financial health.

What is the significance of saving early into retirement funds?

Saving early into retirement funds is significant because of the power of compound interest, which allows earnings on both the initial investment and the accumulated interest over time, leading to substantial growth in savings.

How does the script illustrate the power of compound interest?

The script illustrates the power of compound interest through Excel simulations, showing how a consistent savings plan with a fixed interest rate can accumulate significant wealth over time, especially when started at a young age.

What is the suggested initial savings amount per year in the Excel simulation?

In the Excel simulation, the suggested initial savings amount per year is $2,000, which is then compounded annually at a 5% interest rate after inflation.

What is the impact of saving a consistent amount each year until the age of 30 in the simulation?

In the simulation, saving a consistent amount of $2,000 each year until the age of 30 results in a total savings of $31,956 by the time the individual reaches 65, demonstrating the long-term benefits of early and consistent saving.

How does the script compare the outcomes of starting to save at different ages?

The script compares the outcomes by showing that starting to save at age 22 versus starting at age 30 results in significantly different total savings by the age of 65, with the earlier start providing a much larger sum due to the effects of compound interest.

What is the effect of employer matching on retirement savings in the script's scenario?

In the script's scenario, if an individual contributes 5% of their salary and the employer matches this contribution, it effectively doubles the annual savings amount, significantly increasing the total savings by retirement age.

How does the script suggest adjusting savings amounts over time?

The script suggests adjusting savings amounts over time by increasing the annual savings by 5% each year to account for raises, which helps maintain the proportion of income being saved while also benefiting from the power of compound interest.

Outlines

00:00

💼 Personal Finance Basics and Emergency Funds

This paragraph introduces the importance of personal finance and the need for constant attention to one's financial health. The speaker emphasizes the necessity of having an emergency fund equivalent to three to six months of expenses, which can provide a safety net in case of job loss or unethical demands from an employer. The paragraph also touches on the importance of saving for retirement and the pitfalls of trying to beat the market, suggesting that investing in a low-cost index fund is a more reliable strategy.

05:07

📈 The Power of Compound Interest in Retirement Savings

The speaker delves into the concept of compound interest and its significant impact on retirement savings. Using an Excel spreadsheet as a tool, the paragraph demonstrates how saving a fixed amount annually at a consistent interest rate can accumulate substantial wealth over time. The example shows how saving $2,000 per year from age 22 to 30 at a 5% interest rate can result in significant savings by age 65. The paragraph highlights the benefits of starting to save early and the exponential growth of savings due to compound interest.

10:12

🚀 Maximizing Savings with Early Retirement Contributions

This paragraph continues the discussion on retirement savings, focusing on the benefits of early contributions. The speaker illustrates how saving a consistent amount each year, even if it's a modest sum, can lead to substantial savings due to the power of compound interest. The example shows that saving $2,000 annually from age 22 to 30 and then stopping can still result in over $300,000 by age 65. The paragraph also contrasts this with starting savings later in life, demonstrating the significantly reduced total savings and the increased amount needed to be saved annually to achieve the same retirement goal.

Keywords

💡Personal Finance

Personal finance refers to the management of an individual's financial resources, including budgeting, saving, investing, and planning for retirement. In the video, it is emphasized as an ongoing process that educated individuals should engage in regularly, not just a one-time consideration. The script discusses various aspects of personal finance, such as saving for emergencies, investing in retirement funds, and managing debt.

💡Liquid Savings

Liquid savings are funds that are readily available for immediate use, typically held in a bank account. The video script advises having three to six months of expenses saved in a liquid form, which can provide a financial cushion in case of job loss or other emergencies. This is crucial for maintaining financial stability and flexibility in making important decisions, such as leaving a job that requires unethical behavior.

💡Retirement Funds

Retirement funds are financial accounts set up to provide income during retirement. The script suggests that individuals should start saving for retirement early and invest in low-cost, diversified funds that track a broad market index, like the S&P 500. This approach is recommended over trying to beat the market through individual stock picking, which is often less successful and more risky.

