The #1 Most Important Of All Practical Money Skills

Increasing income, saving more, and spending less, are all powerful foundational money skills.  They are also boring as hell because they are all kind of common sense.  We’ve heard them all before.  However, there is one practical money skill that we are never taught in school. It may be the biggest reason that most of us end up in debt rather than living comfortably off of a pile of cash.

When I entered the work force out of school, over 13,000 workers in my field had been laid off in the metro area where I was looking for work.  I was plastering yet another rejection letter to my wall already papered in rejection when I looked through the mail and found an invitation to a timeshare presentation.  I knew there was no chance that I was buying anything.  In fact, I had less than $1000 in my checking account and was on the fence about whether to splurge and add a kraft single to my spaghetti lunch.  However, I looked over at my interviewing suit. I thought this would be a good chance to wear it for something, get out of the house, and get a free dinner. 

The Hard Sell:

I think back and laugh now about a 22 year old me sitting there in a suit being pressured by some guy in the ballroom of a dated hotel out by an airport.  All I had to do was sit through it and I would get a meal, a $100 gift card, and an unusable mid-week trip voucher to Vegas (subject to taxes and fees of course).  It turned out to be a masterclass in sleazy salesmanship. 

They started by asking me where I would go if I could travel anywhere in the world.  They sold the dream of a good life for my lady and oh those future little precious ones to come.  Picture those happy little kiddos in their bathing suits and your proud wife in a bikini smiling from a balcony over palm trees and surf.  

How much would you pay per day to experience that dream they asked me.  

Once they had a number it was simple.  They just laid it out in front of me.  If I would pay $100 per night and I plan on 2 weeks vacation every year ($1400 per year) for 50 years, well that is 50 *1400 = $70,000.  Maybe they will even throw in a couple of extra nights at any of the luxury resorts that they are affiliated with.  They will let me finance it and even waive payment for the first year.  This is an investment in the life you said you wanted and a commitment to not be some scrub.  Holy crap what a steal.  They are attempting to steal my wallet that is.  The #1 most important money skill that nobody ever teaches you is “time value of money” and how truly impactful it is.  Most of us know that it matters, but do you actually run the numbers or just estimate?

Time Value of Money: The Most Important of Money Skills

In the example above, those sneaky bastards were selling 2 weeks per year in a one bedroom condo for $70,000.  This means that they were selling 52/2 = 26 two week shares in that condo for $70K each.  They were effectively selling a one bedroom condo for 26 x $70K = $1,820,000!  High management fees, and assessments for roof repairs and so on in the future mean that this time share will end up costing even more.  Most people end up hacksawing these time share anchors off as soon as is legally possible.

Time Is Money Friend

Many of you probably already noticed that $70,000 paid today for one vacation per year is costing quite a bit more than $100 per night.  But how much more?  Well the actual answer is that I am paying an average of $855 per night at the time that I take each vacation day over the next 50 years!  While one night of vacation today may cost me $100, that same $100 paid today for a vacation that I will take 50 years from now is actually going to be $2,946 per night when I check my saggy old self into that now dilapidated condo.  In reality, for a $100 charge 50 years from now, it should cost me only $3.40 today.  

How do I know all of these amazing numbers without the benefit of a crystal ball?  I have a magic money maker wand in the form of time value of money equations.  That’s right I said equations. However, they are super simple and will be the difference between you being rich or poor.  Before I bore you with the magic equations, let me wow you with how time value of money actually makes you rich.

How We All Start As Millionaires

The median household combined annual income in the USA is around $62K or around $47.5K after taxes. With an average career length of 45 years, this means that the median household brings home 45 X $47.5K = $2,137,500 dollars over our lifetime. So the majority of us, start out as millionaires!!! Moreover, if one magically did not spend any of this money and instead was able to put it into investments for that 45 years, there would be over $13,500,000 in that bank account at the end for your retirement!!! This is crazy! Even if we could save just 25% of that after expenses every year, it would still end up being around $3,400,000 if saved and put into investments.

If on average we start out as millionaires, the truth is that it is the order and speed at which we spend money after making it that makes all of the difference. If I hold out and wait one more year before spending $10,000 on a car, I can put that $10K into an investment account for that one year and on average it will be worth $10,700 by the end of the year. I just got myself a $700 discount on that car by deferring the spend by one year. Now I also get the next years model rather than driving last years played out old P.O.S. beater. Or at least it is one year newer than the used car I was likely looking at last year.

