3051: [Part 1] Stocks - Part XIX: How to Think about Money by JL Collins

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[00:00:30] This is Optimal Finance Daily. Stocks – Part 19 – How to Think about Money – Part 1 by JL Collins of JLCollinsNH.com Level 1 – It's not just about spending. Get yourself a nice, crisp $100 bill, or 100 pounds, or 100 euros, or any of the bills pictured in this post.

[00:00:54] Now prop it up, or them, up on a table in front of you, or in your imagination, and give some thought as to what it means to you. For instance, you might think about what you could buy with it right now. $100 buys a very nice dinner for two at a good restaurant. A fancy pair of sneakers. A tank of gas for your big pick-em-up truck. A few bags of groceries. Maybe a nice sweater. I don't know. I don't buy much stuff, so this is hard for me.

[00:01:23] I did just buy a $119 LL Bean bed for my dog. It's going back. He won't sleep in it. You might think, hmm, I could invest this money. The stock market returns somewhere between 8-12% a year on average. I could spend that each year and still always have my $100 earning more for me. Or you might think, but inflation and market drops are a concern. Hmm. I'll invest my $100, but only spend 4% a year.

[00:01:53] Any extra earnings, I'll reinvest so my $100 grows and the money it throws off keeps pace with inflation. Or you might think, I'll invest this money and I'll reinvest what it earns and reinvest what that earns, and years from now, after the power of compounding has worked its magic, I'll think about spending. You can probably come up with other variations, but looking at these, it's easy to see that one view will keep you poor,

[00:02:20] one will get you into the middle class, one will elevate that a bit, and the last will make you rich. Consider Mike Tyson. Mr. Tyson was one of the most intimidating and formidable boxers of all time. Few have mastered the sweet science better, the dismal science not so much. After earning some $300 million, he wound up bankrupt.

[00:02:45] A lifestyle reputed to cost some $400,000 a month didn't help. And as is always the case with the suddenly wealthy and financially unaware, I'm sure he was surrounded by sharks looking to bite off chunks of that fortune for themselves. But the root problem is he apparently only understood money in terms of buying stuff. I don't mean to pick on Mr. Tyson. I'm not nuts after all. In this, he's not alone.

[00:03:15] The world is filled with athletes, performers, lawyers, doctors, and business executives and the like who have been showered with money that flowed right off of them and into the pockets of others. In a sense, they never really had a chance. They never learned how to think about money. It's not hard. Stop thinking about what your money can buy. Start thinking about what your money can earn and what the money it earns can earn.

[00:03:42] Once you begin to do this, you'll start to see that when you spend money, not only is that money gone forever, so is the money it might have earned and the money that money might have earned and so forth. Clearly, none of this is to say we should never spend money. Rather, it is to fully understand the implications when we do. Consider buying a car for, let's say, $20,000. For even the least financially sophisticated,

[00:04:09] it should be obvious that if you buy the car, you no longer have the $20,000. I sure hope so anyway. But distressingly, it appears that most people don't understand that in choosing to lease or borrow money to buy the car, they are basically saying, Jeez, I don't want to pay $20,000 for this car. I want to pay much, much more. My guess is that if you're reading this blog, you're already more financially aware than most and you get that. Debt makes anything cost more. Level 2.

[00:04:40] Consider opportunity costs. But what you might not have considered and what I'd like you to look at today is the concept that even paying cash, that car is going to cost you far more than $20,000. There is an opportunity cost to no longer having that money available to work for you and it's easy to quantify. All you need to do is select a proxy for how the money could be invested and earning for you. Since I'm forever talking about VTSAX, let's use that.

[00:05:09] Since VTSAX is a total stock market index fund and the market provides average returns of 8% to 12% annually, we have a tangible number to compare. Let's use the lower end of the range, 8%. At 8%, 20K earns $1,600 per year. So your 20K car actually costs you $21,600, but that's just the first year. And of course you're suffering this opportunity cost every year.

[00:05:40] Over the 10 years you might own the car, that's $16,000. Now your $20,000 car is up to $36,000. But that's really still understating things. We haven't even considered what those annual $1,600 chunks could have been earning themselves. And what those earnings could have been earning. And what those... Oh, should you not already be depressed enough about all this? Remember that the $20,000 is gone forever,

[00:06:07] and so is the $1,600 in lost earnings year after year with no end. Expensive car. You have probably heard of the magic of compounding. In short, the money you save earns interest. Then you earn interest on the money you originally saved, plus on the interest you've accumulated. As your savings grow, you earn interest on a bigger and bigger pool of money. It's a beautiful thing.

[00:06:33] One of the beauties of being financially independent is that by definition, you will have enough money so that the power of compounding is greater than the opportunity cost of what you spend. Once you have your FU money, all you need to do is make sure you continue to reinvest to outpace inflation and keep your spending below the level your stash can replenish. But if you're not yet FI and you see this as an attractive goal,

[00:06:59] you will be well served to look at your spending through the prism of opportunity cost. Level 3. You'll hear that in tomorrow's episode. You just listened to part one of the post-titled stocks, part 19, how to think about money by JL Collins of jlcollinsnh.com. And now a word from our sponsors at Betterment.

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[00:09:22] Go to rocketmoney.com slash OFD today. That's rocketmoney.com slash OFD. Rocketmoney.com slash OFD. I love me some JL Collins. The man just spews out financial concepts and money mindset hacks so eloquently. I think this post is a great reminder that money is always going to be able to work harder than you can. So a key pillar in building wealth is to invest early and often.

[00:09:53] It also reminds me of the key distinction between being rich versus being wealthy. I think being rich is about having a high income and using it to buy external markers of success. But being wealthy, that's much more about having a healthy gap between your income and expenses and investing that gap in assets that will make income of their own. It has very little to do with material possessions and to a certain extent a high income.

[00:10:19] You'll also be far better off in the long run if you focus on building wealth versus getting rich. Just look at Mike Tyson. He was rich but far from wealthy. JL encourages us to stop thinking about what our money can buy and instead consider what it can earn. Another way to think about this is that you're always buying something. Either you're buying stuff or you're buying a little bit more freedom and options. Well that should do it for today.

[00:10:48] Have a happy rest of your day and a great weekend. And I'll be back tomorrow where we'll finish up this post and where your optimal life awaits.