I wanted to make a simple calculator to show just how valuable each $1 (or pound, euro etc) that you have today is really worth to you over the long term. There’s obviously some major assumptions in such a calculation, but I hope it highlights how important it is to start saving early.
If you’ve read any personal finance blog, book or guide, then you’ll know about the importance of compound interest and starting your financial journey early. Kind of like how water can eventually carve a ravine into a mountain, compound interest, if above the rate of inflation, will inexorably grow your savings or investments.
There have been several babies arriving or on their way in the FI community of late (congrats DivHut, Passive Income Pursuit and Dividend Family Guy) who are in an ideal place to start saving and take advantage of all this time.
The normal charts
Now most of the time, the typical graph you’ll see in personal finance literature looks something like the following.
This shows the increase in value of $1 that you’re able to invest or save with an 8% growth each year over the next 70 years. 8% is the number usually thrown around as the “average” that the stock market will increase each year. The chart ends in 70 years time, with a value of $219. Which is awesome if you’re a) really young, b) are able to get an 8% annual yield for the next 70 years.
The shape of the graph is the same regardless of the amount; it’s an exponential curve if you’re mathematically inclined. The annual yield changes the slope / rate of increase however but much like Buzz Lightyear, it aims for infinity and beyond.
The chart above with an 8% growth looks great and everything, but it’s not that realistic sadly. The average stock market return isn’t necessarily 8%, since you’ll likely be investing over say a 30-year period than a 70-year one. And the figures don’t take inflation into account which is a drag on your real return. I’m not mentioning taxes either.
But for the purpose of doing a calculation, you can use the following formula:
Real Rate of Growth = Average Growth of Investments – Average Inflation Rate
Inflation has lately been around 2% a year. This means that if you expect to get 8% each year from your $1 investment then your real growth is only 8%-2% = 6%, since although your money is growing 8% each year, the price of everything around you is increasing by 2% so your money is worth 2% less each year.
Turning it around
Now it’s probably my cold medicine talking, but I wanted to look at this a little differently. Rather than focus on what my $1 would be worth in 70 years time, I wanted a way to show “how much is this $1 worth to me at my age”.
For someone who is 70-years old today, his $1 is not worth as much as someone who is only 20 years old today. Her $1 is worth much more than the older person’s $1 because she could invest or save that money over a 50-year period. As you get older, the value of your $1 becomes lower and lower because you have less time for it to grow. This is why you should start investing as early as possible because you have more time, the most valuable currency around.
How much is a dollar worth to you?
So here’s a calculator that shows the value of $1 against your age – the upper age limit is fixed at 70. It’s set to 2% inflation and a lower 5% investment yield by default, but you can change that by typing numbers into the blue boxes.
For me each $1 is worth about $2, so a $10 meal really costs me $20, yet the same meal costs someone who’s 20 years old about $40. It’s certainly something to think about the next time you buy something you don’t really need.
You can also use the calculator to show the damaging effect of leaving cash in a low-interest savings account. While it’s a great thing to have an emergency fund, if it’s earning lower interest in a bank than the current inflation rate, then it’s losing value. If inflation is 2% and you’re only earning 0.2%, then using the formula above, the account is really decreasing by 1.8% each year. In the US it’s easy to get an online savings account of about 1% but even that is below inflation.
So hopefully you’ve picked up a couple of things from this post:
- You can never start saving soon enough.
- Think about the loss of future value when spending money.
- Investing really needs to be considered as part of your savings strategy.
Quote of the day
Everyday is a bank account, and time is our currency. No one is rich, no one is poor, we’ve got 24 hours each.