time value of money | Squirrelers

3 Time-Related Factors to Consider Before Spending Money

We all know that there are different personality types out there when it comes to money. Some of us enjoy personal finance, others are bored to tears by it. Some of us are savers, others are spenders. For that latter group, there are even bigger risks than might meet the eye!

What I mean is that when it comes to making smart purchasing decisions than simply controlling expenses. Sure, we should make sure that income exceeds expenses, and that the more we save for retirement and old age, the better off we will be. But if we want to increase net worth, it’s important to think about how time and spending can be interrelated.

To illustrate this, let’s use an example of a hard working, responsible person out there. Let’s assume this person makes $75,000 per year and saves $15,000 after all expenses, including taxes. Saving 20% of gross income, not bad!

Let’s say she then wanted take a mini-vacation with friends, and spend $1,000. No big deal? Well, I think the impact of spending extra money might be greater than this person might realize.

Keeping in mind the income and savings of this person, let’s look at 3 things to consider before spending money.

The Time Value of Money

By this, let’s first consider the notion that a dollar today is worth more than a dollar tomorrow. Due to inflation, the purchasing power of a given amount of money will go down over time. Remember when a $1 could buy more than a gallon of gas? Maybe I’m getting old, but I distinctly recall paying 89 cents per gallon back in the 1990’s. I still remember the sign outside that gas station.

What would that 89 cents buy today? As of this writing, less than 25% of a gallon of gas. It’s not just gas that’s gone up, as we know. Food, education, clothing – you name it, it’s gone up in price. The cost of living increases over time.

Rather than spending the money, what if we saved it instead? We could actually keep pace with inflation, or if we invest well, actually see our money increase! Unquestionably, rate of return matters.

Back to the person we brought up earlier. If she saved that $100 instead of spending it, and invested it well, it could be worth more in the future. Let’s say she invests it and earns a rate of return that’s 4% more than inflation, after taxes. After 20 years, that $1,000 would be worth over $2,000 in today’s purchasing power.

Thus, spending $1,000 might really be like spending $2,000.

Hours Worked to Afford It

One of the things we can think about it is the hours worked to afford a purchase. We’ve talked about this before, and we can revisit the concept with this example.

We already said this woman earned $75,000 per year. If we assume a standard 2000 hours of work annually, that comes out to $37.50 per hour. Let’s say that after taxes, this comes out to $25.00 per hour. In this situation, that $1000 mini-vacation with friends ended up costing 40 hours of work. That’s one entire week at work, just for a vacation!

Hourly Savings Rate

Back to our friend and her vacation. If we go beyond how long she had to work for this, let’s consider that what she really had available to spend was her savings. Meaning, after all of her expenses, she had that $15,000 of savings we alluded to earlier. That $1000 mini-vacation ended up being 1/15 of year annual savings!

She would have to work almost 3.5 weeks to earn $1,000 in savings! Just imagine if she only saved $3,000 per year instead. That would be 4 months of work to save that $1,000 she wanted to spend on a vacation!

Bottom Line – when spending money on purely discretionary purchases, let’s keep in mind how hard we really have to work for it and what it can become if we invested it instead. That doesn’t mean we shouldn’t ever splurge of course, but it’s important to think of the real value of our money and our time.

My Questions for You

Do you ever think about these factors when making bigger or discretionary purchases?

Which of the three factors makes the biggest impression on you?

The Long-Term Value of Investing Just $1,000

By Squirrelers 11 Comments

Every penny saved is a penny earned, right?

Well, that’s not really true. At least, not long-term anyway. Save money now, and you’re allowing yourself to make more money in the future.

: Save now, swim in money later!

I thought of this as I had a recent discussion with somebody just out of college, which means that person was a number of years younger than me by the way. Anyway, he was actually talking about saving money, which – as you could imagine – impressed me. Given his age, and his talk about saving, I thought about what a great opportunity this guy would have to grow net worth just if he applied sound personal finance principles right away.

At the age of 22, a person decided to think of opportunity costs, cut back on some extraneous expenses, and save an extra $1,000. He (or she) could do this by driving a less expensive car, cutting back on going out, living with Mom and Dad, or realizing that travel is overrated and often simply expensive entertainment (for many of us anyway). There are many ways one could save $1,000.

Let’s assume he managed to make such decisions to allow for an extra $1,000 to be saved each year for just 4 years from ages 22 to 25. Then, then the money was invested at a 7% annual rate of return (after accounting for inflation, considering the time value of money) and compounded/held until age 65.

