When I was first starting out in my career, the most annoying story I would hear would be some investment advisor saying something like “If you had bought $10,000 worth of company XYZ stock when you 20 years ago, you’d have $15,000,000 today.” Of course, if I had a crystal ball 20 years ago, I would have used $1 and picked the lotto numbers and made $15,000,000 in one day instead of using $10,000 for 20 years. So now, as I’m trying to help friends and family be inspired to pay off debt, save, and invest, this is the example I share.
Two friends Bob and Tom are both right out of college, working in similar jobs, with no real savings, but good jobs and a lot of opportunity in front of them. Neither of them have $10,000 to spend or invest, but they have tons of available credit. Bob decides to buy a hot tub, and Tom thinks that is a bad idea, but can’t convince Bob otherwise. Bob is going to put the $10,000 on a credit card, and make the minimum payments so that he can enjoy the hot tub, without spending his whole paycheck on it. His credit card rate is 18% per year, and the company requires him to pay at least 2% of the balance, or $20 a month, whichever is greater. Meanwhile, Tom is opening a Roth IRA account and has told Bob that he will invest the exact same amount of money as Bob’s credit card payment each month. Bob agrees and laughs at Tom, because he figures he will enjoy his $10,000 hot tub now for $200 a month or less, and Tom will probably have $20,000 several years from now.
Let’s assume Tom gets an 8% return on his investment. Bob and Tom’s first payments are $200 each, then it drops to $199, and by the end of the first year, they are paying or investing $189.27 per month. At the end of year 1, Bob has spent $2,335.08 on his hot tub, and Tom has invested the same amount which is only at $2,439.75. Bob laughs, because he has gotten for more than $104 in enjoyment out of his hot tub, and Tom only has only earned that much in interest.
However, if we jump forward to 5 years from the purchase. Bob’s original credit card payment has now crept down to $148.80, and Tom is still investing that same payment amount. Bob has already spent $10,389.54 on the hot tub, and still owes $7,402.61. Tom has invested that same $10,389.54, and it has grown to $12,935.66. Bob is feeling a little frustrated at this point knowing how much he still owes, and knowing his enjoyment of the hot tub has waned over the last few years.
At 30 years from the date of the hot tub purchase, Bob and Tom each have children who are finishing college, and are in their early 50’s. That hot tub has since rotted away and long been forgotten, but Bob is still making a minimum payment at $33.08 per month that Tom is still investing. They have each put in $33,417.78 at that point in their lives. Bob still owes $1,645.48 but Tom has accrued $185,879.26 after 30 years of growth off of those small payment investments.
Finally, Bob gets to the last payment late in his sixties, 46 years and 1 month later, of $9.37 and has a party. Bob has spent $37,861.96 on his $10,000 hot tub to get to a $0 balance. Tom has amassed $679,763.26 in his Roth IRA, which he has had access to tax-free for a number of years. Tom goes out and buys a similar hot tub for about $40,000 after inflation and invites Bob and his grand-children over for a party to celebrate paying for the original hot tub. And by the way, if Tom had gotten a 9% return instead of an 8% return over the 46 years, he would have broken the million dollar mark at $1,003,802.28.
Of course a scenario like this is unlikely to happen exactly like that, but that is how the straight-line math actually works out. The first step to understanding the impact of your financial decisions is to understand what the alternatives choices are. Looking at the long-term instead of the minimum payment is a critical step in becoming financially stable and sustainable. This type of example, is fairly scalable for other purchases or balances. Also note, no money was account for hot tub maintenance, and not other expenses were ever put on the credit card for the 46 years in the example above.