Today I want to cover what I believe are the top five financial laws of arithmetic that every investor should know cold.
1. The difference between a percent and a percentage points. Friends, this is a big one. When Gov. Quinn and the Illinois General Assembly raised our state income taxes from 3 percent to 5 percent they raised the tax by 2 percentage point, not 2 percent. Be certain, that they said 2 percent but meant 2 percentage points. Let me explain, if you make $40,000 a year, your Illinois State Tax at 3 percent was $1,200. Here is the arithmetic; $40,000 x .03 (3%) = $1,200. Currently, your Illinois Income tax is 5%, $40,000 x .05 = $2,000. The taxes went up $800 on what used to be a $1,200 tax bill, so $800/$1,200 = 0.666. Then you take the 0.666 x 100 to convert to a percentage and voila, the Illinois tax increase was 66.6 percent. Pro-tax politicians loved to say it was only a 2 percent increase. However, if the tax rate would have been increased by 2 percent, you would only be paying $1,200 x 0.02= $24, your current Illinois State tax rate on your $40,000 salary would be $1,224 versus the current $2,000. See a percent and a percentage point are very different numbers. This law of financial arithmetic will allow you to see the forest for the trees. Most people do not understand what a percentage means.
2. SALE- SALE- SALE-irresistible word? My partner loves to see me calculate a good deal versus just a deal. My advice here is not what you save, but it is about how much you are spending relative to what you have. If Oprah gets a phenomenal discount (60 percent) at Gucci on a fabulous purse and after the discount the purse is $1,690 she can well afford it. Since Oprah’s net worth is a respectable $2.7 billion, the purse is an expense of only 0.0000625 percent of her net worth. Now if Rosie O’Donnell was going to buy the same purse, the $1,690 as compared to her $100 million net worth is 0.00169 percent of her net worth. Rosie would be spending 100 times more than Oprah for the same purse as a percentage of her net worth. But wait — what if Lindsay Lohan wanted to buy the same purse with her fretted away meager $1.4 million net worth (proof that rehab and attorneys are expensive) that same purse is 0.12 percent of her net worth. LiLo really shouldn’t buy that purse. That same purse is 100 times more expensive to LiLo than it is for Rosie and it is 10,000 times more expensive to LiLo relative to Oprah’s net worth. View purchases as a percentage of your total income and you will spend less.
3. The best number in the world is 7.2 percent. If you get 7.2 percent on your investment every year for 10 years, your money doubles. So, if your return is about 3.5 percent you know your money will double in 20 years. Make 7.2 percent your benchmark for all your calculations. This financial law is so important and respected that has been dubbed “The Rule of 72.”
4. Always count your change. I have a habit of calculating in my head what my change should be. Nothing could be worse than getting short-changed. I frequent a bar and one particular bartender had shorted me two times. Give him a $20 and he pretends it’s a $10. I have caught him and he acts as if it was an honest mistake. On the other side, I have caught the cashier giving me too much money back. I am happy to say that I have always returned it. From time to time, I do count the change in front of them, and when I am done I always say, “Whew! I thought you had given me back too much.”
5. Always do your own arithmetic. I always check the math on all my major purchases. A couple of years ago, I got a call from a car dealer that they had agreed to my offer that I made them six months back. I went to the dealership, my partner loved the car, and we went to sign the papers. When I looked over the numbers they just looked wrong, and I asked for a calculator. My partner left the room as this was awkward for all but me. As I looked at the arithmetic — guess what — the discount was off the dealer invoice and not the MSRP while the sales tax was on the MSRP and not the agreed price. The difference amounted to almost $1,500.
I know this seems awkward. I want to assure you, my loyal reader, that you don’t have to do this more than once. That car dealership knows I check the numbers and I got awesome service and never another error. Don’t you work too hard to lose money due to sloppy additions or subtractions?
The opinions and recommendations expressed herein are those of Mr. Garrido and do not necessarily reflect those of the firm and are subject to change without notice. This information is not to be construed as an offer to sell or the solicitation of an offer to buy any securities. The information contained herein has been derived from sources believed to be reliable but is not guaranteed as to accuracy and does not purport to be a complete analysis of the security, company or industry involved.