Principles of Macroeconomics- Personal Finance and Compound Interest
Summary
TLDRThis 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
- đŒ Regularly review your personal finance habits to ensure you're making sound financial decisions.
- đ° Aim to save three to six months of expenses in a liquid account for emergencies or ethical dilemmas at work.
- đ Avoid unnecessary expenses and prioritize saving over instant gratification.
- đ Invest in low-cost index funds that track the market rather than trying to beat the market with individual stock picks.
- đ« Stay away from high-interest credit card debt as it can significantly hinder your financial growth.
- đč Start saving for retirement early and take advantage of the power of compound interest.
- đ Use tools like Excel to simulate and understand how much you need to save to reach financial goals.
- đą Even small annual savings can grow significantly over time due to compound interest.
- đ Start saving early in your career to maximize the benefits of compound interest over a longer period.
- đŽ If you start saving later, you'll need to save more to achieve the same financial outcome as those who started earlier.
- đŒ 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
đŒ 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.
đ 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.
đ 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.
Mindmap
Keywords
đĄPersonal Finance
đĄLiquid Savings
đĄRetirement Funds
đĄCompound Interest
đĄCredit Card Debt
đĄInvesting
đĄInflation
đĄSimulations
đĄEarly Retirement
đĄEmployer Matching
đĄRaises
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 itĂs 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
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