Step 4 - Future Value
Know the "Real" cost of purchases
This is the first step to help you fight the temptation to go out and do the 'splurge'. As an example, consider a lounge suite that you wish to purchase that costs $3,500 today. Assume this is your current financial situation:
- You have $5,000 in an investment where you need to withdraw the $3,500 from.
- The investment returns 10% per year
- You regularly contribute $500 per week into this investment.
Weekly Contribution |
$500 |
|---|---|
Currently Invested |
$1,500 vs $5,000 |
Timeframe |
20 Years |
Return on Investment |
10% |
Following is a comparison showing the difference between buying the lounge and leaving the funds in your investment.
| Purchase The Lounge ($5,000 initial minus $3,500 for the lounge) |
Leave the money invested ($5,000 remains invested) | |
|---|---|---|
| Initial | $1,500 | $5, 000 |
| After 5 Years | $170, 248 | $176, 007 |
| After 10 Years | $447, 891 | $457, 366 |
| After 15 Years | $904, 700 | $920, 289 |
| After 20 Years | $1, 656, 291 | $1, 681, 940 |
| Difference | $25, 649 |
If you proceed with this purchase, your investment balance in 20 years time will be $25, 226 less than if you'd left it invested. To be more specific, that $3,500 lounge has actually cost you over $25,000! In contrast to an investment that increases in value, the lounge you purchased today will be worth closer to nothing in 20 years time. It may be that you have no choice but to buy a lounge, but if it was purely a cosmetic choice and you're asking your self "why not" then at least you'll be making an informed choice even when knowing what it costs over the long term.
Future Investment Value
From the previous steps we've been able to solidify your financial planning to eliminate debt and start planning towards investing surplus funds. You can use this information to look into the future hypothesising:
this is how much I will have"
Consider the following scenario where you have determined that you will have a surplus of $200 a week with which you could invest:
Weekly Contribution |
$200 |
|---|---|
Currently Invested |
$2,000 |
Timeframe |
20 Years |
Return on Investment |
10% |
In twenty years time you will have saved over half a million dollars! Let's assume that knowing this information you review your income and expenses and find ways to squeeze an extra $50 a week where you're now able to invest $250 per week:
Weekly Contribution |
$250 |
|---|---|
Currently Invested |
$2,000 |
Timeframe |
20 Years |
Return on Investment |
10% |
The extra $50 a week that you are able to invest has gained you an extra $167, 226 over twenty years!
Continuing on from the last example where rather than looking 20 years ahead, we continue the same pattern as above only we look 40 years ahead:
Weekly Contribution |
$250 |
|---|---|
Currently Invested |
$2,000 |
Timeframe |
40 Years |
Return on Investment |
10% |
Calculators don't lie. It's a mathematical certainty. The only thing that would stop this from happening is by not sticking to the plan.
Of course unexpected expenses may come up and in order to pay for them you may have to withdraw money from your savings and/or investments. However as with the couch purchase, when you know how the purchase can affect your long term goals you'll be surprised how these "unexpected expenses" can suddenly seem unimportant!
Looking back at your goals that you listed in step 1:
- Are you currently on target to reach your goals?
- Are there any changes that can be made to aide you in reaching those goals?
- What would happen if you were to reduce your spending money by $50 a week?
- Is there any way that you could increase your income - even by $50 a week?
- How does this affect your long-term strategy?
Ensure that you're saving at least 10% of your income. If you're not, look at ways of changing your circumstances in order to facilitate this.