## How to calculate the interest you can earn

Here’s a quick explanation on how to calculate the interest that you can earn on your savings (or pay on your debt).

Let’s use an example of R1,500 (don’t worry about the currency – the maths is the same) and you deposit it in your bank account that earns 3.5% interest.

First thing to note is that the interest rate is always given as the annual rate (unless very specifically detailed otherwise). If you use a calculator (or a spreadsheet such as Excel) and do the following : 1500 x 3.5% the answer you get is 52.50.

Thus R1,500 invested for 1 year at 3.5% interest will earn R52.50. That’s easy!

To calculate what the monthly interest is, simply divide 52.50 by 12 and you will get R4.38 (rounded up) interest for 1 month. You could be more accurate and divide 52.5 by 365.4 (number of days in the year) and then multiply by the exact number of days in the month (e.g. 30).

E.g.  52.5 divided 365.4 multiplied by 30 = R4.31 (a very slight difference to the first answer we received)

So, if you invest R1,500 for 1 year at an interest rate of 3.5%, the interest at the end of the year would be R52.50. However, banks and all financial institutions calculate interest on a daily basis and pay it out monthly. If you withdrew each months interest (and leave the original amount of money in the account) then you would effectively earn “simple” interest – just as we calculated above and you would have R52.50 (assuming no fees or charges)

However, if you leave the interest that you earn each month in your account, then the bank would calculate the next months interest on your original amount plus whatever extra interest is already in your account. So each month you would earn slightly more. This is what is called “compound” interest.

In this case the difference is not great, but the larger the starting amount is, and the longer time you keep reinvesting the interest, the larger the difference is! In fact, after a few years, compound interest can be really large. Remember of course that we are assuming that no fees or charges apply.

This example may seem simple, but there is no need to complicate things!

## Find Extra Money

We’d all love some extra money I’m sure, so here are some steps to literally find it.

Step 1 : Look at your bank statement

Look at your bank statement as well as your credit card statement for the past month and make a list of all automatic payments that are deducted (eg internet bill, mobile phone, insurance, Netflix, etc)

Step 2 : Analyze all payments

One-by-one look at each automatic payment and ask:

• Do I need this service / subscription or whatever it is?
• Do I need all the features I pay for? Can I downgrade at all or pay for less?
• If it is a store card, do you need the extra’s such as insurance, magazine, etc?
• If it is a debt repayment, how much interest am I paying? What must I do to pay it off?

Step 3 : Insurance

Pay special attention to your insurance payment. Look at your latest insurance policy or contact the company for it. Are the values correct? Now, get new quotes and see if you can find a cheaper option.

Look at optional features you may have on any insurance, store card or debt policies. Perhaps you have the same benefits offered by different policies; in that case you can cancel some.

Step 4 : Look for wasted money

Look at your monthly expenses and take special note of the following:

• Eating Out / Take-Aways
• Groceries
• Clothing
• Entertaining at home
• Alcohol bought
• Luxuries
• Telephone
• Electricity
• Internet
• Make-up

Can you spend less on any of the above?  Try for just 1 month to spend less than the previous month and you will see that you really can survive quite easily!

Important note is that what you save today should not be spent tomorrow, don’t feel tempted to spend your savings on other things. See when saving is not really saving.

Step 5 : Be strict with yourself

Make a list of every area where you feel you can save a little and be strict with yourself over the next month to actually do this!

## When saving ins’t saving

I am constantly looking at how and where I spend my money and deciding whether what I am doing is worth it or not. There needs to be balance between enjoying live but at the same time living well within ones means and achieving ones financial goals. All it takes to be conscious about what you spend. I have come across times though when I think I am saving money when in fact I am not.

### Hosting people vs Going out

The first instance is the fallacy that entertaining at home is cheaper than going out. This can be true, but not necessarily all the time. It is great to host friends and family and one should enjoy every moment of it; life is too short not too. I am definitely not implying that one should not host people in your home, but the point of this post is about saving money. If you specifically decide to host people at your home instead of going out (in order to save) then you need to ensure that you do actually spend less money.

Think of the average restaurant bill that you would be paying if you went out, and now look at what you are about to spend in order to host your friends. Flowers, candles, snacks, wine, groceries, dessert, etc… It is easy to go overboard and spend more than you would have. (Especially if you’re married to a chef, which is the case for me.) The point is not to be stingy though. If you wish to save money then calculate the costs of going versus what you would like to spend when entertaining and chose the cheaper option.

