Surplus, Interest, Debt: Personal Finance in a Nutshell

Author: Michael McNiven, Ph.D., Post Date: October 26, 2017

Cumberland Advisors in partnership with the University of South Florida, Sarasota-Manatee (USFSM) and the Global Interdependence Center (GIC), with support from the Financial Planners Association (FPA), are proud to announce the 2nd annual Financial Literacy Day which will be held in Sarasota, FL at USFSM on Thursday, April 5, 2018.  Several nationally recognized speakers are already on the agenda. Stay tuned for further information about our upcoming Financial Literacy Day!

The conference agenda will include high-level discussions on municipal markets, technical analysis, the U.S. banking system, the global stock markets, and the global economic outlook. However, what follows here is a basic guide for individuals regarding their personal approach to debt management and wealth creation. U.S. household consumer debt has reached an all-time high of almost $13 trillion. This includes student loans, auto loans, credit cards, and mortgages/home equity lines of credit. Many of our friends and neighbors of all socioeconomic classes have not been exposed enough to fundamental financial principles.  Feel free to share it with others in your communities who may benefit from a refresher on these basic points.

An easy to share and downloadable PDF version of this piece is available here:

Surplus, Interest, Debt: Personal Finance in a Nutshell

Far too many people are living beyond their means. Many of us are spending more money than we make. Many of us are living inflated lifestyles supported by debt. Far too many of us are not prepared for unemployment or economic disruptions. A large group of us are not prepared for even minor financial emergencies. Many workers are not saving enough for retirement. Somewhere along the line, a vast majority of us—including high-income earners—have not been taught how to think properly about money or to transcend the cycle of debt and perpetual want.

There is a better way. It begins by thinking properly about surplus and interest and the dangers of indebtedness. We then can learn how consistent saving over time can take part in the grandeur of investment and compound interest. Albert Einstein called compound interest “the greatest mathematical discovery of all time.”(1)  When money is mixed with time, good things can happen. As such, we may benefit from a renewed understanding of the words surplus, interest and debt. We can begin with a very basic socioeconomic classification of people based on these concepts.

Four Economic Classes of People (Which one are you?)
1.      The Destitute: The truly forgotten men, women and sometimes children. They are homeless and often helpless. They need our empathy, respect and assistance to secure food, shelter, clothing and fuel.
2.      The Dependents: They rely on others including the government or family for the majority of their personal maintenance and support.
3.      The Poor: They pay interest.
4.      The Rich: They receive interest.

Everyone has income and expenses. When our expenses are higher than income, we have debt. When the income is higher than our expenses, we have a surplus (Income + Expenses = Surplus or Debt). It is a simple concept that even a child can understand. Whatever one’s circumstances, the key concept is to create a surplus and to then build financial security from there forward.

Things to do:
1. Create a surplus. This can happen on any income.
2. Direct surplus for short-term cash reserve ($1000, then 3 months expenses)
3. Use surplus to pay down debt, start with credit cards, cars, education, home.
4. Use surplus to build savings and then investments to start receiving interest.

Education Charts: Compounding Interest and Growth Rate Returns

Take a look at Chart 1. Starting at age 19, Investor A contributes $2,000 per year for eight years ($16,000 total) and then invests the money until retirement (39 years more). In contrast, Investor B did not start investing until age 27 at $2,000 per year for the next 39 years (total investment $78,000). The charts show returns for each investor assuming average annual returns of 6%, 8% and even 10%. Receiving interest over time can be rewarding.

Take a look at Chart 2. This chart shows how many years it takes an investment of $10,000 to double given the interest rate/portfolio returns it can achieve. It is clear from the chart that getting to 6% per year or greater returns is important for accelerating investment growth.

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