The net result? He would have over $66,000 accumulated by the age of 65. Just for those annual $1,000 investments for 4 years, from ages 22-25. Not bad!

If the rate of return was improved, that figure could be even higher. Let’s say he took those 4 years of $1,000 investments, and hit it out of the park by earning a 10% rate of return adjusted for inflation. He would then have an extra $210,000 in today’s purchasing power by age 65, just for making a few smart decisions when younger.

While it’s clearly much, much better to start when young, those getting a late start can still benefit. If somebody starts at age 42 with these 4 years of $1,000 investments, and holds until 65, that 10% rate of return means over $31,000 by 65. If you multiply this out, one can see the value of compounding based on time and rate of return.

Again, it’s just a matter of making a few adjustments for a lot of people, deciphering wants versus needs, and having the discipline to follow through on a few adjustments. Really, the possibilities are exciting when you think about it!

My Questions for You

Do you ever think about trying to set aside incremental smaller amounts like this, and squirreling it away for the long-term?

Do you apply the opportunity cost concept, when thinking about spending money? In other words, if money is spent today, what it could become in the future if otherwise invested.

Have you thought about how powerful time and rate of return can be in terms of impacting your future net worth?

A Personal Finance Time Capsule

By Squirrelers 16 Comments

Have you ever come across a time capsule?

I recently found what amounted to one when I was going through a box at my parents’ house, which was also my childhood home. They’re selling it after 34 years, which brings about a range of emotions in them and me as well. It’s for the best at this point in time, but it doesn’t make it fun. Wow, I wish they could keep it forever, but as we know, nothing lasts forever, including us. Sometimes we need to embrace new beginnings.

If there’s a good side benefit of this, it’s uncovering things that were sitting around for years that you forgot about, but are nice to see again. I found so many of those things, it’s really surprising. Almost all things that really me or someone in my family could personally value, but those are often the best kind, right?

Well, I might share a few of these in future posts, as there were many. But one type of item I found was a group of ticket stubs to baseball games in the late 1980’s. Yes, I’m not super young. I was a teen back then who just got my license, and would occasionally drive from the suburbs into Chicago to see major league ball games with friends. I even have some opening day memories, when we missed school to see a game once (Mom and Dad if you’re reading this – Surprise!).

Anyway, finding those ticket stubs in mint condition, while I never knew were still there, brought a smile to my face. I don’t know why they weren’t thrown away originally, it was probably an accident that they were kept way back when. But once I saw them, I recalled how a few times we took off on a few school nights to go into the city. I can still remember, back before cell phones, we would tell each other at school that we would meet up at someone’s house at 6:00pm, after we all ate dinner, and then drive into the city to catch a 7:30 game. If we hustled, we got there early to catch batting practice and maybe a ball.

It brought back memories of how carefree we were back then, and even how the worries that we had were really miniscule in the big picture. And also, conversely, how little we worried about what we should have. The area around grand old Comiskey Park (1910-1990) was commonly perceived as high-crime and dangerous at night during that era, but we threw caution to the wind and just drove up from the vastly different suburbs without caring. What a great time of life!

It also brought a smile to my face when I saw the cost of the ticket. You know I would do that, right? Well, the one of the tickets I saw was for $2. Can you imagine going to a game today for $2?

I’m sure it was for some kind of discounted day, like a half price night or something like that. But still, if you take $2 and apply an inflation rate of 3.5% to it and let it compound for 24 years, it still comes out to just $4.57 in today’s purchasing power. How easy is it to get admission to a major league game today for $4.57? Go check on the prices of tickets anywhere these days, and you might be surprised by how expensive it can be.

I think you tell I thought it was a fun find J

My Questions For You

Have you ever come across something from your youth that was fun to find? It doesn’t have to be money related, just something that was cool or surprising to find, and reminds you of good times.

Do you recall times in the past where you went out with friends and had lots of fun for little money?

Squirreling Gone Wild #28: Amusement Park Shenanigans

By Squirrelers 16 Comments

Amusement parks can be fun for kids and families! What a classic way to spend a summer day. Of course, a day at the park can be expensive for the family as well.

