Fixed Income Mathematics

Sometimes some of the costs are so small that their inclusion will not

change the final decision. The costs of postage to mail a check to pay down a

loan would not usually be considered in the analysis. In Example 2.15 (the GI

insurance), the annual 2% costs were much smaller than the real estate tax

savings. However, you should always try to include all relevant costs and

returns before making a final investment decision.

Note that the word “return” can be somewhat ambiguous. It can mean

everything you get back from your investment, including the value of the orig-

inal investment. However, it could also mean simply the profit, or earnings,

from the investment. For example, if you buy a bond, receive the interest until

the bond matures, and get your money back when it matures, your return and

your interest earnings are the same. However, in the case of the pig, the return

of one-half a full-grown pig included the original investment of the piglet or

grain feed for the pig. The context will usually show the correct meaning of

the word.

䊏

ANALYSIS OF INVESTMENTS OR RETURNS

WITHOUT EXPLICIT MONEY VALUES, AND

INTANGIBLE INVESTMENTS AND RETURNS

Sometimes you make an investment or receive a return that is not expressed

in money but is important in the decision process. Try to assign reasonable

values to these items.

In Example 2.13 (the lakeside cottage), you might figure the value of your

labor and the value of the cottage rental. Suppose you earn $25,000 per year,

or $500 per week, equivalent to $100 per day. Suppose also that you spend

your two-week vacation and 10 two-day weekends helping your neighbor. You

might have worked two weeks ($1,000) and 20 additional days (another

$2,000), for a $3,000 total. If similar cottages on similar lakes rent for $200

per week, then the value of your free use is $400. You are receiving $400 each

year in value on an investment of $3,000 in value.

Often these intangibles will have some element of judgment. For example,

in the preceding case, should you use before-tax or after-tax income? Should

you include the Social Security and Medicare deduction? Sometimes these

factors can be important.

In many cases, the intangible return may be quite important, but not mea-

surable, or at least not easily measurable. For example, many people find that

paying off their home mortgage results in a level of peace of mind and general

contentment that is important to them, but cannot easily be evaluated.

In Example 2.14 (the pig), the intangible benefits would include having

plenty of meat to offer guests without worrying about running out, especially

14 Interest, Its Calculation, and Return on Investment