Today I will be presenting additional new insights on investing while further explaining this concept of perpetual value towards funding. This will be focused on the inner workings of resources and shows that ironically, money does grow like trees.
We’ve been taught to see money as a direct trade off between consuming something today, or putting it aside and wait for something bigger, but I’m going to talk about how both can happen at the same time.
WARNING: this post has a lot of numbers and calculations, but I provided many visual aides so you should be able to trace all these calculations to one the tables. Plus I’ll be repeating a lot calculations, so it shouldn’t feel too much like a math lesson.
The Perpetual Value of PV & FV
In my previous post, I used an apple tree as an analogy for the difference between purchase consumption and investment consumption: when you make a purchase from wages, you make a direct transfer from the time you worked for that money that you used for that apple, which requires the same cost to repeat that transaction, meanwhile consuming from an apple tree are like returns on investment that doesn’t require additional transactions.
What these contrasting methods show is a different application of present value. Remember that present value is the value that can be expressed today; it not only says how much something is worth today, but it shows how much would have to be invested today to produce a given future value. Future value is the value that can be expressed over a measured set of time from an investment today (if you want better understand this, go back to my blog post on this: https://grantxstorer.com/2018/personal-finance-investing-part-1-time-value-of-money/ ).
If we want to know how much to expect something will be worth in the future, Future Value (FV) will give us that answer, but if we know what we’re aiming for in the future, Present Value (PV) will show us how much we need to start with. When we consume a whole apple, we have a FV of 0 for whatever money we spent on that apple. Whatever the PV we had before the apple will be all that we can get from that financial asset. But if we invest a bit of that apple to grow apple trees, then the FV is exponentially larger. Even when we pluck apples off that tree in the future and consume some of that future value, that forward motion still continues.
This pretty abstract, so let’s now return to the financial model. Because while that might make sense when we’re talking about apples, but how does that really work and how is that actually demonstrated in this investment model? Because we are pulling 5% of an investment balance, so how is that exactly working?
The life cycle of investment
Let’s look just at that first year’s investment: We earned $50k, of which we consumed $45k and invested $5k. In that first year, it grew by $279, and has a year-end balance of $5,279. In year 2, you cash out $263, which leaves $5,016 in the account. At the end of the year, that initial investment grew another $525, which brings the total value to $5,540. That means in year 3, you get another $277 to spend from what came from your wages two years ago, meanwhile there’s still money being invested.
These numbers are slightly different than when I made the first demonstration in the investment because we were just looking at what is happening to that first year’s investment over time. If we reframe these numbers a bit, it may help to see what is actually happening with our money now.
In that first year, we made $50k, spent $45k, and invested $5k that grew by $279. So that means the total value of that $50k we made that year is actually worth $50,279 overall. In the second year we consumed $263, and gained another $525, this means that of that $50k from year 1, we now have spent $45,263 of it, and yet there’s now $5,540 left over, thus results in a total value of $50,804 in year 2. When we get to year 3, we spend another $277 that came from year 1’s investment, and the investment grew another $551, thus we’ve now consumed $45,540 of that initial $50k while the investment total of $5,814 means that the total value is now worth $51,355.
When we fast forward to year 30, we start the year off by cashing out $1,020 from that initial investment made 30 years ago, but yet the investment will actually be worth $21k. We can now observe that over 30 years, we took that initial $50k and were actually able to spend $61,310 and also have $21,418 left in investment. That means over 30 years, we were able to consume more than the total initial value, while have some leftover for the future. In all, we took the $50k and now it has a total value of $82k.
Just to remind you that this is a different concept than traditional investing, because if we were able to invest that whole $50k and let it sit and grow over time, it would be exponentially larger than the $82k we have at year 30, but it also means that value would have no relevance to us presently since we won’t be able to use it in our daily lives; it’s always left in potential, and never brought to reality. I’ll explain this more in detail later, but I just wanted to make that quick disclaimer.
Stacking Investment Years Together
Hopefully looking at how a single investment is being used over again over time, while continuing to grow its foundation, stretches the usefulness of one’s income. Let’s now see the relationship that one investment has on the other series of investments being made over time.
