Something that is very important about any kind of investing mindset is the understanding of perspective. Essentially this means understanding the time value of money – money that you spend or choose to not spend at this moment – what could potentially happen to it in the future?
The time value of money
The time value of money is an essential concept that gets drilled into the head of pretty much every financial manager out there. I had a 5EAP subject at TTU this semester which basically boiled down to this same idea as well. To save you the trouble of having to spend time with my mildly sexist professor – in the event of other things being equal it’s always better to have the money now.
Money loses value as time goes on. This was painfully obvious during the financial crisis – inflation ate away at the value of money so if you had 1000€ at the beginning of the year, then by the end of the year it was more likely to be worth closer to 900€ than the original 1000€ in terms of purchasing power.
This very idea is the basis for pretty much all investment advice which tells you that the best time to invest was 20 years ago and the second best time is now. The younger you invest, and the more, the more likely you are to end up making huge returns. The stock market’s historical returns are around 8%, which means that every year that you delay your investing you have to invest roughly 8% more to get to the same results. As time goes on, that 8% keeps increasing as compounding interest starts working against you.
So much is your 1€ worth?
Quite often people spend money on tiny purchases without thinking much – it’s just 1€. The problem is that if you add up an euro here and there, then it ends up in hundreds and as years go by that compounds into thousands.
Just to give you a visual of what this works out to. I’m currently 25 so I’m likely to retire at about an age of 75 looking at the current trends in retirement ages – this means that I have 50 years to gather up money. (Or less if I want to retire early.)
This is what is likely to happen to any single euro that I invest at this point with a pessimistic return of 5% and a more likely historical 8% of the stock market. Looks impressive, doesn’t it? At a 5% return it climbs to 11€ in value, at an 8% return it climbs to 43,5€ in value. (Leaving out inflation and changes in money value, let’s think in today’s money.)
How much should you worry about that 1€?
MrMoneyMustache I think was the one who has a great philosophy about the impact of saving on your future. Essentially, it isn’t so much about short term savings and keeping yourself from spending that x amount (though that is important too). It’s about adjusting your standard of living to spend less recklessly – every euro that you save WHILE keeping that euro off your everyday life expenses actually ends up saving you the original 1€ that you’ve not spent and also saves you from having to save so much for retirement – because you don’t need that much money.
Seeing as the logic of most retirement portfolios is that if you want to spend x amount of money per year, then you have to save 25 times that. For example, a 1000€ per month vs 950€ per month in planned expenses means that you have to save 15 000€ euros less for your portfolio.
This doesn’t mean that you have to go mad with saving money (some do) and sacrifice your free time, health or enjoyment of life to save that money. There are however several very reasonable things that you should be doing that will help you free up those very important euros for investments. Like a lot of other financial tips, these things compound on each other as time passes.
Important steps to keep expenses down
1. Spend reasonably on the big things. (It’s silly to fuss about the lattes if you’re overpaying on your car or rent)
2. Buy high quality items. (This might mean higher initial costs – but you can afford that – it will mean lower overall expenses)
3. Spend on things that matter. (I’m sure just looking around your room you can find things that you wish you hadn’t bought – I can!)
4. Put in some effort to find good deals. (This means rewards programs, sales etc. A bit of effort can have high returns)
5. Take good care of your things. (Things like your home, your car, all sorts of tech lasts a lot longer with proper maintenance)
What’s your great habit to keep expenses down?