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The equations that will help you grow your money

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On 14 December 2012


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There have long been calls for personal finance education to be taught in schools. However, some of key equations you need to know are pretty simple. Once you understand them, you can make more from your money.


Most people just need basic maths to manage their finances – that’s addition, subtraction, multiplication and division. Knowing these basics can help you make a whole range of financial decisions, from setting a budget to borrowing and saving.

Here’s what you need to know:

Adding and subtracting

It may sound obvious but adding up and taking away are the basic skills you need to manage a budget. Get it wrong and you’ll probably end up permanently in the red.

To work out a budget make a list of all your outgoings each month: rent or mortgage, household bills, insurance, utilities and broadband, mobile phone, travel to work, food, debt repayments etc.

Then make a list of your income. For most people this will just be their salary but others might include income from investments, rental income, support from parents, tax credits and housing benefit.

Next, subtract your outgoings from your income. If you’re left with a positive number, that’s good. You have this amount left each month to save, invest, or spend on luxuries. If you’re left with a negative number then you’re living beyond your means and you’ll need to make some changes if you don’t want to end up drowning in debt.

Percentages

We hear about percentages all the time, from interest rates to inflation, and they form the basis of many personal finance calculations.

Percentages are a way of expressing a number as a fraction of 100 — “per cent” means per hundred. So, 25% is 25 parts of 100. 100% is 100 parts of 100, in other words, the whole amount.

When it comes to tax, the per cent is how much the tax man takes. So if you’re taxed at 40% and earn £1000, HMRC will take £400 (40/100 x 1000).

Borrowing money

When it comes to borrowing money and interest, the percentage will tell you what you have to pay back. So if you borrow £100 at 5% interest per year, you need to multiply £100 by 0.05 or 5%. This works out to £5 so you’ll have to pay back £105.

If your minimum credit card repayment each month is 5% of the outstanding balance and you owe £2,000, then the calculation is 0.05 x 2000 = £100. So you need to pay £100 to avoid a late payment charge.

Percentage increases

When it comes to percentage increases you need to do a different calculation. This week E.ON announced it was putting up fuel prices by 8.7%. If your fuel bill was £1,000 a year, it will now be 108.7% of £1,000. So you need to multiply 108.7 by 1,000 and divide it by 100 to get the new bill. This works out to £1,087.

Compound interest

If you’re saving money it’s good to know about compound interest.

Suppose you had £1,000 in a savings account which paid 5% annual interest after tax. After year one you'd have £1,000 plus £50 interest (5% of £1,000), a total of £1,050. After year two, you'd earn another £50 interest (the interest on the original £1,000), plus a further £2.50 of interest earned on the £50 interest from the first year. So now you'd have earned a total of £102.50.

By year three, you'd be earning interest on the interest from years one and two, and your money would soon start to grow.

Inflation

Inflation is a measurement of how much prices rise over a period of time. It’s calculated by the Office for National Statistics (ONS) every month. The ONS compare the different changes in price of around 120,000 products and services, to come up with an overall percentage.

Rising inflation can mean your money is worth less. For example, if the inflation rate is 3% over a year, put simply what cost you £100 this year will cost £103 next year.

If you earned 2% interest on £100 of savings, you’d earn £2 in a year meaning you have a total of £102. But if inflation is at 3% your money would be worth less in real terms as you couldn’t buy as much as you could last year with your money, despite having more cash.

Probability

Probability is the chance of something happening. Something that will definitely happen is expressed as 1, while the probability of something which definitely won’t happen is 0.

To work out the probability you divide the number of ways of achieving success by the number of possible outcomes. So if you look at a dice there are six sides so the chance of rolling a three, for example, is one in six, 1/6 or 0.17.

The probability of winning the lottery is about 1 in 13,983,816 – very low indeed.

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