What's $1 really worth?
Updated: Feb 22, 2019
Who cares, it's only $1! Right? I mean, what can you buy with just one measly dollar? Stuff at a dollar store, before taxes, I guess. A "hamburger" from the dollar menu. But here's the thing, if you spend that dollar now, you're missing out on WAY more money down the road.
Today I want to talk about compound interest and opportunity cost. These two concepts, when understood together, can really shape the spending and saving decisions we make that have big impacts on our future and Financial Independence. Let's start with compound interest.
Depending on how you calculate it, over the course of the stock market, it has averaged between 6% and 12% return. This means that if you invested in a stock market index fund that closely tracks the market and did nothing else, that dollar would go up in value over time. And each gain would then be added to the original value, which would then gain between 6-12% again, and again and again. So soon, your original dollar that you saved instead of spent turns in to some serious money.
A lot of financial writers think that an average return of 7% is fairly conservative and a good number to base calculations on. I wanted to see what would happen to the same $1 at 8% and 9% over the years as well, so I made this handy chart using an easy-to-use compound interest calculator
So let's say you are trying to retire in 20 years. Every dollar you spend now, in 20 years, with compound interest at 7% would be worth $3.87. At 8% it would be worth $4.66 and at 9% it would be worth $5.60. If you got really lucky with your investments and made that 12%, it would be worth $9.65. So every dollar present-day you spends, you deny future-you of way more.
And who spends just $1? Most of our purchases are at least $100 and many bigger purchases like cars and furniture and televisions are thought about in units of $1000.
This loss of future value is opportunity cost. You may get something you want right now, but you could be missing out on thousands or tens of thousands of dollars later on. So you have to ask yourself, is it worth it? The problem with that is, your own brain might be betraying you at a level that is truly weird and insidious.
A few years ago, in a study at Yale, researchers determined that the language you speak helps determine how good you are at saving money. Sounds crazy, right? Here's how they think it works. If you speak a language, like English, that has verb tenses (Past, Present, Future), you are WORSE at saving money because your brain changes so that when you think of yourself in the future, you use the part of the brain that you use for thinking about other people, not yourself. You literally have a much harder time thinking of your future self as your real self. So the decisions you make, if you speak English as a native language, aren't as concerned with your future self's needs, because hey, that's someone else's problem.
Native speakers of languages without verb tenses, like Chinese, don't have this problem. When they think of their future selves, they have no problem using the part of the brain that is for the self. This is one explanation for why people in those cultures save more money, they don't think of their future self as someone else.
If you want to save money, you have to realize this problem, along with all the other challenges that come with saving like being bombarded with advertisements, keeping up with the Jonses, student loans, and basic survival in a tough world.
But I think that if you keep in mind that every dollar you spend now robs your future self, the self that may not be able to work or not want to work, of massive amounts of spending ability, you might think about your purchases differently. This is especially true if you're a few decades from retirement, where compound interest can help you the most.
Save the money, your future self will thank you.
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Disclaimer: The views expressed is provided as a general source of information only and should not be considered to be personal investment advice or solicitation to buy or sell securities. Investors considering any investment should consult with their investment advisor to ensure that it is suitable for the investor’s circumstances and risk tolerance before making any investment decisions. The information contained in this blog was obtained from sources believe to be reliable, however, we cannot represent that it is accurate or complete.