Hello SOTGC community,
This is an excerpt from my forthcoming book, Every Woman Should Know Her Options: Invest Your Way to Financial Empowerment.
When my stepdaughter, Rachel, was young, she liked math. When she reached middle school, she hated math. One night, when she was struggling with her homework, she exclaimed, “Math is useless! Why do we have to learn this stuff?” I asked her not to give up on math, because although she might not realize it now, math has tons of practical applications.
Even baking a cake requires a mathematical formula. You need certain ingredients as your inputs and you also have to understand the ratio of how much flour to eggs, sugar, and butter is required. Since Rachel loved baking (and still does), one day I gave her a mathematical challenge. Since we only had two-thirds of the flour called for in the recipe for the chocolate molten lava cake she wanted to bake, I asked her if it would be possible to calculate how many eggs and how much sugar and butter would be required. She was so excited to eat cake that she figured out how to multiply all the ingredients by two-thirds in her head! Later, as we were biting into delicious pieces of chocolate heaven, I asked her, “So do you still think math is useless?”
Unfortunately, girls who do not appreciate math while they are in school sometimes grow up to be women with dangerously little knowledge about personal finance and investing. Beth Caldwell, author of Get Paid What You’re Worth! A Guide For Professional Women, tells her clients that if they start investing—even with a small amount of money—over time as they watch their money grow they will “suddenly have a newfound passion for math.”
Achieving wealth can be represented by a simple mathematical formula and requires fewer ingredients than a cake. For the basic “sheet cake of wealth” you need only three ingredients: principal, rate of return, and time. For example, if you were investing your money in a savings account, your principal would be the money you initially put in the account, and the rate of return would be the interest rate the bank pays you to keep your money there.
Let’s take the $1,600 inheritance I received from my grandmother 21 years ago as an example. Had I invested that money in 1993 in a certificate of deposit (CD) that paid 4% annual interest (the average interest rate for one-year CDs during 1993), one year later it would have been worth $1,664. It’s a simple calculation: you multiply the principal by one plus the interest rate: $1,600 x (1.04) = $1,664. On its face, this “sheet cake of wealth” recipe is fairly simple. But factor in inflation and taxes, and suddenly your cake isn’t very big.
One Sunday afternoon in the late ’70s while I was visiting my father, my stepmother showed me how to bake a Bundt cake using yellow cake mix, pistachio pudding, and orange juice. I brought the cake home that evening and told my older brother, who was eyeing the cake, not to eat any of it. On Monday morning I could hardly wait to take it into school. But when I tried to transfer the cake from the cooling rack to the platter, it fell apart. I discovered that someone had taken a utensil and entered the cake from the bottom underneath the cooling rack and scooped out an entire tunnel of cake! This is precisely what inflation and taxes can do to your wealth-building recipe.
In 1993 the inflation rate was about 3%, which would have left me with a 1% inflation-adjusted rate of return from my 4%-yielding CD. To make the situation worse, if the funds weren’t invested in a tax-deferred retirement account, state and federal taxes would have been deducted.
To illustrate how inflation impacts savings, according to the U.S. Department of Labor’s Bureau
of Labor Statistics, in order to buy the same amount of goods and services in 2013 that my $1,600 could buy in 1993, you would need $2,590. Inflation is real and greatly affects your ability to achieve wealth. But just as you cannot control what ratio of flour to eggs makes a cake stay together, you cannot control the rate of inflation. So you need to invest your money in something with an interest rate (or return on investment) that exceeds the inflation rate.
Figure 1 is a graphic depiction of what happens when you invest $1,000 at different rates
of return in a tax-deferred account. If you invest $1,000 in a portfolio averaging 5% a year, you end up with less than $3,000 after 20 years. In contrast, the same amount of money invested in a portfolio averaging 10% a year over the same time period would result in nearly $7,000.
Which outcome would you prefer? And do you have a plan for what you need to do TODAY to grow your money? If not, I suggest you go to www.theoptionslady.com and subscribe to the mailing list to be notified when my book is available for sale. It’s not too late to start investing for your future and in this book I show you how.