$5 Coffee Today or Retirement at 66?
While studying Finance, we could never have enough of this formula –
To find out the present value of an investment, you would discount the future value by the prevailing interest rate & similarly, to find out the future value of an investment, you would multiply the present value with the prevailing interest rate (raised to the power of however many years).
It seemed pretty simple at the time when we applied financial mathematics to conclude whether an investment was worthy and how much return you could expect to get on it.
However, it’s not so simple now. Well, for Finance, this formula was sound. What would you prefer — $100 today or $100 2 years from now? We all place more value on consumption in the present which naturally means you need to be compensated well to forego consumption in the present.
I loved solving such problems in university but when a mathematical equation starts governing people’s behavior and all their life choices, that’s when it gets more challenging than what the exam halls made it out to be.
I see people, from myself to my friends to my acquaintances, talk constantly about saving (foregoing the present value for the future value). This one time, a senior executive at my firm, was visiting Melbourne and presents an interesting argument when he says to me “Why would you buy $5 a coffee every day when you can save that money, multiplied by 365, a year, for retirement?”
I thought this through in my head. $1825 a year. In all honesty, it’s a fair chunk of money for coffee. Say the interest rates hovered between 5–7% & with compounding interest for 37 years or so, I could save a fair amount by the time I got to my retirement age. How many assumptions are going into this future value though?
First is I’ll actually make it to the 60s club alive. Another being I will actually be able to enjoy this hefty chunk of money I save from the coffee I forego in my 20s & 30s & 40s and even 50s (Will my mental health deteriorate? What about my physical health?). There are some crucial financial assumptions too like I will actually be able to earn a fair return to make it worth foregoing in the first place which depends hugely on the state of the economy which in turn depends on a number of intricate global & domestic factors. Another one being that I actually have nowhere better I could spend this money on so would funnel it into retirement savings.
I truly respect the principle of saving. I want to save for a comfortable life when I’ve retired. I want to save for an emergency that might befall myself or my loved ones. I want to save for my education. Heck, I want to save for the sheer discipline for it. However, I see this principle stretched to it’s very extremes in certain cases, when people keep foregoing the present value for a future that may never come. When they forego beautiful experiences in the present, trying to save it all for THE FUTURE.
This really struck me when Abhay turned to me with a stern expression on his face & asked,
“Should I be earning more?” and when we delved into this discussion, the crux of this conversation was the principle of saving. Should he be earning more so he could save more for emergencies that might arise in the future?
I really thought about this one. What emergencies? There could be a number of categories for this revered term, “emergencies” & then to be able to put a price tag on them is itself quite a daunting task. I started listing all of these hypothetical emergencies and the list was endless.
- Parents could fall sick and loose all their money leaving us to support them with health expenses.
- Friends could get bankrupt and loose all their money leaving us to support them for as long as they needed.
- We could fall sick and loose all our money leaving us to support ourselves on emergency fund
- All of this could happen together.
I can also think of emergencies that might not rely on money at all. Examples being -
- Loved one falls sick, everyone has the money, but doctors have not been able to diagnose the problem
- Friend is depressed and has locked himself into his room, refusing to come out
- Natural catastrophe happens
- Wars happen, money stops mattering altogether
So we’re essentially biasing our principle of saving towards saving for emergencies which unequivocally would require a certain sum of money to be saved every day. This is a sensitive topic in the sense on either side you can have extreme outcomes of irresponsible spending in the present or frugally saving every cent for the future. So where do we find balance? What is the perfect approach?
Well I definitely don’t know, I’m purely pouring my thoughts on the subject. For me, I’ve realized, here’s what works –
1. Living in the present — This always restores my balance where I’m able to tell what needs to be spent on and what doesn’t (along with the infinite other benefits of keeping me in tune with life)
2. Spending on experiences that bring me joy — If I can afford to spend on experiences that bring me utter joy, I will always be a yes to them, which very much includes my daily cup of coffee. I have never taken that magnificent cup of coffee for granted.
3. Base level of saving for emergencies — Just a certain amount you keep in your savings for the “money requiring category of emergencies” & above all, to maintain your peace of mind
4. Invest a fixed comfortable amount — Idea here is to not only invest but LEARN. Lose money? Great — opportunity to learn. Why did this happen? What did you learn about the market and the psychology of people? Take risks, loose money, get better, keep learning.
Another lesson that strikes me — in planning for a lot of these emergencies, it might all come down to your resourcefulness & level of presence. People you know, how quickly you can galvanize people & actions to get what it is you need to get done, how quickly you’re able to read and assess the situation, and many more.
Abhay and I are watching this series on FIFA 2022 Captains and there was a scene in one of the past world cups wherein one of the key players of the Denmark team suddenly collapsed on the field while playing — his name is Christian Eriksen. The Denmark team captain, Simon, upon quickly reading the situation, puts him to one side to make sure his airway was open. This action turned out to be a vital factor for Christian’s survival. Good news — he did survive! You must see this story for yourself — truly brings you to tears to see such great leadership.
You can pick out any emergency in the world to showcase that it’s not one consistent factor that can solve for these emergencies (not downplaying the importance of money in actually solving for many of these but underscoring the interaction of money with other factors). The world that we live in is so obsessed about safeguarding the future, hedging it against all risks, no matter what. In all honesty, it is for good reason — the future on many worldly aspects looks bleak — high inflation, end of the golden era, high taxes, climate change, populism, etc. However, in hedging for a wide variety of these risks, we have to consider money as one of the various tactics to hedge with. Not the only one.
