The following are the two most crucial concepts I wish I’d known about when first getting a job and making money out of school. In this article we will take a deeper look at the principle of compounding interest and the meaning of opportunity cost.
Let me start by asking you: what’s YOUR opportunity cost?
Change Chumps!!! WTF are you talking about?Shut up and keep reading.
Opportunity cost is what better things you could be doing with your time instead of what you’re currently doing.Gee, I could be watching Netflix instead of reading this BORING ASS blog!
It’s that simple, and can be applied to any use of resources: time and money.
Anytime you choose to dedicate time to a particular task, it is time you’re NOT ALLOCATING to another task with BETTER REWARD POTENTIAL. Better is subjective.
You sleep in and miss work. That extended sleep sesh just cost you 8 hours at $20/hr = $160.It was probably worth it.
You watch mindless TV shows instead of reading this blog.Hehehe…
You drive 30 minutes out of the way to get gas that’s 5 cents/gallon cheaper.One of my favorites.
Sounds harmless, right? You probably readily recognize these and even attempt to fix them in your daily routine.
Are you aware of your opportunity cost? Could you, maybe, optimize it with a few tweaks?There, there…
Let’s talk investing
Now let’s apply the same thinking to investing money:
Opportunity cost is what your money COULD BE EARNING YOU instead of what it’s CURRENTLY and effectively earning you from your choices.Oh f*** me Change Chumps! Not again with this BORING ASS SHIT!
Change Chumps! Just get to the point already!Fine.
Just take a look at where your excess money is placed. Is it in savings? Checkings? Stashed under your bed? Stocks? A car? A house? ETFs or mutual funds? Do you have loans or debt that you’re procrastinating about paying off?
It is a common thing to have surplus money sitting in places where it loses to inflation (like in cash under your bed at the rate of ~3% yearly) or depreciation.
Maybe you know but don’t know what to do? I was there.
Similarly, whenever I nudge people in my professional circle for action, I get met with resistance along the lines of:
But Change Chumps!!! Investing sucks!!! It only returns little money and I can’t afford a house with that little money anyway! What I really want is to spend all my hard-earned money to buy a new Lexus with a Gucci bag and Yves Saint Laurent shoes and also a bunch of things that I don’t really need so I can impress all those assholes!!I knew this was coming. Go ahead and buy them. Quick aside: do those assholes also contribute to your bank account?
Here’s the thing: investing for long-term wealth and Financial Independence is definitely not a get rich quick scheme. But the end results?
- You want to make “work” optional? Check.
- You want to travel the world indefinitely? Check.
- You simply want more time to spend with your family? Check.
We shall revisit this in a later post. For now, let’s talk about the accelerator!
The power of compounding interest
Compounding: to calculate interest on previously accumulated interestCorrect, but boring shit.
I like the following definition better:
Compounding is the sneaky manner how small shit grows to be huge without you noticing.The Change Chumps definition.
That hole in your jeans that you keep poking slowly keeps getting bigger and bigger, and before you know it you blow out your pants.
The brand new car you bought for $35k is now worth $8k five years later due to losing 25% of its value every year.
You are either benefiting from the law of compounding or you are paying it.If you don’t know then chances are you’re paying it!
In the latter case, the bank made all the money on the car loan interest and you’re paying for it. Not only that but the vehicle’s value is also compounding downward as it depreciates!
Omg shut up Change Chumps!! I love my car!! I just wanna GET F**** PAID!!!Say no more, fam.
GETTING PAID in Chump Change
Let’s go back to our 5k Chump Change example.
If you had just let the 5k sit in your 0.08%-yielding savings account (in the US), then after 30 years of compounding gains, you get this:
But you’re not an Average Chump, so you decided to HODL 5k worth of carefully-selected ETFs (which is what I do), so this is what your account would look like instead:
See what we mean by making your money work for you? Tip: use this calculator and apply your own situational examples.
In fact, compounding is like putting a TURBO (that’s kinda slow at first) to make everything SNOWBALL.
However, there are 3 assumptions for the last example:
- Re-investment: You re-invest all the gains and don’t withdraw anything. Keep the compounding going!
- Average gains: The market continues to grow at an average of 7% yearly counting up-trends and downturns.
- Time-span: You’re patient as hell and still around after 30 years.
Typically, factor #3 is typically the reason why most people don’t even invest in the first place. After you get over the knowledge barrier, you’ll run into these 2 obstacles: time and discipline.
You tend to overestimate what you can accomplish in 1 year, but underestimate what you can do in 10 years.
Once you apply the effects of compounding you really start to notice the opportunity cost of NOT BEING INVESTED.The secret to building wealth.
In a nutshell: Compounding interest amplifies opportunity cost
Question for you: Does compounding interest PAY YOU? In what way?
Need a bit of motivation? We will re-attack this part with the next article in the series! Stay tuned and subscribe to our newsletter for more easy-to-read articles!
Remember that any application of information found here is at your own risk, and Change Chumps cannot be held liable in any way.