💡Compound Interest

Compound interest is the interest earned on both the initial principal and the accumulated interest from previous periods. The video highlights the power of compound interest in growing savings over time, especially when savings are started early. The script uses simulations to demonstrate how even small annual contributions can accumulate to significant amounts due to the effects of compounding.

💡Credit Card Debt

Credit card debt refers to the money owed on a credit card, which often carries high interest rates. The video strongly advises against accumulating credit card debt due to its high cost and the potential financial strain it can cause. It is presented as a financial pitfall that should be avoided to maintain good personal financial health.

💡Investing

Investing in the context of the video involves placing money in financial assets with the expectation of earning a return. The script discusses the challenges of beating the market through active trading and suggests a more passive approach, such as investing in index funds, as a more reliable strategy for long-term financial growth.

💡Inflation

Inflation is the rate at which the general level of prices for goods and services is rising, and subsequently, purchasing power is falling. The video mentions inflation in relation to the interest rates on savings, suggesting that a reasonable rate of return on investments should be above the inflation rate to ensure that savings maintain their real value over time.

💡Simulations

Simulations in the video are demonstrations or models used to show the potential outcomes of different financial strategies, such as saving and investing. The script uses Excel simulations to illustrate how compound interest can significantly increase savings over time, especially when savings begin at a young age.

💡Early Retirement

Early retirement is the concept of retiring from work before the typical retirement age, often achieved through diligent saving and investing. The video emphasizes the benefits of starting to save for retirement early, as it allows individuals to take advantage of the compounding effect of interest over a longer period, potentially enabling early retirement.

💡Employer Matching

Employer matching refers to a benefit where an employer contributes to an employee's retirement account, typically in proportion to the amount the employee contributes. The video script mentions this as a valuable component of retirement savings, suggesting that taking advantage of employer matching can significantly increase the total amount saved for retirement.

💡Raises

Raises in the context of the video refer to increases in salary or wages. The script discusses the impact of annual raises on retirement savings, suggesting that as income increases, so should the amount saved for retirement. This is part of a broader strategy to continually invest in one's financial future.

Highlights

The importance of constantly considering personal finance and its impact on an educated person's life.

The recommendation to save three to six months of expenses as a liquid emergency fund.

The significance of having a financial cushion for potential job loss or unethical demands in the workplace.

The advice against spending on luxuries early in one's career and the emphasis on saving instead.

The argument that playing the stock market is less effective than investing in a tracking fund.

Evidence from experiments showing that random stock selection can outperform financial experts.

The warning against high-interest credit card debt and the importance of avoiding it.

The demonstration of the power of compound interest through Excel simulations.

The illustration of how saving $2,000 annually at a 5% interest rate can accumulate over time.

The concept of compound interest, where interest is earned on both the initial deposit and accumulated interest.

The advantage of saving early due to the exponential growth of savings with compound interest.

The hypothetical scenario of saving consistently from age 22 to 65 and the resulting savings.

The impact of employer matching contributions on retirement savings and the benefits of taking advantage of such programs.

The comparison between saving a fixed amount annually versus increasing savings with raises and the difference in outcomes.

The significant difference in savings when starting at age 22 versus starting at a later age, even with higher contributions.

The lesson on the importance of starting to save early and the potential financial benefits of doing so.