This edition of the Squirreling Gone Wild series will share a story of a friend of mine who discovered a way to maximize the return on his investment of time and money at the park. Just keep this in mind: don’t shoot the messenger who’s sharing this story, this wasn’t me:)

Anyway, first of all, let’s talk about the friend. He’s someone who likes to save a buck or two. I’ve known him a long time, but don’t see him as often in recent years since we’re both busier. Anyway, he’s a good guy – let’s establish that up front.

We were on the phone the recently catching up, and he started to tell me about his visit to a major amusement park earlier this year. I haven’t been there since I was a kid, but would like to take my own kids sometime in the future. So, I asked him what it costs to visit these days. He proceeded to tell me how expensive the park is, counting tickets, food, etc. Plus, they stayed multiple days as they made a vacation out of it. Needless to say, he shelled out a fair amount of money for this trip.

Then, he started laughing as he told me that he found a workaround for visiting the park that could save time and money, if someone had the guts to do it. The idea is to complain to customer service in order to board rides immediately.

The Problem

Here’s how he figured this out. First, they had arranged for something called a fastpass, which apparently allows you to “reserve” a time window during the day in which you can visit a certain ride and stand in an express line. The way he described it, you could get fastpass at say, 11:00am for a certain ride. The fastpass will have a window of 1 hour later in the day, say 2:00pm to 3:00pm, where you could go back and have a shorter wait. For comparison, he indicated that if a ride’s normal line might be 45 minutes, the fastpass line might be 15 minutes. So, you end up saving time by scheduling your ride ahead of time.

So, they went to that ride at their allotted time, and got into the fastpass lane. They were excited to have a relatively short wait in this express line! Well, unfortunately as they got in line the ride wasn’t working. They didn’t get to go on that ride, even though they had planned around it with their fastpass scheduled time. Bummer, right?

The Customer Service Response

Well, he wasn’t happy about it. His next move was to go to see customer service and complain about it. Not something I would have even thought about, actually, but he went and did it. Lo and behold, they gave him some kind of special pass for immediate boarding on one other ride! So he got something for his family’s inconvenience, after all.

He went to another ride and bypassed the long line and boarded immediately with his new, special pass. He mentioned that it was great walking right on, bypassing not only the massive wait in the regular line, but also the shorter wait in the fastpass line. Essentially, he didn’t wait at all!

The Scheme

Then, he had a thought come immediately to his mind. Apparently, he liked the convnenience of immediate boarding so much that he went to complain to customer service again, saying that he was unable to board a ride. Now, this wasn’t exactly the case. He just wanted to board another ride without waiting.

So, he got the special immediate boarding pass and went to another ride. Later in the day, he did it again. Complain to customer service, then get immediate boarding on your next ride – that was his formula.

Then, the money saving aspect came into the conversation. He assessed that yes, one could cut out an extra day of visiting by compressing more rides into one day. Then, there’s no need to stay an extra day because you’ve experienced all the rides. You just have to complain a bunch of times, get immediate boarding passes, and get it all done in less time. That means one day less in the park, which means less money spent overall – including hotel, food, etc.

Savings by complaining: Hundreds of dollars and a day of your life!

The Post-Mortem

So, would he do it again? No. The reality is that he only complained those few times I had mentioned above, and that’s it. He felt guilty about it, and didn’t think it set the best example for anyone. Plus, seeing everyone standing in the other two lines (regular long line and fastpass line) while he boarded immediately made him feel bad. He just got carried away in his enthusiasm. He just had the lightbulb go off in his head, got fired up, and took advantage. But he has a conscience and won’t do it again. Like I said, good guy.

That didn’t stop us from laughing about it though, and talking about the money savings opportunity that it presented:)

Two takeaways I had from this story:

It seems like the park’s customer service might be pretty good. Kudos to them.
Don’t actually do this. Rather, be honest.

My Questions for You:

Have you (or anyone you know) ever schemed to save money at some kind of entertainment venue, be it a theme park, concert, sporting event, movie, etc?

Ever do something along these lines that seemed funny at the time, but you might not do again?

We’re Spending Much More Than We Might Realize

By Squirrelers 25 Comments

When making everyday purchasing decisions, we have variety of ways that we determine whether or not something is a deal. Maybe it’s at a low price compared to the price we’ve seen it elsewhere. Perhaps, it’s priced well compared to substitutes. For some of us, we consider how a purchase fits into our budget.

What about thinking about how a purchase impacts our long-term financial situation?

On the surface, this makes sense. The more we spend now, the less we might have in savings later.

