The Time/Value of Money

What happens when you take the time/value of money for granted? You may be tempted to rely simply on the math at the moment you make spending decisions ("I need to make the loan payment every month on my new car") and discount the emotions surrounding our decision and how they may affect what happens to you financially over time ("I'm so excited that I qualified for my new car loan, I'm not even going to think about what might happen if I lost my job!"). The math we use to calculate a loan is easy - what we decide to do on an emotional level about our indebtedness is what requires more conscious consideration. This consideration is the deciding factor in what costs us or makes us hundreds of thousands of dollars over time.

Most people are willing to go into debt for thirty years to purchase a home, but don't give a lot of serious consideration to saving and investing for that same thirty-year period. Let's say Couple A puts away $100 a month for 360 months (thirty-year mortgage term) at 6% interest. With the interest they are earning, that $100 is actually worth $279, which will ultimately earn them $100,451 at the end of the thirty-year period. How does their story compare with Couple B, who instead of saving $100 every month, spends that money on eating out, new clothes, and new home electronics? It's true that both couples have $100 they can spend, but one is considering what that $100 will be worth over time and the other couple is only considering how they feel today.

How does credit card debt affect the value of money over time? To answer this question, let's see how many years it will take to pay off a credit card balance of $3,600 at 19.9% interest if the borrower only makes the minimum payment of $60 per month. It will take an unbelievable 26.8 years to pay off and cost the borrower 4.3 times as much as the amount borrowed!

You can see from the example that decisions made today have consequences tomorrow, and you can't afford to simply be caught up in the moment. You must become more accustomed to thinking about how small spending and borrowing decisions today may have far-reaching effects in the future, and more accustomed to weighing the cost of purchases made now as compared with the cost of owning that purchase in the future.

How can you learn to think outside the immediate "gotta have it now" moment that keeps you perpetually in debt? I believe this only possible when you apply principle-based thinking to your finances - principles like the time/value of money. I also believe it requires looking at financial masterly like a puzzle. It's not enough just to concentrate on the "debt" piece of the puzzle - you must look at the entire picture, have all the pieces of the puzzle in hand, and understand how all the pieces are inter-related and must work together in harmony. What are the four pieces of the financial puzzle?

1. Spending

2. Debt

3. Saving

4. Taxes

Everything a person needs to know to be successful financially is included in these four pieces.

All of these pieces must be working together at the same time in order to achieve success. Let me illustrate. Suppose you work really hard to get your debt under control, but you and your spouse still aren't tracking your spending habits so you don't realize that you're still over-spending by $250 every month? What good will getting yourself out of debt do if you'll just be forced back in debt again? And how does debt affect your savings? The example I used previously about Couple A and Couple B and how they each used $100 illustrates perfectly what happens to our savings opportunities when we don't think about how spending and debt can affect those opportunities. Finally, when was the last time you really took a good hard look at how taxes are affecting your ability to get out of debt and save for the future? Taxes now exceed what most people pay for food, housing, clothing, and transportation, combined! Do you know what that really means for you personally?

We must understand how the financial puzzle really works if we ever want to get out of debt and have money for the future. You are most likely to put this puzzle together successfully when you learn to rely on ageless foundational principles, such as the time/value of money, instead of on popularly accepted financial trends, products, or people.