From the title, this seems like an easy answer.
How could $500,000 ever be more than $2,000,000?
Don’t worry, I haven’t found some mathematical theory that will turn your world upside down. Although, I have an uncle who wrote a book on solving time-dependent partial differential equations. *Ahem* Nerd alert…
If I had attached more qualifiers to the numbers, the true value of each has the potential to change. Context plays an important role in any equation, whether in engineering or life. Understanding context helps the user to dissect, separate, and reassemble the information. We’ll get into why this is useful later on.
Let’s take a step back and re-examine those numbers. I’ve utilized the Mad Libs format to really drive home how much impact context has.
Case #1:
John worked as a ____ with ____ for _____ years. He made ____ a year.
He saved $500,000 after ____ years.
Case #2:
John worked as a _____ with _____ for _____ years. He made _____ a year.
He saved $2,000,000 after ____ years.
You can probably see where I am going with these cases. Even though I’ve included several blanks, we only need to focus on how much each case EARNED and how much ease case SAVED. Note: For simplicity, the percentages below are based on gross values. No other factors (taxes, inflation, interest, etc.) were considered.
If Case #1 earned $50k/yr over 20 years, then he saved 50% of his salary. Pretty good.
If we knew even more about Case #1, like that he put 3 kids through college, then our impression would turn to REALLY good.
Say Case #2 makes $8mil/yr and saved $2mil in one year. On the surface, that’s a large sum and impressive for the timeframe. However, it equates to 25% – half the effective savings compared to what Case #1 was able to achieve. Therefore, it can be said Case #2 didn’t OPTIMIZE their financial system as efficiently as Case #1.
Scaling it back, say he makes $750k/yr and saved for the same amount of time as Case #1 (20 yrs). That $2mil now looks even worse as it represents an unlucky and unimpressive 13%.
For those who may find flaw with the example, flip the scenario around. What if I offered you $20k and $80k, which would you prefer? What if I then added it was debt, would your answer change?
As we should now be able to see, numbers are the “trees within the forest”. By themselves, numbers don’t paint the whole picture. Understanding the context surrounding those numbers allows the reader to disseminate what really is going on.
Reader Poll:
How well-oiled your financial system is. What’s your effective savings rate for 2009? Are you improving or digressing from last year? What catalyst in your life prompted the change? Have you identified areas for improvement?
Photo by masochismtango
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Great perspective that people often don’t consider. Optimization is a good way to put it. All things being equal, or not, this is why I compare everything to a persons rate of savings. Like net profit for a business, this is what we are really working for. The question is how hard we must work for each dollar saved. This will give you perspective on how important savings really is and why its much harder to earn a dollar than to save a dollar.
Exactly. There’s plenty of sites about living frugally & clipping coupons or investing & making stellar returns. Because this is an entire system, you have to look at all faucets. The common misconception I noticed was when all my friends were graduating and talking about IBank salaries. Sure, you’re making a lot – but what’s your HOURLY rate? If you dedicate 60-80 hrs/wk, than you’d almost be better off mowing lawns.
I like the point you are making. Too many people focus on the end result or number and completely miss out on the context. It is that large number that the financial industry markets to and gets people to believe in. Unfortunately, if your goal is $500,000 or $2 million, it might not be the best for your situation.
.-= Evolution Of Wealth´s last blog ..Life Insurance Breakpoints =-.
@ Evolution:
Thanks for commenting. I’m going through a few of your articles now.
One of my reasons for starting this site was promote more education and more individualism. The name itself: personal finance indicates that there’s no single solution for every person.
Good point on the financial industry. Just like a real estate agent tries to “upsell” you into a better (read: more expensive) house, the financial industry needs to “upsell” you on retirement.
Not only that, the 500K will last the first guy, with annual expenses of only 25K, a lot longer than $2 million will last the second guy.
As for mowing lawns 60 – 80 hours per week, I just want to say that it’s not safe to mow in the dark. :-)
@ Debbie
Very true! I noted that somewhere else on this site. A former 401k advisor I keep in contact with was explaining how difficult it was to get people pre-retirement to switch their habits to make their retirement income last.
HA – not unless you have a headlamp! just may miss a few spots…