Invest for options in Life, not just for Retirement.

1. BUYING OPTIONS IN LIFE

The ideas most associated with investing are wealth, retirement, and interest. And when you’re younger and maybe living paycheck to paycheck, it’s hard to imagine what investing could do for you.

The end goal of investing isn’t all about achieving a happy beachside retirement. But instead about buying options in life. Options in life mean different things to different people, and they are different to goals. Your goals may be to get an 8% return a year or have $500,000 in 10 years. These are reasonable specific goals, but they don’t factor in the changes to your life along the way. Options in life are more about being able to make decisions, to take you in a different direction. Imagine, what if you had an opportunity to move to another country, go back to school, or even start your own business?

These options in life may cost you in the short term but may pay you back either economically or in quality of life in a long time. I experienced the journey of buying options in life when my kid was born. Going back to work with a baby at home and undergoing profound sleeplessness was genuinely horrifying. And I needed and wanted to take time off work and work for myself instead. So when my wife and I did the math on selling our car and what some shares would mean to our long-term portfolio versus taking the short-term benefit of spending time and getting healthy and watching the baby grow, the answer was easy.

Yes, selling some of your assets (liabilities in our case was the car) and investments to explore a different option in life may impact your long-term success. But more importantly, so will change your spending habits and prioritise putting money into investments. Adapting your spending habits to prioritise investing can significantly impact your future financial success.

For many people, step one in that equation is to save. And instead of keeping cash in a bank account, I strongly recommend you put that money to work. Depending on your risk profile, you have a range of options like stocks, bonds, or funds; that are highly liquid. Most can be sold within a day should you urgently need the money.

Regardless of where you are on your investment journey, think about your goals, not just in terms of a number that you need to retire or things you want to buy, but by creating a way to buy options in your life. The last thought to leave you with: you work so hard to earn your money, you go to school, compete for jobs, jostle for races, and spend a large portion of your waking hours dedicated to generating income for you and your family. Why not make it a priority to put your money to work for you first? There are no future facts; you don’t know what will happen, but having a healthy approach to money and investing, can help buy you better options in life.

2. RELATIONSHIP BETWEEN TIME AND MONEY

First, you’ve heard the expression — “time is money”. It’s usually applied to time wasted when you could be earning money or doing something productive. But it’s even more applicable when it comes to investing.

Let’s start with compound interest, which is how your investment money grows exponentially versus in a straight line. With compound interest, $1000 invested today, assuming a conservative 4% return, will be $1,480 in 10 years, 2,190 in 20 years, and 3,243 in 30 years.

But not so fast.

You also have to consider inflation. A cup of coffee (kopi-O) cost 40 cents in the 1990s. It was about $1.20 in 2018. So has the value of the dollar decreased?

Not really. But the buying power has gone down. You get ‘less’ coffee for your dollar, and that’s inflation.

So let’s play it forward. Will the cost of a cup of coffee triple again in 30 years? Maybe. Your money in pure terms will probably be worthless in the unknowable future.

So what does that mean to you? If you’re using a bank account to save every dollar, what you save today isn’t paying interest higher than the inflation rate. However, if you’re investing, you expect the gains you make through investing to be more than the effect of inflation.

Two more sophisticated concepts: Present value and future value. These are two different ways to think about the time and money relationship. Present value calculates what you need today to get to a specific future goal.

Let’s say I have a goal of someday buying a boat. And that boat is going to cost me an estimated $500,000. First, let’s give that someday a date — 15 years. And then let’s assume the annual return. Historical stock market returns have averaged about 8% a year. But being conservative, let’s put it at 4%. The present value of the money I need to invest today to buy that boat is $277,000. So with 277,000 and 15 years of investing, I should be able to afford my $500,000 boat. A good way to think of it, right? It seems a little bit more affordable now.

Let’s look at it a different way. Let’s say I did have $277,000 lying around. The future value of that money at a 4% return is $500,000. However, if I don’t invest, the future value is $277,000. But inflation will also affect what I can afford with it. Probably a little more than a rowboat, but certainly not the boat I may have imagined. You can apply the concepts of compound interest and the time value of money to do the math on other life questions.

A pencil and a calculator, or even better, an Excel Spreadsheet, can help you make sense of questions like, when does it make sense to cash in an investment? The mathematical answer is when the average future returns on that money are more than the current projection of the asset invested.

But life isn’t that simple. And it’s often not just about reinvesting it. The future growth that you’re giving up on that money and that the value of what you need the money for today is more significant than what you’ll need it for. For some people, it can be hard to get out of the cycle of paycheck to paycheck.

The ideas around compound interest, inflation, present, and future value of money, can help you think beyond where you are today and look to a more financially secure future where your money works as hard as you do. If you’re starting your investment journey and have many years ahead of you, you have something that the most successful established investors do not. You have time. And the sooner you start, the better.

3. COMPOUND INTEREST AND INVESTING

Let’s start with a simple definition. Interest is what someone will pay you to borrow your money. When you put money in the bank, for example, you’re essentially loaning the bank your money so that they can lend it to someone else. Bonds work the same way. When you buy a bond, it works as a loan to the government or company that issued it. In both cases, the bank, government, or company pays you interest for the right to borrow your money. The amount of interest you get paid is based on several factors, but the higher the risk of not getting paid back, the higher the interest rate. This is why the US government loans have a very low-interest rate, because they have a low chance of default, and junk bonds have a much higher interest rate because they have a much higher chance of default.

Let’s look at the impact of interest rates. Over time, interest paid out can add up, which is excellent, but the real beauty of interest is that it can also be compounding. This happens when you earn interest on the interest already been paid. Over time, this compounding effect can be considerable. As an example, take a $1,000 bond paying 4%. Without compounding, that money doubles after 25 years. With compounding, the money doubles after 18 years. That’s seven years sooner, and it’s a big difference.

To calculate the impact of compounding, a super simple method is the rule of 72. All you do is take 72 and divide it by the interest rate. The result will give you the number of years it will take to double your money. So at a 12% interest rate, your money will double in six years. 72 is divided by 12, and it’s super easy. The key to compounding is to make sure interest is reinvested. Some bonds add interest to the principal owed and compound future interest payments until the bond is paid out. But many bonds, like US Treasury notes, pay the interest out every six months. Unless you reinvest the interest yourself, you will not get the benefit of compounding.

So, let’s flip the coin and look at what happens when you’re the one who owes the money. Interest is now no longer your friend. Interest now gets added to what you owe, and compounding can quickly multiply your debt. You can very quickly owe more than you can manage. High compounding interest rates on loans are the scourge of modern economies. Interest rates can be astronomically high, from credit card debt to payday loans. For example, using the rule of 72, a loan of 30% will double your debt in less than 2 1/2 years if left untouched. So the takeaway here is simple. Never take a loan, and if you do, pay it off right away, and make sure you pay something on your credit card each month. The penalty rates on credit cards are terrible.

Please look at the interest your bank is paying you for the money you deposit with them. You’re lending them the money, so they should give you a fair interest rate, right? If your interest isn’t zero, it will be close to that. Now, does that make any sense? Absolutely not. Maybe we should start looking at better places to keep spare cash.

So, interest can be your friend, especially when compounded. But if you owe money, it can also be a terrible burden to overcome.

4. CONCLUSION

Combining the three concepts above; buying options in life, understanding the relationship between time and money, and compound interest, you will see why it’s more important to invest versus just save your money.

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