A common question in high school math classes is, “when are we ever going to use this?” There are many ways math comes in handy in life after high school, but one major way you will use math in everyday life is in your personal finances.
We consulted Bob Lee, a financial planner with 25 years of experience. This article will skim over the top three ways the math you learn in high school can help you work through your personal finances throughout life.
Interest is something that is part of most people’s finances, and may be the first type of financial math you encounter after high school. It is likely you will soon use a credit card or borrow money for college. Taking student loans as an example, interest is compounded daily and payments are made monthly. It’s important to understand how much interest is owed each month so you can ensure to pay more than that amount.
Let’s say you take out a $25,000 loan for college at a 5 percent annual interest rate.
Interest amount (I) = ?
Principal amount owed (P) = $25,000
Annual interest rate in decimal (r) = .05
Time period involved in months (t) = 12
To calculate how much interest you owe in your first monthly payment you would use the interest formula:
I = P(r/t)
I = $25,000 (.05 / 12)
I = $25,000 (0.4166)
I = $104.15
This means that the first $104.15 of your monthly payment goes to interest. Any payments in addition to this amount chips away at your principal amount of $25,000.
To better understand your loan payments–and subsequent interest payments–take a look at an amortization table, which shows you in detail what your loan payments go towards depending on payments, principal, and interest rate. Enter these factors into an online version of the table or other loan calculator to see what the process of paying off your loan is.
For other tips on managing student debt, see Student Loans: How to Manage Student Debt.
2. Credit cards and compound interest
Many loans use compounding interest, which is essentially the accumulation of interest on interest. For example, credit cards use compound interest. In the case of credit cards, you may spend a certain amount and pay only the minimum payment for that month. Then, the next month when you spend money, you accumulate interest based on the amount you spent both this month and last month, as well as interest on the interest you did not pay off the month before.
Jeff Brainard, Co-owner of Noble Wealth Partners, compared compound interest to a snowball rolling down the hill, acquiring more and more snow. While it sounds menacing, you can use a formula you may have learned in your high school math classes to visualize what this snowball is and how it accumulates.
The interest formula for credit cards uses similar elements to the interest formula, but the rate used is what’s called a daily periodic rate, as credit card companies charge on interest that is accrued on a daily basis. The elements of calculating credit card compound interest are as follows:
I = Interest charge on your bill
A = Balance amount on your credit card
r (Daily Periodic Rate) = Annual Percentage Rate (APR) found on your credit card statement / 365
t = number of days in the billing period
To form an example, many credit card companies charge around 18 percent interest, which we will use as the APR. You have a credit card balance of $1,000, and the billing period is 30 days.
Start by calculating r : 18% / 365 = 0.049%
Then, use I = A * r * t
I = $1,000 * 0.049% * 30
I = $14.70
So, I is the interest charge you can expect on your next bill. However, since this is calculated based on daily, not annual interest, if you do not pay this interest, it will be added onto your unpaid balance. Again, putting interest on interest.
Of course, you don’t have to calculate this yourself and can use online compound interest calculators. But understanding how easily you can wind up paying much more for interest than the principal balance will deter you from racking up credit card payments.
For more information and tools for navigating credit cards in college, read Taking a Look at Compound Interest: Why You Should be Leary of Credit Cards.
3. Balancing your bank accounts
Nowadays, you don’t have to do this by hand like you may have been taught in school. As you know, when you check your bank account, your bank adds and subtracts your deposits and withdrawals.
But, you may have multiple credit cards, income sources, or savings accounts (i.e. basic savings, 401k, Roth IRA, 529 plan, etc.) and will have to combine these to balance your income, spending, and saving.
“You’ve got to be able to balance a checkbook. Understanding how much to put away on a monthly basis is another factor that gets back to the time value of money,” said Lee, who used the example of a 529 account. “‘How much do I need to put into a 529 savings account each month to achieve enough money by the time my child turns 18 and wants to go to college?’ That’s just looking at how much time do I have today, relative to the college [the child wants to go to] and then, what kind of rate of return will be used.”
When you start your first college job or paid internship, one of the first questions you will be asked is how much you want to put in your 401k. You’ll have to decide what percentage of your income will be beneficial to contribute to your 401k that you can afford to part with for now. This is where simple percentage calculations will come in handy. What percent of your income goes to your fixed living expenses like rent, electricity or parking? What remaining percent do you need to keep for other needs? Calculating this will help you determine before you walk into your first day what number to write down.
When you begin college, it’s imperative to know how to manage your own finances, even though you may not have done this before. Yes, you get to use calculators, Excel, even your phone to make your everyday calculations, but learning what numbers to use–and even more importantly, what numbers those numbers mean–will help you effectively manage your finances in college and beyond.