Transcripts

hey welcome to our principles of

macroeconomics quick lesson on some

personal finance basic personal finances

of stuff that actually is an educated

person is going to be earning money this

is not a thing that you should think of

one and then discard this is something

you should think of constantly every

month you should be thinking about what

you're doing for personal finance are

you doing the right things there's all

sorts of good tips best practices I

can't possibly cover them all so I'm

going to let me give you a very brief

overview of a few points and then we're

going to discuss a little bit about the

power of compound interest in saving or

early and I'm going to show you some

simulations that those who are taking my

class you're going to be asked to be

doing some homework assignments that are

similar to these simulations so the

quick tips that I recommend first of all

for the moles you know if you're taking

this in you're in college as soon as you

possibly can save three to six months

expenses and I say this that our liquid

don't go buy a new car don't go buy

expensive I mean you treat yourself a

little bit but do your best to have

money in an account this is going to be

especially true if you are in any sort

of a sensitive type of a job where a

boss might ask you to do something

unethical and or illegal which for most

of you it won't happen but there are

accountants and other business

professionals who've gone to jail for

cooking the books the boss asks you to

do this you need to leave the job and

you want to have money available where

you can do that not a good option but

ruining your career and spending time in

prison is far far worse and that might

sound dramatic then maybe it is a bit

too dramatic but there are people who

this happens to

and even if this crazy scenario if you

think all that just sounds ridiculously

crazy people do lose jobs from time to

time three to six months expenses just

gives you a huge life cushion should

something happen but especially if

you're going to get a job that's at all

you could see somebody unethical asking

you to do something illegal you want

this I would say within your first two

years in the workforce do your best to

have three to three to six months

expenses saved and that should be liquid

to you should be saving for retirement

as well but playing the market doesn't

work as well as tracking phones we all

hear stories of people who can get rich

by playing the market but it's very

tough to beat the market with fees and

in the long term more it's usually just

better to put your money in a tracking

fund there's you know there's been news

stories right where John Stossel for

example threw darts at a board it just

bought the stocks at the dark starts

randomly hit and he beat them he beats

the financial experts right like having

a monkey pick stock has beaten financial

experts playing the market doesn't work

as well as just buying a tracking fund

at holding things in there now can the

very best people perhaps eke out a tiny

little gain by over the market by

playing the market a little bit sure but

that's the very best and I don't care

what kind of ego you have if you're

watching this video you're probably not

the very best at this point if you get

to be the very best fantastic you know

you can ignore this but for the most

part everybody watching this video good

advice would be don't try to play the

market find a low-cost fund that tracks

like the S&P 500 or a huge range of

stocks and just put your money in and

then don't think

three avoid credit card debt high

interest rates on credit card debt are

insane do whatever you can to avoid that

debt and then the fourth one is safe

early into retirement funds because the

power of compound interest is absolutely

enormous so I'm going to do a couple of

cell files for those who gets into

finance classes later you will do a

whole lot more using Excel to find out

like how much you might need to save to

reach a certain target we're just going

to show a couple simulations of how

compound interest can be really valuable

slip so we're going to just we got an

excel book started up and let's say take

a person to graduate and their age is 22

expand the screen a little bit here go

first in graduate age is 22 and let's

see let's go to and I keep adding a year

so 22 and

I'm going to go to 91 right but so

simple Excel spreadsheet amount saved

that year for the second column interest

rate and total total savings so let's

say you start with zero before that you

get a job you decide to save two

thousand dollars that year not that much

but then we're going to simplify in

theory if you're saving two thousand

dollars in a year right your sis you're

splitting this up month by month earning

some interest on the money you put in

right away you're earning much less

interest over the course of a year on

the money you put it at the end plus

it's a stock market so there's going to

be ups and downs we're going to simplify

and let's just say you're in a five

percent interest rate after inflation so

five percent interest rate after

inflation well what would be your total

savings then well your initial amount

plus

the two thousand times the interest

you're right so it's five percent on two

thousand which is 100 plus the hundred

dollars plus the two thousand you had in

that's what you'd have a five percent

five percent a relatively reasonable

rate to think about above and beyond the

inflation rate in fact the stock

market's actually been higher than that

over the years see you do two thousand

every year until you're 30 so it's nine

years or three year 30th or same let's

say you get a five percent interest rate

each year well what's your total savings

