Everything with money is either an investment or the sacrifice of one. This seems simple enough, but the more I think about it, the more shocking is it’s impact.
What It Means For Business
In short: All any business is about is creating positive returns on shareholder equity that are greater than the combined impact of inflation and taxes.
Whether publicly traded or not, any business that fails to do this is going to erode shareholder confidence — even in small business — and encourage them to invest their money elsewhere. “Sustainable business”, 1%FTP and all that feel-good karma can’t escape the fact that if Ambler, Apple and Patagonia don’t perform, then:
1) Holly and I would rather start a donut shop; and
2) Folks owning shares in Apple may prefer to sell and buy Microsoft or Wells Fargo instead; and (even)
3) Yvon would rather start a donut shop… because no amount of karma is gonna pay for those fishing trips.
As I mentioned, the simplicity and importance of this really dawned on me after reading the WBW. Also, that any gain, regardless of size, operates by the same principle whether in 10s of dollars or 10s of billions. What makes larger numbers more exciting is their relationship to our individual cost of living. And the only way to get to larger numbers is to have the smaller numbers perform until they’re large. If “I only made X%” repeatedly results in those gains being spent on coffee and ice cream, then the compounding — that could make a small number a big one — is lost. The opportunity cost of that coffee and ice cream — or that new car — is huge.
In addition to positive returns on shareholder equity, the goal of business, work and investment is the same: to create livable cash flow. Jobs are interim solutions for small portfolios that cannot grow themselves and support their beneficiary at the same time. Jobs create livable cash flow for the beneficiary and hopefully also accelerate the portfolio’s growth through additional investment. Once the portfolio is great enough to both grow itself and maintain it’s beneficiary… well then, we can get some serious, personally-important shit done. (Some people may say “retire” but I’d rather French kiss a shotgun than do what most people mean by retire — i.e. kill time until we’re killed. “Financial independence” is a much more palatable term.)
Opportunity Cost
So… that led me to think, how important is it to save, invest and pinch pennies? What is the opportunity cost of every dollar we spend today?
If we spend a dollar today, then how many future dollars are we spending if we assume that the other option is to put that dollar into an S&P 500 Index and it would perform as it has historically? To make it easier (perhaps more painful), what was the opportunity cost of every dollar we spent in 2002?
If invested in an S&P 500 Index fund, $1 at the end of 2002 would have been worth:
1) $1.29 at the end of 2003 (28.7% annual growth rate);
2) $1.43 at the end of 2004 (10.9% compound annual growth rate)
3) $1.50 at the end of 2005 (4.9% CAGR)
4) $1.74 at the end of 2006 (15.8% CAGR)
5) $1.83 at the end of 2007 (5.5% CAGR)
So every dollar we spent in 2002 was the equivalent of spending $1.83 of our 2007 dollars. (Bull years for the market to be sure, but the principle is the same regardless of the degree of gain.) Suddenly the dollars at the supermarket and coffee shop take on a whole new value…
Conclusion: Get a high-paying job, live in a van.
Inflation
What about inflation? How much do we need to gain on investments to at least keep pace with it? If we use 3% as the discount rate, then a dollar today will be $0.97 next year, $0.94 the year after, etc. So (similar to keeping it in a bank account), $1 we DON’T spend and DON’T invest today will be worth:
1) $0.86 five years from now;
2) $0.74 ten years from now;
3) $0.63 fifteen years from now; and
4) $0.54 twenty years from now.
OR… in order to keep pace with inflation (i.e. tread water), a portfolio needs to grow:
1) By 16% over the next 5 years;
2) By 35% over the next 10 years;
3) By 59% over the next 15 years; and
4) By 85% over the next 20 years.
So any investment must obviously exceed the rate of inflation to be worth the effort, exercise, time, etc.
If we discount the S&P 500 gains (above) according to a 3% inflation rate, then:
1) That $1.29 in 2003 would have bought as much as $1.25 in 2002;
2) $1.43 in 2004 ~ $1.35 in 2002;
3) $1.50 in 2005 ~ $1.37 in 2002;
4) $1.74 in 2006 ~ $1.54 in 2002; and
5) $1.83 in 2007 ~ $1.57 in 2002.
So, corrected for inflation, every dollar we spent in 2002 was the equivalent of spending $1.57 of our 2007 dollars. So the opportunity cost of spending a dollar in 2002 is reduced by inflation, but the importance of a good CAGR becomes even more important…
Conclusion: Get a high-paying job, live in a van, don’t pay for a camping.
Then There Are Taxes
Currently, if you live in Alberta, 50% of a capital gain is taxable at 20.828%. That means that a $100 capital gain will have $10.41 payable in tax – 20.828% of 50% of $100.
So the government would have looked at that $1.83 in 2007 and taxed 50% of the $0.83 for $0.09.
So after taxes and inflation (which the government contributes to, but conveniently ignores), that $1 we invested in the S&P 500 in 2002 is worth $1.48 in 2007.
Conclusion: Get a high-paying job, live in a van, don’t pay for camping, over-throw the government.
