March 25, 2014

There are lots of online calculators for doing interest-based math. Here’s something you might find helpful: find a text on engineering economy and take 20 minutes to familiarize yourself with basic concepts of the time value of money. (For a very good summary of this resource in PDF format click here.)

This brief but important exercise will give you what engineers like – simplified, straightforward equations for calculating interest, opportunity cost, amortization, depreciation, and other finance concepts boiled down to some simple steps for decision making.

The typical online calculators are used for accounting purposes. I think one reason people struggle with finance is that they assume you have to be an egg-head or a number cruncher, because numbers are for accountants with ledgers, spreadsheets, and green eyeshades. In reality, you’re probably not managing books for anybody, so you just want to know practical stuff, like are you better off financing a car at 2.9% interest, or taking a loan from your 401k to cover it.

Most people flunk this test.  They assume it’s cheaper to borrow your own money “interest free.” Yet they neglect to calculate the future value of the 401k not just across four years, but the next 30 as it continues to grow and multiply. In opportunity cost, the person who taps their 401k pays many times the value of the car, long after it has gone to the boneyard. It definitely pays to reset your thinking around time value of money, and I found that a simple understanding of engineering economy presents an easier way to do so.

About the author 

Erik Conley

Former head of equity trading, Northern Trust Bank, Chicago. Teacher, trainer, mentor, market historian, and perpetual student of all things related to the stock market and excellence in investing.

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