### A picnic vs lunch out

As with the first example, if you decide to go on a picnic in order to save money (rather than an expensive restaurant), then be sure to do some calculations. It’s funny how in our minds we convince ourselves that because we’re taking the cheaper option, we can now spend more. A bottle of bubbly, expensive cheeses, some tapas, etc… It’s really easy to spend more on the picnic than in a restaurant.

###### The point of these examples is that if you choose to do something in order to save some money, keep that in mind and be sure to actually save! Don’t let yourself be tempted to buy the more expensive items to compensate for the cheaper option. You will actually end up spending more.

Now, take the money you calculated you would save and immediately transfer it into your savings account! Do it now before you find something else to spend it on!

## Calculate the Future Value of an investment

In this article we looked at the effect of extra payments into ones home loan (mortgage bond).  That’s all good and well, but what if you don’t have a loan?  Or perhaps you would rather invest in a Unit Trust or Interest Bearing bank account.

Microsoft Excel has a simple formula called “FV” which will help you to calculate the future value of your investment.  This does not account for changing interest rates or complicated scenarios, but it will give you a simple tool to give you an idea of how your money can grow.

To start with a simple example, let’s save 600 each month for 10 years (120 months) at an interest of 6%.  The answer as you see is 98,327.61.

That’s pretty easy.  Let’s quickly look at the input parameters:

Rate: This is the interest rate per period.  Generally speaking, financial institutions will quote an annual interest rate.  In this example it is 6%.  To get the monthly interest rate we simply use 6%/12.  If we change the example an decide to make quarterly payments we would need to use 6%/4.

Nper: This is the number of periods (in total) for which we will make a payment.  If we wish to pay monthly, this is the number of months.

Pmt: This is the amount we wish to pay each period.  This figure cannot change over the lifetime of the investment.  But, see further down how we can circumvent this potential problem.  Excel expects the payment to be a negative figure as payments out of your account would “minus” from your account.  You will see that if you use a positive figure, your answer will show negative.  The figure will be the same though.  (If that is confusing, try it yourself)

Pv: The present value.  If you are adding money to an existing bank account, use Pv as the present value in the account.  If this to calculate a new investment leave it blank or type a zero in the box.

Type: This is to specify whether the payment is being made at the beginning of each period, or at the end.  This will affect the interest that you earn.  By default Excel will assume you are paying at the end of each period.

So, in the example above we assumed a constant 600 payment each month for 10 years.  But what if you decide to pay 10% more each year?  For that we will need to spice things up a bit.  See how I have calculated the Future Value for 12 months at a time.  I then use the answer as my Present Value for the following year.  The monthly payment is simply increased by 10% in each row.

## How much is your coffee costing you?

I love coffee!  The very thought of drinking less makes me quiver with fear. But, sometimes one must take the emotion out of decisions and just look at cold, hard facts.

In a previous article on being more conscious with cash, I discussed how I buy 2 coffees each day, along with a breakfast and lunch.  I’m not good at planning meals to bring to work but I have decided to spend slightly less.  The savings I calculated was only R150 per week, but I’ve decided to look at how this could affect my home loan (mortgage bond) if I pay R600 extra per month.

These figures may not make sense to you if you use a different currency and your countries interest rates may be significantly different.  I’ll post something soon about how you can do these calculations yourself.

The calculations can get messy so take note of the following assumptions:

Home Loan Value: R1,500,000
Interest Rate: 11% (annual)
Total Loan period: 20 years
For this example I will assume 2 years of the loan are already complete, and that up to now no additional payments have been made.  Also, the R600 p.m. will remain constant (with other words I won’t save more in years to come)

This may all sound complicated, but the end result is simple to see.  If I pay R600 p.m. extra into my bond until my bond is paid off I will:

• Save a total of R236,000 (rounded to nearest thousand)
• Pay the loan off 22 months earlier

That’s pretty amazing don’t you think?  Considering that I am making this extra saving by cutting down on my weekly coffee/food expenses at my office.  In fact, it was quite easy to find the extra R150 per week.  Imagine if I actually analyze my expenses properly and relook at my insurance policies, health care, mobile phone contract, bank charges, etc.  Imagine the savings I can make then!

What if you don’t have a home loan?

That’s really not a problem.  If you invest this money in either a unit trust or interest bearing account for the next 15 – 20 years you will have quite a large lump sum.  We’ll look at how to use the Future Value formula in Excel to calculate this.