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?