The Future Value of Money

Most people see a $20 bill as twenty dollars.  Makes sense right?  However, the financially savvy and the wealthy see a $20 bill as having a value more than $20.  Why is this?  To understand this, one must understand the concept of the future value of money. 

This concept is very similar to the opportunity cost of every dollar you spend.  The future value of money is the value of a certain amount of money if one were to invest it for “x” amount of years at a certain rate of return rather than spending it immediately.  For example, if a twenty year old college student found $20 in the laundry what is the future value of this money?  If he were to invest it at an 8% return until age 65 when he retired then he would have around $827.04.  Therefore the future value of this $20 is $827.04.  People rarely take into account the future value of money when making everyday purchases.  However, I take it into account on everything I buy.  I am going to make thousands of purchases of around $20 in my lifetime.  If I abstained from a pizza every Saturday night and ate a turkey sandwich for one year then I would have amassed around $43,006.08 in future money ($827.04*52).  These kinds of small decisions throughout one’s life can make a person live from paycheck to paycheck every month or have $10,000 in dividends roll in every month for doing nothing more than being a shareholder.  Do not despise small beginnings!  Compounding takes a while to get going, but once it gets going it is nearly unstoppable! 

The future value of money changes as you get older.  If I were 30 years old and wanted to buy a Bentley for $250,000 then I would really be spending about $4,520,000 in future purchasing power if I invested until age 65 instead.  However, if you take the same scenario except I am now 55 years old, I am only spending $571,600 in future purchasing power.  This is a huge difference, and this example shows the power of starting early.  The younger you are the longer time horizon you have.  This effect partially explains why a lot of young wealthy people do not spend money frivolously although they may have millions of dollars.  They know that if they can just hold off spending large amounts of money for another ten years then they will have more money than they could ever spend.  They can buy everything they want and more.  They can start a scholarship fund, donate to a city project, retire early, travel with their loved ones, enjoy life doing whatever they please.  This kind of financial freedom can be achieved much more easily than most people would have you believe.  Older people are free to spend money as it has very little future value to them personally.  Also, the older they get, the richer they are.  Of course, many choose to setup trust funds and pass on their wealth to future generations. 

 It all starts with a good understanding of the future value of money in my opinion.  If you can work this concept into every purchase you make, you may find yourself saving and investing more money.  Believe it or not, these are the first steps to gaining financial independence for most people.  The earlier one starts the better, but it is important to realize that it is never too late! 

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: