What's Worth More Than Money?

Love. Love is the answer. In life, sure, I'll concede that. But that’s not what I'm writing about today. Today, and next week, we are focused on time and its impact on our money. "If we take care of the moments, the years will take care of themselves." Maria Edgeworth wrote this thought-provoking statement about 200 years ago, and it still rings true today. She was not talking about personal finance, but I will take that same logic and apply it to our money goals. Taking care of moments like investing in your company's 401(k), paying off credit card debt, or refinancing your house to a better rate will set you up for long-term financial success. Conversely, sitting on the sidelines while the little things add up, your fiscal future doesn't look so bright. We often think about money statically - I have $50 in my wallet, or I have $500,000 in my 401(k). Do we have enough to pay the bills? Buy the dream car? Retire? Of course, taking account of your money at a given point is valuable, especially before making a major decision. What we fail to consider is our financial health is more of a journey, and with that, the time value of money. How we invest, spend, or borrow can have long-term impacts on our financial well-being. This week will be dedicated to the most powerful, and under-appreciated, components of your relationship with money: time.

Literally the 4th result when I search for "time"... timeshare resort. The guy who created the images probably got sucked into one recently.

Net Present Value (NPV)

One of the most valuable measures of the time value of money is net present value, or NPV. To truly understand the value of time relative to money, think of it this way: would you rather have $100 today or $100 a year from now? Of course, you want it today. But, what if I said you could have $110 in a year - guaranteed - or just $100 today? Hopefully, you play the long game and take the $110 guarantee, representing a 10% interest rate. Try finding that kind of return in a checking or savings account!

The real question becomes how you will use the money. What if, using the example above, you happen to have $100 in credit card debt, accruing interest at 20% annually. Wouldn't it make sense to pay off the debt instead of waiting for the $110? Absolutely! Now, if you were going to spend it on an NFT of a Terrell Brandon 2nd-quarter layup, perhaps you should accept the 10% return.

NPV is a way to capture how your financial decision look accounting for future costs/returns against an interest rate. Continuing the example above, if you opted to take the $110 a year from now, your cash flow would be -$100 to start, but +$110 a year from now. Depending on how you would use the $100 - for our purposes, let's say you put it in your savings account earning 0.50% interest. You would use that interest rate to determine your value a year from now, or however long your decision will play out. In this example, you would have $100.50 after one year ($100 times 1.005).

Making Money Work

Now that we've covered NPV, how do you apply it to everyday life? Let's start with a major decision - your retirement investments. This could include a 401(k), Roth IRA, or any long-term savings. How you invest this money may make or break your retirement goals. Risk is always a consideration (and a topic for a future Dough-Nuts blog), so let's consider the options. You could invest in the stock market, where historical returns in the U.S. are around 7-8%. Not bad, but there's always risk of a market downturn. You could play it safe in bonds or Certificates of Deposit (CD's) and earn a more modest return (2-8% in recent history). Or, you could stash it away in an FDIC-insured high-interest savings account (we will say 4% interest to be generous).

Rather than carry out a hypothetical example, let's play this out in real life. Let's say Frank just retired on his 65th birthday, which happened to be December 31st, 2020 (just trying to make the math easier, folks). He contributed $6,000 per year to retirement starting at age 35. Of that, $2,000 went to each of three options above: a stock fund that tracks the S&P 500 (VOO, for example, one of my personal favorites), and bond/CD mix, and a high-interest savings account. For simplicity sake, let's assume all of the money for each year goes into said fund on January 1st, any dividends are reinvested, and rates are flat for a given year. Doing some research, I found historical S&P 500 returns for the investment years (1991-2020), as well as some rough interest rates for the bonds/CD's using the 15-year U.S. Treasury Bond rate. The high-yield savings rate was not clear, so I just used 4% as a rough (and generous) average. Applying the yields of each path, over the course of 30 years, here's what Frank would have in each investment:

High-Yield Savings = $118,656.67

CD/Bond = $167,614.72

Stocks = $237,610.41

Oh, Frankie, are you kicking yourself now? Had you invested all your retirement savings into stocks, you would have had about $190,000 more today. Of course, no one can predict the stock market perfectly, but here's the amazing power of the time value of money. While the initial CD/Bond yields were 7.97% (who wouldn't take that today?!?!), the interest rates slowly declined to a pitiful 0.9% annual return. However, the stock market returns - while volatile at times - were substantially better. A good measure of growth over time is Compound Annual Growth Rate (CAGR), which gives you an average rate of return over a longer period of time. In this case, the CAGR of the stock market was 8.5%, and the CD/Bonds were around 6%. Of course, at 4% annual rate for the savings account, CAGR would also be 4%. While an extra 2.5% doesn't seem substantial, the difference over 30 years was about $70,000!

Let's pause here and pick it up again next week, where we will discuss the right (and wrong) ways to mitigate lost time. Enjoy your time between now and then!