Debt/Saving Inspiration

The Halk · 7 Jul 2012 at 02:31

Lots of people in here are in better than average jobs, and lots of us like to buy nice stuff. My job is financial and I see lots of people's bank accounts, savings, investments, debts etc. I see stark differences between people and I see some people winning and some losing depending on a few basic choices.

I've created this thread to help people, mainly young ones, grasp some realities about money in the hope that it'll inspire them to make positive choices and significantly improve their lives.

It hinges on the comparison between two people. One who saves and one who spends. The assumption is that they come from a family where a small amount of money is saved for them by relatives. By age 25 the saver has got 10K saved, and the borrower has spent it all and blown 10K in overdrafts, cards, loans.

I have not taken into account mortgage loans - these are of course much lower in interest, however they do go higher. The results would be similar if I illustrated the borrower with far greater debts than the saver, with the debts being secured on the mortgage.

Finally, before I get into the figures, remember that it is NOT the case that the saver can't spend his money and the borrower is having the time of his life. That's a common fallacy. Someone with lots of savings can spend much more money each year than someone in lots of debt, and the year after they'll have more savings, and the other person will have more debt.

By age 25

10K in bank
Gain per year - 0.5K

-10K in bank
Cost per year - 1.5K

2K difference per year
2.5K before tax

By age 35

30K in bank
Gain per year - 1.5K

-15K in bank
Cost per year - 2.25K

3.75K difference per year
4.7K before tax

By age 45

60K in bank
Gain per year - 3K

-20K in bank
Cost per year - 3K

Difference 6K
10K before tax (now a higher rate tax payer)

Pattern is visible by this point.

Even from age 25 the person in debt needs to earn 2.5K a year more to have the same spending power as the guy with savings.
By age 35 there is a significant difference in lifestyle
By age 45+ there is a clear blue sky difference

Want it to seem more apparent? Let's assume these people live similar lives and have similar jobs.

By age 35 their mortgage is 500 a month, their council tax 150, their gas, water and electricity 100 on average, 150 for sky, phones, mobiles, insurance is 75 per month. Car depreciation, tax, insurance, petrol costs them 250 a month. Food costs them 200 a month. 1425 per month for bills.

Let's assume a modest/realistic salary of 30K each. That's 1900 a month approx. That means disposable income for saver is 516. For borrower it's 350. And of those disposable income, clothes, Christmas presents, birthdays, charity money at the office... all sorts of things need to come from that. Let's assume another 150 a month for that to find out what their *real* optional stuff is. 366 vs 200. The saver has almost double the spare money the spender has. As you can imagine the difference is even larger at 45 and beyond.

tamzzy · 7 Jul 2012 at 02:38

and then they get married and have kids...lawl

The Halk · 7 Jul 2012 at 02:41

tamzzy said:
and then they get married and have kids...lawl

You're missing the point.

They'll both get married and have kids. One of them will have a far larger disposable income because he has saved. The other will be condemned to be in debt forever.

That's why it matters.

muon · 7 Jul 2012 at 02:44

Well you are certainly stupid if you are perpetually in debt at a rate of 15%.

Because interest is compounding, it is completely unfair to have such a large difference 15% v 5% in this comparison. Inflation also erodes savings and helps debt reduce which you need to include.

There is also a 20K endowment difference in the beginning which cannot be ignored. The person borrowing gained utility from that 20K.

tamzzy · 7 Jul 2012 at 02:46

nono, i know what u meant ;p
i dont understand how ppl can live under a mountain of debt though...idk, my parents always taught me i should save for a rainy day =x

The Halk · 7 Jul 2012 at 02:48

anyon said:
Well you are certainly stupid if you are perpetually in debt at a rate of 15%.

Because interest is compounding, it is completely unfair to have such a large difference 15% v 5% in this comparison. Inflation also erodes savings and helps debt which you need to include.

The figures are a simplification. There's other factors I haven't included which push it in the opposite direction from where you're going.

"Normal" interest rates for savings are higher than 5%. These people would have investments by the time they were 35 which have a higher expected return.

15% is a reasonable rate for unsecured lending in the long term. I did mention that there is also mortgage lending. I didn't talk about it though because you can always add more detail to these figures - which is what you're doing... However adding more detail doesn't change the basic point.

muon · 7 Jul 2012 at 02:49

The Halk said:
The figures are a simplification. There's other factors I haven't included which push it in the opposite direction from where you're going.

"Normal" interest rates for savings are higher than 5%. These people would have investments by the time they were 35 which have a higher expected return.

15% is a reasonable rate for unsecured lending in the long term. I did mention that there is also mortgage lending. I didn't talk about it though because you can always add more detail to these figures - which is what you're doing... However adding more detail doesn't change the basic point.

Adding details can massively reduce the magnitude of the difference.

The Halk · 7 Jul 2012 at 02:49

anyon said:
Adding details can massively reduce the magnitude of the difference.

Or amplify it.

muon · 7 Jul 2012 at 02:50

The Halk said:
Or amplify it.

Reduce is in this case though.

The Halk · 7 Jul 2012 at 02:51

anyon said:
Reduce is in this case though.

