Wednesday, July 9, 2008

Turn 1 cent into 5 million dollars in 30 days. Here's how.

Here's a math problem. How can you turn 1 penny into $5 million dollars in 30 days? It's rather easy.

The answer is simple and can tell you a how most fire departments waste money when they finance their new fire truck.

First, let's turn that penny into a cool 5 mil.

I'll give you 1 penny the first day, the next day I'll give you 2 pennies, the third day I'll give you 4 pennies. I'll continue to double the previous day's gift each day for 30 days.

On day 30, I'll give you $5,368,709.12!

So, will you take that deal? (P.S., send me an email to jrhill@envizionfire.com and I'll send you the math so you can double check).

You probably would like that deal.

You are benefiting from a principle called compounding. Each day, your number increases based on the previous day's number. As we see from our 1 penny to $5 million example, it can lead to some dramatic calculations.

So how does this cost fire departments a lot of money?

Bankers play a reverse game of this when they loan you money. Instead of starting small and increasing each day, they give you a large amount of money upfront and start compounding interest until you pay off your new truck.

So, instead of starting small (the 2nd day, you only get 2 cents above), the bank charges a large amount of interest at the beginning. It does get smaller but you spend a lot upfront.

How does my fire department not get caught?

Well, the biggest cost of compounding is time.

In our penny to $5 million example, on day 15 (halfway) , I would only pay you $163.84. Not bad, but a far cry from $5 million.

When you borrow money, the reverse is true. If you borrow for a shorter amount of time, you'll pay dramatically less interest.

The key is to find the balance (as I mentioned in last week's column) of an affordable payment and paying the least amount of interest.



Stay safe!

John R. Hill
Apparatus Budgeting Consultant
ENVIZION Financial
www.envizionfire.com

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