Monday, June 20, 2011

Mark's Theory of Large Numbers

Through years of working with people in their estate planning and financial matters, I have come to conclude that we as humans may understand that the number 1,000,000 is a fairly large number; however, when we see the number 10,000 we think that is a large number as well. We see them both as large numbers and so often do not appreciate the extent of the difference between the two. For example, if I explain that my fee for an estate plan which is designed to save $1,000,000 in taxes will cost $10,000, the prospective client will just see the fact that 10,000 is a large number and, although $10,000 spent with an expected return in tax savings of $1,000,000 seems a good return on one’s investment (i.e. 100 to 1), often the client will decline the services on the basis that $10,000 is a big number and not on the basis that it is small in comparison to the expected tax savings.

It seems our misunderstanding of the significance of large numbers carries over into our reactions to our ever-escalating federal budget deficit. There was a time when $1,000,000 seemed like a pretty significant amount of money. However, these days, when speaking of budgets, the only number that gets anyone’s attention is a number with “trillion” after it. There was a time, not long ago, when we were aghast at the prospect of a deficit of, say, $50 billion. In the month of February, our deficit exceeded $50 billion PER WEEK. But what’s the difference now, billions or trillions, it’s just another very large number that we don’t fully understand. We can see it on paper, but we cannot comprehend the difference between a billion versus a trillion. A few years ago the president challenged his cabinet to come up with savings of $100,000,000 from their budget requests. $100 million seems like a lot. But in fact, $100 million is equal to 16 hours of interest on a $1 trillion deficit (and our deficit is about $14 trillion). The federal government cutting its budget by $100 million is like a family earning $75,000 cutting its annual budget by about $1.75. It’s the equivalent of telling your spouse to buy the generic box of Cocoa Puffs instead of the name brand and calling it a year for budget balancing!

Maybe comparisons like this can help us understand a little better the difference between millions, billions and trillions. Who would have ever thought we would see S & P cut the federal government’s AAA borrowing rating from “stable” to “negative” but this is what happened today. Someone in Congress better learn to understand the significance of large numbers.

1 comment:

  1. I like your Cocoa Puffs analogy. There is a video on youtube that shows a good way to visualize how these two large numbers ($100 million & $14 trillion) compare: http://www.youtube.com/watch?v=cWt8hTayupE

    ReplyDelete