With this it is time to reveal the magic wand equations that are time value of money. Don’t panic when you see math I will explain below:

 Time Value Of Money Formula Sheet:

*Note: Unless otherwise stated, I have assumed an i=7% interest rate in all of the examples in this article.  7% is the inflation adjusted average annual return of the stock market based on the last 90 years (1).

It is a travesty that these equations are not shared in every high school classroom.  It is the reason, that car dealerships make more on financing than on selling cars.  The reason timeshares, payday loans, layaway, carrying credit card balances, and installment payment plans exist.  It is also a big reason that we are not all millionaires.  Time value of money is the basis for many of the posts on this site including: The Obligatory Get Rich In One Blogpost Blogpost and I’ll Never Be Able To Retire.

When I learned these magic equations in college, it blew my mind!  Simply stated, if I want to compare the cost of 2 choices they need to be adjusted to the same moment in time.  Remember me and the timeshare? 

How did I know how much a night of vacation would actually cost me in 50 years if I paid $100 today?  All I did was calculate the F/P of $100 at a 7% interest rate = $2,945.70. 

How did I know that a night in 50 years should only cost me around $3.40 today?  I simply calculated P/F of $100 at 7% interest. 

How did I know the average cost I would effectively pay at check in for each night of vacation over the next 50 years?  I simply put the F/P equation into a spreadsheet and filled down the column for 50 years and then averaged the answers = $854.87. 

Giving Away Money

Who would ever pay $855 per night to stay at an average sort of condo if they actually understood the true cost?  The answer is nobody.  Paying $180-190 per month on a $10,000 car doesn’t sound that bad until you do the P/A calculation and realize that you just gave away $3,000-$4,000 dollars because you financed it (72 month loan at 10% interest). When is the last time you gave someone you love $4,000? Do you love your used car salesman?  Businesses out there are literally banking on the idea that you will make emotional decisions and be too lazy to run these simple equations.  This is how we all start as millionaires and then end up in debt because of the order and speed at which we spend money after making it.  This is what makes all the difference.

Time Value Of Money Real Life Example Question

I want to tell you one last story to make sure you’ve been paying attention and then ask you a question.  Try to calculate the answer yourself rather than guessing before looking at the answer using the magic equations above:

Phoebe works at a gas station out of highschool and saves $27 per day in an investment account until she is 65.  However, Jonathan became a doctor who also had a weekend place in the Hamptons.  He lived the good life and also had medical school loans and the 2 mortgages to pay off.  However, by the time he was 60, Jonathan was head of the surgery department.  He socked away $500,000 every year from age 60 to age 65.  The question is who has more money?

Time Value Of Money The Answer (Don’t Cheat Now):

• Phoebe has an annual sum of $27*365=$9855.  The F/A over 47 years is: $3,244,506.3
• Jonathan has an annual sum of $500,000.  The F/A over 5 years is: $2,875,369.5

Phoebe ended up with more money pumping gas than Jonathan did saving lives. This is the power of time value of money, the most important of all practical money skills.

Money Skills: The Hard Way

I think back to me sitting in that time share presentation so many years ago.  My future wife was with me. They separated us and tried to find our weak areas.  “Maybe you are just too young and don’t know what a good deal is.”  “Are you man enough to commit or are you just too scared?”  “We can tell that you are a strong woman that actually wears the pants in this relationship, just sign here.”  Wow it was every dirty sales trick in the book. 

Back then I thought we were the ones scamming them so it was funny to me.  But do you know what?  I put on a suit for them. I wanted them to think I was someone that could possibly qualify for this “exclusive vacation club”.  What does that tell you?  For every 9 of me that walked away with a $100 cash card and a useless vacation voucher in my hand, 1 of me walked away with five to six figures of crippling debt. 

The Single Greatest Wealth Secret

We all want the good life and we come into the working world wanting to believe that we deserve it.  Whether it is time share con artists, car financing, layaway, paying in installments, carrying credit card debt, etc.  Most of us will make enough to become financially independent over time but the application of money at the right time time and the temptations along the way are how many of us squander our millions. An understanding of these simple time value of money equations may be the single greatest wealth secret.

What do you think? I’d love to hear from you in the comments.  Also please consider sharing this article if it opened your eyes.  Let’s spread financial literacy and take back our millions!