No. Reduce or amplify. It depends if you're cherry picking or not.

You are cherry picking though, and you don't have a point. You're just trying to argue for no reason.

I considered adding a sentence asking people not to nitpick the figures because it's pointless and doesn't change what the meaning is. I guess I should have added it although by the looks of things you're not remotely interested in it other than to argue.

Yes what you've said would move it away from the large gaps, but I could explain ways in which the gaps would be larger. I'm not going to because this is supposed to be a simple explanation.

muon · 7 Jul 2012 at 02:52

It is perfectly possible to hold debt and be maximising your lifetime utility. Learn some microeconomics.

Shady89 · 7 Jul 2012 at 02:54

you must live in a fancier area then me , its all warehouse work here etc = £1k a month.

The Halk · 7 Jul 2012 at 02:55

anyon said:
It is perfectly possible to hold debt and be maximising your lifetime utility. Learn some microeconomics.

You're just arguing. Adding more detail makes no difference to the point. Something I've repeatedly said to you.

Clearly you're just interested in some kind of ****ing match. I'm not. I'm trying to explain to people why debt will make a massive difference to their quality of life. You're trying to win an argument on the internet and my suspicion is that you've already derailed the thread to the point where it's been a complete waste of my time trying to explain it.

muon · 7 Jul 2012 at 02:56

The Halk said:
You're just arguing. Adding more detail makes no difference to the point. Something I've repeatedly said to you.

Clearly you're just interested in some kind of ****ing match. I'm not. I'm trying to explain to people why debt will make a massive difference to their quality of life. You're trying to win an argument on the internet and my suspicion is that you've already derailed the thread to the point where it's been a complete waste of my time trying to explain it.

Unless you prove the direction of that change, this thread is pointless.

It isn't a simple accounting exercise. That's my only hint.

The Halk · 7 Jul 2012 at 02:58

anyon said:
Unless you prove the direction of that change, this thread is pointless.

I disagree.

I'm disowning the thread though. The thread is pointless, but not because I'm in any way wrong. It's because pointless ***** like you make GD a frustrating experience when it could be much better.

You just want an argument.

Zefan · 7 Jul 2012 at 03:00

Good thread gone bad

I find it amazing watching people I work with literally **** their enormous disposable income (military so almost zero outgoing) up against the wall month after month. People are desperate for pay day... it's like, duh!!! Sort yourself out!

muon · 7 Jul 2012 at 03:03

Since I have the time and this actually interests me, I'll even do all the Maths with variables people can change in an Excel file to show my point.

The Halk · 7 Jul 2012 at 03:10

anyon said:
Since I have the time and this actually interests me, I'll even do all the Maths with variables people can change in an Excel file to show my point.

It's not an exercise that'll achieve anything.

Not unless you can show that someone who saves is worse off than someone who borrows. Which you can't.

Even if you do show that there's less of a difference than I've said - then so what? Unless the difference is near nothing (which it's not) then you've proven nothing. And even still I'm sure I could come up with many reasons to skew it in the other direction.

Do you agree with the basic point?

muon · 7 Jul 2012 at 03:14

The Halk said:
It's not an exercise that'll achieve anything.

Not unless you can show that someone who saves is worse off than someone who borrows. Which you can't.

Even if you do show that there's less of a difference than I've said - then so what? Unless the difference is near nothing (which it's not) then you've proven nothing. And even still I'm sure I could come up with many reasons to skew it in the other direction.

Do you agree with the basic point?

Person who borrows can most definitely be better off than someone who saves. All it requires is that you appreciate what certain variables do.

The best variable I can think of to demonstrate this is of inflation. What if it was at 50%?

Whilst inflation isn't at that high of a level (and there is endogeneity between inflation and the rates faced by borrowers/savers), you should appreciate that there are many complexities which can most definitely reverse the optimal decision from saving to borrowing under various conditions.

I'm going to try to create a model where people can see this for themselves.

Mercenary Keyboard Warrior · 7 Jul 2012 at 09:58

Nice try Halk

For the record I agree in principle (Im an accountant) the terrible money management I see regularly just really pains me. The sooner Martin Lewis wins his effort to get basic education on money into the school curriculum the better.

There are two comments I would make, one supports you, and one supports anyon.
1) Borrowing for property will typically allow you to exceed the interest you pay, giving you a net gain. I think Halk your talking about borrowing for consumption not assets and hence I support your case 99%
2) Inflation is a factor if your "wasting" a high proportion of your income on consumption and THOSE items are suffering from infaltion. I see lots of fail quotes about inflation and its effect on destroying savings, it has an effect if what your saving to provide againts has inflation, not if it doesn't. Take houses outside London, there is practically no inflation, in fact most are deflating slowly. Saving against them is far better than borrowing as you can exceed any capital growth easily.

Summary, its almost always better to save, unless the most likely thing your going to spend it on has high inflation then you need to match that inflation at a minimum if your saving. If you cannot match the inflation then you need to purchase now.

I have this conversation with people and have to show them some maths to help them, its not clear cut but its ALMOST clear cut.