For example, let’s say you’re deciding between 2 vacations for the summer:

An inexpensive, 4-day vacation that’s within a few hours from home, with fun activities and solid if unspectacular lodging. Cost: $1,000
A pricier, 7-day vacation that requires booking a flight across the country, also with fun activities, but more upscale lodging. Cost: $3,000.

If these are your two alternatives, you have a decision that involves an incremental $2,000 at play. So, by choosing option #2, it can be said that you’re taking $2,000 away from your future retirement. That is, assuming of course that you would saved it instead of splurging on something else. That’s an assumption to be sure, but let’s go with for now.

Down the line, you’ll have to earn an extra $2,000 to make up for that amount, right?

I think that might be true, but in reality it could potentially be a lot more than that. As I postulated in a post last year (when Squirrelers was fairly new), what you spend today could mean something very different in the future. Your opportunity cost is not just what you spend today, but what that money might become in the future.

Let’s take that $2,000 from the example above. What would that be worth in the future?

Well, let’s assume it’s invested and grows at 5% per year. Let’s say this is after taking inflation into account. That $2,000 will be worth the following amounts, at different points in time:

Clearly, that $2,000 which was spent turned out to be just like spending a lot more future dollars. Factoring in growth, that vacation actually cost $8,644!

Crank up that growth rate to 8%, and this $2,000 becomes something much more:

$20,125 after 30 years. That sure was an expensive choice, to upgrade to a deluxe vacation!

Now, the purpose of this exercise is obviously not to focus about different expected rates of return, or the merits of spending on vacations. Rather, the takeaway is that when we spend money today, we’re really spending a sum of money that might be worth a lot more in the future.

From big purchases all the way down to the smallest purchases, I think this concept holds.

My Question for You:

Do you think about how a sum of money today can be worth a lot more in the future, and connect it to spending decisions made today?

A Dollar Today > A Dollar Tomorrow

By Squirrelers 3 Comments

I recall a conversation with a former colleague of mine, a sports fan like I am, talking about a $500,000 bonus that a former collegiate sports coach had lost based on violating terms of his contract. We were both shaking our heads, each of us having a hard time understanding how someone could basically just throw away this kind of money with a simple mistake.

My former colleague then made a comment to the effect of: “If you had $500,000, you might be able to retire.” This comment surprised me, as he was generally very bright guy, good at his work and a very sensible, level-headed person. The reason this was surprising to me is that he was in his late 30’s, with a family, and felt that he might be able to retire on that amount. Mind you, this means retire with no pension to supplement – just the $500,000 principal.

Intrigued, I asked him how this would work. He was someone who watched his expenses, like me, so I expected an answer based on extreme penny pinching. Rather, he told me that one could earn 10% in the stock market, and then would have $50,000 per year coming to them. Not bad as retirement income, passive income nonetheless, he said.

Of course, I had to jump in with my own feedback. Sure, 10% each year could happen, but the market would be up and down, so it isn’t a reliable way to earn a steady amount passively. That said, even if you had some investment that paid at that rate, you would have to pay taxes, have transaction costs, etc.

When I told him that his $50,000 would buy him less and less every year, he didn’t get it. The biggest thing he seemed to miss was the time value of money: a dollar today is worth more than a dollar tomorrow.

I didn’t get into a full discussion with him, but if I could go back and continue the conversation, I would tell him about the concept of PV – present value. PV = the value of future cash flow in today’s purchasing power. The calculation is as follows:

C / (1+I)^T

C = cash payment
I = inflation rate
T = Time – years into the future

In explaining the concept, I would illustrate with the following example:

Lets say you had $50,000 due to you. Which way would you like to receive it – all up front, in equal $5,000 installments for 10 years, or all at the end of 10 years? No reinvestment, compounding, etc. Just straight cash payments. Inflation rate is 3%. Let us examine the PV of each scenario.

Scenario 1 – All up front. PV is $50,000.

Scenario 2 – $5,000 at the end of every year, for ten years. PV is $42,651.

Scenario 3 – $50,000 at the end of the 10th year. PV is $37,205.

Clearly, getting the money up front is a better deal. Why? The time value of money – a dollar today is worth more than the same dollar tomorrow.

So, when my former colleague does his retirement planning, and projects what his needs will be in the future, lets hope he considers the impact of time on the value of his money. We should all do so.

Do you ever think of the time value of money in this way, where the purchasing power today is greater than it will be in the future?

How do you apply this concept to your finances?