Lady Gaga Should Read Money Music 101

Dull, inanimate, and invoking complete boredom is probably a common first impression of musicians glancing at the average finance journal.  Unless you are deeply immersed in financial markets, papers like the Wall Street Journal or the Financial Times are not your preferred reading material.  Every now and then however, there are moments of glory when music and finance come together in the form of an article that speaks to both left brain and right brain.

One of these moments was the highly anticipated interview of Stephen Fry with Lady Gaga in this week-end’s edition of the Financial Times.  If not for Lady Gaga, do yourself a favor and read it anyway.  Stephen Fry, a “quintessentially English” actor, who also happens to be a fascinating writer well-versed in the subtleties of sarcasm, always leaves an impression and a smile on your face.

You may or may not approve of Lady Gaga’s flamboyant public persona, or of the music that has been described as rather madonna-esque, but the Pop Diva is a force to be reckoned with in the entertainment industry.  Her new album “Born This Way”, which could be downloaded for 99 cents at Amazon this week, brought Amazon’s sever to a stand-still; it is projected to sell a million copies within the first week.  Her last major world tour in 2009 was said to be one of the most successful promotional tours ever and yet, it was one of the least profitable ones too.  In her own words:

I put everything in the show, and I actually went bankrupt after the first extension of The Monster Ball. And it was funny because I didn’t know! And I remember I called everybody and said, “Why is every­one saying I have no money? This is ridiculous, I have five number one singles – and they said, ‘Well, you’re $3m in debt.’

How could that be possible one might ask.  A major recording artist running out of money, going bankrupt? 

Well, it’s not the first time.  The list of famous musicians that went bankrupt rivals any guest list at a red carpet Hollywood event. But poor money management skills are not limited to musicians only. Famous artists, movie stars, athletes and even some businessmen had to appear in bankruptcy courts. Their money problems were not caused by an inability to make money. They all made plenty of it, often tens of millions each year. Yet, the rules of finance apply to the big stars just as they apply to you and me. The only way to get financially ahead is to spend less than you earn.  “It’s not what you make but what you keep!”

In Lady Gaga’s case, the scary part from a financial perspective is the fact that she was technically bankrupt and “she didn’t know.”  Granted, things get slightly more complicated when you have to manage a larger pile of money and essentially run a multi-million dollar business.  But there is no excuse for  “not knowing” at least a rough ball park figure and to put a stop on spending sprees before it is too late. 

When Lady Gaga says “It’s honestly true that money means nothing to me” take a moment and consider the validity of her statement.  It sounds like the most often quoted lie of successful people.  Money always means something to them or else they would not spend much of their waking hours accumulating more of it.  The value of money just has different meanings to different people.  To someone living on the streets, $5 could mean the difference between having a meal for the day or going to bed hungry. To a young billionaire like Mark Zuckerberg, founder of Facebook, the difference between $5million and $10 million might cause him nothing more than a lame yawn.  No matter who you are, whether you live on the streets or in a $30 million mansion, the rules of personal finance apply.  If you can remember to spend less than you earn, you will get financially ahead!

As for Lady Gaga, she should consider learning the basics of personal finance. She could start by reading Money Music 101. 

Would someone kindly recommend it to her?

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Five Things Every Musician Should Know About Personal Finance

Dealing with one’s finances can be a daunting task. However, learning the basics and using a consistent approach to managing your personal finances, the task is not all that difficult after all. Below are the five most important finance concepts every musician should know.

1. The Time Value of Money 
Despite recessions, deflation threats and falling house prices, a dollar today is worth more than a dollar tomorrow.  This is really one of those big dilemmas in the world of finance because you have to make a choice between something of value (your cash) for another thing called time.  You can’t have both at once. You either spend your money now or you save your money and spend it later. If you wait and spend it later you want your money to grow over time and be rewarded for not spending it right now. Otherwise, why bother waiting knowing that your dollars will buy you less over time. Can you see that time has value?  How much value is better understood once you appreciate the power of exponential growth and how it applies to interest.

2. Compound Interest
Albert Einstein once said: "Compound interest is the greatest mathematical discovery of all time." Yet, everyone seems to memorize his famous E=mc2 in favor of the good old compound interest formula. What was that formula again?  Here it is:  P_n = P₀ (1+r)ⁿ

Where, P_n = Future Value, P₀ = Present Value or Principal, r = interest rate (per year), n = time (in years) a.k.a. compounding periods

To really appreciate the power of compound interest let’s call it by its real name: Exponential interest.  Exponential interest is based on an exponential function with the value for time being the exponent. For longer periods of time, the exponential increase of the interest amount becomes all the more clear when comparing it to a linear growth rate, the much more intuitive way of looking at increases over time. 

This can have particularly devastating effects when underestimating the power of exponential interest for credit card and other debt.  Understand the exponential function to get a sense of how the power of compound interest can make or break you.

3. The Rule of 72 
The Rule of 72 is a simplified way to estimate how long an investment will take to double, given a fixed compound interest rate. Here’s how it works: 

72 ÷ interest rate =  # of years it takes to double your money

For instance, if you could earn 6% return on an investment each year, it would take approximately 12 years  (72 ÷ 6 = 12) to double your money.  If you are a guitar player, the number 72 should ring a bell.  In case it doesn’t, please consider the Guitar Player’s Rule of 72.