you need to actually do a slightly

different formula for year two because

in year two we have the total savings

from year 1 plus the new savings and now

we're assuming we're putting this two

thousand dollars away basically the very

first day of the year and then what do

we have at the very last day of the year

is kind of how we're working with so we

have the 2100 plus the two thousand plus

we have the interest rate that we're

earning on the 2100 the 2100 plus the

two thousand times our interest rate and

now we're up to 40 305 right you know

it's just kind of interesting if you

think about this right we earned we had

two thousand and year one and two

thousand and year two at five percent of

four thousand dollars you might say oh

that's about five percent of four

thousand dollars we're going to two

hundred dollars in interest that year

but actually we also earned interest on

that extra 100 we earned in year one so

we didn't turn two hundred we need 205

right 305 minus 100 we earned an extra

five dollars as that extra five dollars

as the result of what we call compound

interest so we're not only earning

interest on the money we're putting away

each year but we're learning interest on

the interest and the power of compound

interest is pretty enormous

and with compound interest it really is

incredibly valuable to save early you

start to see this so now once we have

the end we have this formula right we

can actually just copy and paste and we

can see what we have at the age of 30 so

2,000 a year by h 30 we have 23,000 156

just kind of interesting how much should

we put away here we put away 18,000 all

right that's the amount would put away

there's an extra 5156 dollars in

interest earnings over those nine years

what if we carry on this without without

some what I'm gonna ask my class to do

and I mean itís with some cheese you

could take out a sheet of paper imagine

that we're going to do this till age 65

we're going over 2,000 a year and we're

going to earn the same five percent per

year which is unrealistic but it's not

out of the realm of possibility because

some years you might earn a slightly

negative rate somewhere in some years

you learn a positive great but if you're

investing in a low-cost often this is a

perfectly reasonable rate of return to

think over the long term that you might

get 65 how much do you think you'll have

to take a moment and just break down the

number just so you have it how much

money do you think you'll have at age 65

you can pause it if you want I'm going

to resume so let's go and see at age 65

how much would we have but I went back

to the beginning

by age 40 with 64,000 in savings I'm

going to create another column total

amount say our total amount we put away

which just equals this number times and

I'm going to do age- 21 that'll show how

many times we put away to two thousand

dollars so at age 40 with 64,000 dollars

in savings we've only saved we've only

quit early 38,000 but not the money is

really going to start to take off a

little bit more because we're actually

not earn more interest income than we're

putting away each year because of the

once again the power of compound

interest we've been earning interest on

the interest year after year so by the

time we get to h50 we have 130,000 the

time we get to h-60 it's 230 9065 317

thousand dollars that's by putting away

88,000 and savings now 2000 is not

probably a recommended amount a lot of

employers if you put away five percent

they'll match five percent will start to

think a little bit more realistically on

how much you might be putting away why

don't we say you're putting away five

percent and the employer is putting away

five percent a new range fifty thousand

in a year so it means ten percent of

50,000 you're putting away 5,000 and

let's assume you're going to keep that

up but you're also going to get raises

and we'll say your raises amounts of

five percent per year so we got to go to

the previous year's amount saved and

then x 1 point 05

how much could you have here at age 65

numbers don't look pretty impressive

right remember five percents a good rate

of return after adjusting for inflation

okay I want to try something different

now just to show you another thing why

the x is pretty powerful to save early

go back to where you're just saving five

thousand dollars every single year year

in and year out instead of keeping

increasing at age 65 at a five percent

interest rate and five percent interest

rate remember this is pretty reasonable

even after inflation let's be like

having 800,000 in today's dollars at age

65 there's a lot of power in saving

early if you save age 22 to 30 and then

you stop saving still up 319 thousand

dollars at age 65 what happens if you

don't start until age 30 well if you

start at age 30 and you did nine years

just like we did 22 to 30

remember we had like three hundred and

forty thousand last time I'm going we

have 216 the same amount saved in

nominal terms five thousand dollars a

year for nine years but quite a bit less

in total savings let's say we put away

an extra twenty five thousand five

thousand a year another five years we're

still below the amount we had if we save

five thousand a year what you do we have

to put away looks like we have to put

away instead of nine years from age 22

to 30 from age 30 we would have to save

until age 45 that's actually 16 years

just to get to the same amount and this

amount this this difference will be

pretty drastically different actually if

the interest rates are higher it's a

more pronounced difference like if you

could earn a ten percent interest rate a

year or is it such an enormous advantage

to start at age 22 versus starting at a

later