Going back to year 2, we increased our investing percentage by 2%, and thus we put another $6k into our investing account along with that initial $5k investment from year 1. We were only able to cash out $263 at the beginning because that was 5% of year 1’s investment, but when we look at the end of year 2, we have an account balance of $11,875. What this is actually showing us is the combined total of the two separate investing years; as we saw earlier, year 1’s remaining $5,016 balance grew by $525 to be a total of $5,540, but we also put in an additional $6k over that year that grew by $335. This means our $11,875 account can also be observed as two accounts:
Year 1: $5,540
Year 2: $6,335.
Why it’s important to observe each year’s value is that it will help us to now look at the cash returns we’re receiving and to better understand where it’s coming from.
For year 3, when we cash out our investment return, we are taking 5% of $11,875 which is $593. But remember we mentally split up the account by investment year, and so we can easily break down the source of the $593 by taking 5% from each of the investment year’s current balance:
Year 1 $5,540 x 5% = $277.
Year 2 $6,335 x 5% = $316.
We’re still not talking about a significant amount of money here. $594 is only 1.36% of your annual budget at year 3, but a subtle shift is starting to happen where your consumption is not all based upon what you make this year. Up until this point, the money you spent came from wages you earned within the past month; this isn’t simply living paycheck-to-paycheck, which means you have no savings and you use up all of your wages every pay period, but even if you have savings, the source of what you spend today is coming purely from the nominal value of your wages. But now that almost $600 is coming from returns of the past two years, what you are using to consume is no longer all coming from recent wages.
Let’s now jump ahead to year 15. We already know we’re starting off the year with $11k from investment returns, but let’s now observe where that’s coming from. Here is a breakdown of each of the past 14 years’ investments that are effectively being cashed out for the start of year 15:
Year 1: $494
Year 2: $565
Year 3: $628
Year 4: $684
Year 5: $733
Year 6: $776
Year 7: $814
Year 8: $846
Year 9: $873
Year 10: $896
Year 11: $915
Year 12: $930
Year 13: $941
Year 14: $950
When seen from this perspective, we see that the $11k is actually the combined total of returns from all the previous years of investing we’ve done, and how each one is stacked on top of the next to create a rolling tide of funding that perpetually washes onto our budget with increasing intensity. Every year we that continue to contribute compounds the growth of what we are able to use in the near future along with long-term.
When we observed the year 3 cash out of $593, that only accounted for 1.36% of our $43,593 annual spending budget, but now 15 years later, this cash out accounts for 26.28% of our annual budget. What this means is that every 4th dollar that we spend this year is coming from wages we earned in previous years. We are no longer just earning money and then spending it all, but we’re starting to live on the returns of previous years’ investing. Going back to the apple tree example, we’ve planted enough apple trees that are producing fruit that 1/4 of our apple consumption is coming from our own trees rather than from purchasing new apples.
Moving to year 30, we are cashing out $51k at the beginning of the year, which when we break it down, that means $1,020 of that $51k is still coming from our $5k investment we made 30 years ago. At year 30, the $51k we are cashing out is not only more than we will make in wages that year, but since our spending budget is $67k, that means 76.22% of what we spend that year is coming from investment returns. What that also means is that 68% of our income will be able to be invested for perpetual use, while we only use up the remaining 38% for a single use.
I hope the point is sticking here, but if I’ve been throwing around too many numbers, let me summarize what all this is about:
We have been taught to see money as the medium of exchange; when we hold money, we can exchange it for other things we desire, and then we exchange our time and effort to collect more money to then convert into more consumption. Instead, we should be looking at money as seeds; we should be doing everything we can to be planting them and nurturing them so that it has life. We were told that money doesn’t grow on trees, but the irony is that money does grow like trees. The dilemma is that we don’t have the luxury of planting all the money we receive, and we have to pass on those seeds for needs today; but if we can start small today and incrementally increase how much we are able to sow, the easier it is to live from the growth of those seeds.
The question isn’t deciding between consuming today or 30 years from now, but how to be able to consume from renewable resources over the next 30 years and beyond.