4. Understand Credit, Debt and Leverage 
Consumer credit, credit cards and various ways of financing have become an essential part of today’s economy. No industry has been untouched by the pervasive use of credit and the global economy would come to a standstill if credit were to dry up completely. During the financial crisis of 2008/2009 we saw a glimpse of what could happen when the well of instant credit dries up.

It is essential to understanding how interest and financing charges on your credit cards and loans work. But it is equally important to limit the amount of overall debt.  Credit can be a tool just like a lever; it can multiply your purchasing power.  The downside however, is also clear.  If you use leverage to purchase depreciating assets like consumer goods and electronics, you may find that the amount of debt you took on can be overwhelming.

I use credit cards for their convenience and for some of the benefits they provide.  In essence, credit cards give you about 20 days to use their money without any interest charges.  The tricky part though, you should be prepared to pay back any outstanding balance in full when it’s due.  That takes a lot of discipline.  More often than not, you may only have a partial amount of the payment available and try to catch up making installments as you go.  Credit card companies are banking on your inability to pay back the money they lend you.  Be very careful when you purchase goods with a credit card.  Only ever charge something to the card when you know that you can pay it back in full at the end of the month.

5. Plan Ahead, Budget and Live Within Your Means 
Planning and budgeting are essential concepts when it comes to managing your personal finances.  It’s all based on the notion of living within your means.  As they say:

It’s Not What You Make, It’s What You Keep!

Making a ton of money does not mean that will remain financially successful. Just do a Google search for famous bankruptcies or bankrupt musicians. You will get a list of names that rivals any guest list at a red carpet Hollywood event. Their money problems were not primarily caused by an inability to make money. These artists all made plenty of it, often tens of millions each year. Yet, they spent more than they earned and therefore ended up in bankruptcy court.

Learning how to establish and keep reasonable budgets is the key to living within your means and to get financially ahead.  Musicians and independent artists often have highly fluctuating incomes.  They can make a ton of money for a few months only to experience a dry spell and earn substantially less during the following months.  For instance, a musician may go on tour and earn quite well.  When the tour ends, the regular payments end as well.

Who knows, that one project that wasn’t going to pay you until completion 4 months down the road could be the most important musical project of your career.  But without having enough of a financial cushion, you will simply not be able to afford the project that might make you as an artist.



Summary
Taking care of your personal finances is not rocket science but it does require some work, lots of discipline and a healthy dose of common sense.  Musicians know all about discipline and hard work.  Nobody wakes up one day to become a great violin player or pianist.  It takes years of practice.  Similarly, it takes some practice and some time to learn how to manage your finances.  Start saving early, spend wisely and always live within your means.  Your financial success depends on it!

Credit cards and “Savings”

As you may know, credit card companies have to display the following warning on your credit card statement:

Minimum Payment Warning: If you make only the minimum payment each period, you will pay more in interest and it will take you longer to pay off your balance. For example:

While this is a very good development raising some awareness about the dangers of borrowing too much debt, notice the subtle word “Savings” in the last column.  Very clever marketing which draws attention away from the better choice:  You should always pay off your credit card debt in full every month!

Yes, paying off slightly more than the minimum amount is better than paying only the bare minimum but it is still making the credit card companies far too much and far too easy money and it’s costing You the credit card holder a fortune in interest expenses.
Instead, one should consider to either pay the full amount now ($564 in the example above) or pay a total of $816 within 5 years.   

You DO NOT save by paying anything less than the full payment today but you may make the credit card company a little less money by paying a slightly higher amount than the minimum payment.  Still, the credit card companies would rather you pay them in incremental amounts. As attractive as it may sound (Savings), you are better off facing the music now than later.

Let’s look at this from another angle, using the rule of 72 that we mentioned in a previous post:
At a typical rate of 20% for finance charges, credit card companies (not you) can double their money they make from you every 3.6 years and here’s how...

72 / 20(%) = 3.6 (years)

Sounds like a real good business to be in...and a bad deal if you don’t pay your credit card balance in full.  Keep an eye on those charges and pay your credit card balance in full every time!
 
For questions, comments and suggestions, please feel free to use the commentary section or email: clemens@moneymusic101.com
 
Please help us spread the word and promote financial literacy!

The Rule of 72 in a different light

We previously discussed the the Rule of 72 as a simplified way to find out how long an investment will take to double at a given interest rate. Here’s how it goes:
Divide 72 by the given interest rate and you can find out how many years it will take double your money.
The Rule of 72 also works in another way;  you can find out the exact interest rate or rate of return needed if you wanted to double your money within a certain number of years. You can rework the Rule of 72 like this:

72 ÷ # of years = the rate needed to double your money

Here is an example:
Let’s say you saved up $5,000. Now you would like to double that amount in the next 6 years but you are not sure what type of investment or interest would be needed to achieve that goal. Let’s plug in the numbers...

      72 ÷ 6 (years) = 12 (%)

Solution: In order to double $5,000 in 6 years time, you will need to find an investment giving you a compounded annual return of 12%.

Really simple stuff, but you should consider using this as a gauge when looking at your own financial planning.  If your time horizon is say 10 years, remember that you need about 7% of compounded annual return to double your money.  This might come in handy when you talk to your broker the next time.