What is personal economic value and why is it important? Our personal economic value is our earnings potential or what can we expect to earn between now and when we plan to stop working. As an example, if I currently earn $44,000 each year, I’m 32 years old, and I plan to retire at age 62 (30 years from now), then my economic value is $1,320,000.00.
$44,000.00 x 30 Working Years = $1,320,000.00
If I expect to receive annual increases of 3%, then the number will change significantly. My Personal Economic Value is $2,093,318.29.
$44,000.00 x 30 Years with 3% annual increases = $2,093,318.29
Notice that factoring in my expected annual salary increases adds another $773,318.29 to the total amount. One caution though, if I really did receive an increase of 3% every year, then at age 62 my annual income would be $106,799.55. That may or may not be a realistic amount for earnings in a particular occupation, so we should be careful when projecting salary increases.
But how is this number important in personal finance? Well, most of our financial plans assume that our income will not only continue, but increase from year to year. Unfortunately, increases in income tend to go hand in hand with increases in expenses…if we make more, we tend to spend more. So we’re simply maintaining the status quo from year to year.
Calculating our economic value reveals the large amount of money that we might earn, which can help us to prepare for the unexpected. If I were to die suddenly, would my dependents find it difficult financially to maintain their current lifestyle? Would they be burdened with bills and debt that I haven’t prepared for in advance? Is $2,093,318.29 the amount that my survivors would need if I were to die tomorrow? Well not quite. This amount shows what I expect to earn between now and retirement, and doesn’t take into account current debts and liabilities, future major expenses, and the time period and expenses past retirement age of my survivor. But it does shed some light on what my finances look like during my working years.
This is why determining economic value can be a real eye opener. Using the example above, when I consider that I may earn $2,093,318.29 over the next 30 years, I also have to realize that I will spend most of it. We don’t often reflect on the fact that we will spend millions in our life time simply living. This can be an incentive to save some of those earnings and to keep debt at a minimum. When I realize that I may be earning two-million dollars or more in my working years, I just might want to hold on to some of it and keep a closer watch on where it’s all going. And this is one of the first steps in personal finance management.