Understanding how time helps your investments!
While fulfilling our desires for present value can be satisfying, it isn’t the only way we should be valuing our time. Most decisions in life have long term impacts on both our own lives and society.
Today, we are going to continue our discussion for the value of time, but we are going to look at the future value. As before, we still have opportunity costs to weigh before determining the true future value of a choice.
In this example, let’s use a very mathematical and financial approach. I know I totally just lost you with the word “mathematical,” but trust me it’s easy. In fact, you don’t even need to do the math because I’ll just give you the excel formula, plus I’ll do it for you!
Let’s say we wanted to save roughly one million dollars. As economists we must always hold something constant to measure the true benefit. In this example, I will keep the “real rate of interest” at 8%, and income at $70,000. We will learn what “real rate” means some other time, but for now just think of it as adjusted for inflation.
Well, to get started we should note that time is the best indicator of future value. In fact, if I invest $40k today, it will be worth $1M in 40 years at 8% interest. Or, I could invest $202K today for 20 years, at 8% interest to be worth $1M. However, most of us don’t have this much cash lying around to invest in one lump sum. In which case, we need to consider making monthly payments.
First, take a look at the graph below:
The first thing to look at is the years left until collecting the one million dollars. The more time we have to save, the easier it becomes to hit our target. Now compare the years to the “contribution” column. This is the percentage of our income going to savings. Of course, it only makes sense that the more time you have, the lower your monthly payment. If you were making $70k a year and had no savings, you probably couldn’t afford to pack away 94.5% of your pay for 10 years. However, saving 4.95% of your pay for 40 years is a lot more reasonable and still accomplishes the same goal!
The most interesting fact here though, is total contribution compared to the roughly $1M saved. If you did accumulate the money in only 10 years of time, you physically paid over half the total value in cash! However, if you saved for 40 years of time, your cash investment is not even 15% of the total value!
So, what’s the point? When we make choices today, they have consequences and/or benefits in the long run. While we would all appreciate several hundred more dollars per month today, our future selves might think otherwise.
Or in other words, if someone asked me how much getting an extra $300ish a month would be on my “present value” ranking scale, I would give them a fat 10! Heck yeah, in 4 months that’s a new surfboard, or maybe even some house projects. But when I compare it to my “future value” ranking scale I recognize that I’m over rating my present value.
In the end, the value of time must be looked at from two angles. There is the present value of time, and the future value of time. In Part 1, we learned that the present value accomplished our immediate needs and goals. However, here we saw an example where the future value of time outweighed the benefits of our present value. So where is the opportunity cost? The opportunity cost of having the extra $300ish per month today, is not having the one million dollars in the future.
Remember, life constantly throws us for a loop with choices. We often want to cave in for what is going to make us happy today, but we don’t always think about how this will make us feel tomorrow. In fact, we don’t even know what our future self would actually say, but we must make an attempt to balance the happiness and security amongst all of our years, not just take care of today.
As always, have perspective on your decisions. I challenge you this week to say “no” to your present value indulges at least 3 times, and instead make a choice that benefits your future self.
If comfortable, share your examples in the comments below so we can all learn about ways you made a sacrifice today, for the benefit of tomorrow.
Photo Credits: William Fleming