By Dhirendra Kumar
Many years ago, I read a book by John Allen Paulos, an American teacher of mathematics. Paulos recounted some examples from a test he conducted for potential employees of an organisation he was consulting for. One of the questions was that if a quantity grows from 50 to 100, has it increased by 50%, 100%, or 200%?
The answers that the candidates gave were all over the place, indicating that many of them were just guessing. It’s notable that getting the answer correct requires no great competence in calculating—it’s entirely a question of understanding the underlying concept.
There was another question where the test takers were asked the population of the United States, which was about 220 million at the time. This was not a multiple choice question and the test-takers had to actually write down the answer. Perhaps half the test-takers got it right.
However, what was actually more interesting were the wrong ones. The wrong answers were not randomly spread, nor were they clustered around the correct answer. Instead, there was a cluster of answers around 20 million, another around 2 billion and a handful at 20 billion. Clearly, there were many people who, when seeing a number, do not think of and absorb its scale—how much it actually is. Instead, they just notice the starting digits.
So what does all this have to do with investments and personal finance? To appreciate the connection, think of what you are supposed to need to be successful at personal finance, whether it be choosing a loan or mutual fund investing, or perhaps even equity investing.
Conventionally, the answers are about what information or analyses you have access to, or what methodology you follow while making your choices. Certainly, most personal finance advice is about giving you information and instructions about what to do. Certainly, much of what I write in this newspaper falls into that category. What salespeople of various financial products do is also the same, but of course with very different motives.
Nevertheless, based on what I have observed, actual investing success seems to arise from an investors’ own capabilities. A lot of this is temperament, which is a different story. However, of the actual functional competence that are needed, basic arithmetic skills are the most important. Unfortunately, they are also not very common. What’s worse is that one doesn’t see investors appreciate this as a problem, or make any attempt to rectify it.
In the same book Paulos points out there seems to be no social stigma attached to not being able to deal with numbers. People who are hugely embarrassed at making the smallest grammar or punctuation mistakes happily, even proudly, declare themselves unable to understand or do even the simplest calculations.
It’s not my brief to speculate on why this is so, although the underlying social factors are pretty clear. I’m just here to say that if you want to manage your money well, then don’t do this. You owe it to your financial well-being to understand the basic arithmetic of investments. No one is going to do this for you. In fact, there will be plenty of people who will take advantage of savers who are innumerate.
And it’s not hard. Like everything else, there are a lot resources on the Internet, with Khan Academy obviously among the best. One needs only basic stuff, not much more than a refresher of some parts of 10th standard maths. If you are curious about what else we get wrong because of widespread innumeracy, Paulos’ two books, Innumeracy: Mathematical Illiteracy and its Consequences, and A Mathematician Reads the Newspaper, are both available online at a very reasonable price. They’re fun, funny and more than a little useful.
(The writer is CEO, Value Research)
(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)
FAQs
"I don't think advanced mathematical knowledge is of any use in the investment process. Understanding mathematical relationships, and having an ability to quantify - numeracy - I think that's generally helpful in investment, because something that tells you when things make sense, or don't make sense [is useful]".
What is the math equation for investment? ›
It's the idea that you can earn returns not just on your original investment but also on the returns you've already earned. The formula for compound interest is A=P(1+(r/n))^nt, where: A is the amount of money accumulated after n years, including interest. P is the principal amount (the initial amount of money).
How good at math do you have to be to be an investment banker? ›
The Truth About Math
You don't use it that much. The math you do use is very simple. As in, arithmetic. Therefore, you don't have to be a math genius – but you do have to be good with numbers.
What is the math behind investing? ›
To calculate the annual rate of return for an investment, you need to know the income created, the gain (loss) in value, and the original value at the beginning of the year. The percentage return is calculated as: Return = 100 x (Income + Current Value – Original Value)/Original Value.
Do you need math to be successful? ›
Every student can be good at math with practice in a supportive learning environment. MYTH: You don't need to learn math to be successful—unless you are going to be an aerospace engineer. TRUTH: Everyone needs math and uses math. Math helps you to navigate through everyday life successfully.
Can I do finance if I'm bad at math? ›
Believe it or not, mastery of advanced math skills is not necessary to have a career in finance.
How do I calculate my investment? ›
You can calculate the return on your investment by subtracting the initial amount of money that you put in from the final value of your financial investment. Then you would divide this total by the cost of the investment and multiply that by 100.
What math is most important in finance? ›
Algebra is the foundation of many mathematical concepts. Students interested in finance will most likely learn linear, quadratic, and rational functions and exponential and logarithmic functions.
What is the formula to calculate investment? ›
Return on investment (ROI) is an approximate measure of an investment's profitability. ROI is calculated by subtracting the initial cost of the investment from its final value, then dividing this new number by the cost of the investment, and finally, multiplying it by 100.
Why is math important in investment banking? ›
Investment banking is a quantitative field, and having a strong foundation in mathematics is essential. If you're considering a career in investment banking, it's important to have a deep understanding of mathematical concepts such as calculus, probability, and statistics.
Financial analysts often use mathematics to analyze market data, find patterns in data and predict risks. Financial risks can fall under these categories: Market risk: Market risk refers to financial risks in the company's target market, including market changes.
Is math major good for investment banking? ›
Earning an MBA is part of the traditional path to an investment banking career. An advanced degree in mathematics is also highly prized by investment banking companies. You will likely face licensing requirements once you are hired by a firm.
Do investors need to be good at math? ›
Asset Management: Asset managers need a fundamental understanding of numbers to make investment decisions, but relationship management with clients and stakeholders is equally vital. If you're passionate about a career in finance but are wary of your math skills, don't be disheartened.
What is the magic formula for investing? ›
Magic formula investing uses a set of quantitative screens to eliminate certain companies, and ranks the remainder in order of highest yield and returns. By slowly building and rebalancing the portfolio every year, it is possible to achieve reasonably high returns.
How to do investment math? ›
To calculate the percentage gain or loss of an investment, work out the difference between the purchase price and selling price, then take the gain or loss from the investment and divide it by the initial purchase price. Finally, multiply that figure by 100 to determine the investment's percentage change.
Do you need to know math to invest in stocks? ›
While you need not be a math whiz to start investing in stock markets, knowing a few concepts around stock market mathematics can certainly go a long way in helping you analyse your investments better.
Do traders need to be good at math? ›
There is a lot of math involved in trading, but it is represented through charts with indicators and patterns from technical analysis. Consequently, traders need to develop their analytical skills so they can recognize trends and trends in the charts.
Do you have to be good at math for private equity? ›
Private equity firms usually seek someone with a strong sense of numbers. As such, the majors they generally look for include Finance, Accounting, Statistics, Mathematics, or Economics.
Do entrepreneurs need to be good at math? ›
To be an effective entrepreneur, you should know more than the basic maths concepts like addition, subtraction, multiplication and division. These are just some of the fundamental operations that underpin many business processes such as budgeting and forecasting.
