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Holiday Shopping and the Power of Compound Interest

I should have gotten this blog post out before Black Friday. Actually, I should have gotten this out before Thanksgiving. (Anyone out there care to set the line on when turkeys will have something to rejoice over?)


So-called responsible adults warn kids about peer pressure – and for good reasons. Sure, a generation of meth-heads and Oxycontin addicts can probably do a better job of running the US than the idiots currently in office. But being more competent than sheer incompetence doesn’t ensure competence. A generation of meth-heads and Oxycontin addicts is not a good thing.


Unfortunately, the adults who serve as great role models in some respects fail miserably as role models in other respects. In particularly, the typical US adult is likely to be a horrible role model when it comes to managing money – at least in my opinion which, I admit, is not backed by any solid data. And if an opportunity exists to mess up financially, the holiday season certainly qualifies.


Seduced by sales and the notion of looking like a hero during the holidays, people make stupid decisions. They use money they don’t have to buy stuff that nobody needs. Sometimes, they use money they don’t have to buy stuff that nobody wants! Don’t buy an XBox 360 if you need a payday loan for the cash. Don’t put a PS3 on your credit card unless you already have the cash on hand to pay the balance in full.


No ordinary investment vehicle exists that can earn you more money than the interest you’re stuck paying on consumer debt. Be disciplined, and avoid consumer debt at all costs. Though don’t feel too badly if you’ve trapped yourself. Like many a talented poker player, I’ve made my share of sub-optimal financial decisions off the felt. Fortunately, I’ve rebounded with vengeance.


Are you managing your money the best way that you can? Suppose you have no consumer debt, and you have an emergency fund in the neighborhood of $25,000-$50,000. What are you doing with the rest of your money? If you’re simply spending it all, you’re putting yourself in a tough situation later in life – which is inexcusable since a way exists for math to work in your favor.


Suppose that you opt not to splurge on one needless extravagance during the holidays. Actually, that’s too easy. Instead, suppose you opt not to buy $25 gifts for 10 people – such as friends and distant relatives.  You park the $250 you didn’t spend in an investment where you earn 10% annually. 25 years from now, that $250 will be $250(1.10^25) = $2708.68! Even after accounting for inflation (which, historically, has been on the order of  3.5% per year), you’ll be well ahead of the game.


When money invested earns interest, and the interest you earn also earns interest, then you’re taking advantage of what’s known as compound interest. Leveraging compound interest possibly entails giving up some short-term pleasure. However, foregoing immediate gratification can make life much less stressful over the long-term (and therefore much better – at least in my opinion).


Of course, theory isn’t much good if it can’t be put into practice. Knowing how much money you’d have on an investment with a 10% annual return is one thing – finding an investment with a 10% annual return is another thing. For example, the historical annualized growth rate of the S&P 500 is around 10%. However, past performance is no guarantee of future performance. In fact, once the human population reaches its asymptotic limit (based on how much life Earth can support), then it’s possible that the S&P 500 will grow much more slowly – or not at all. At that point, investing in growth might no longer be a path to riches. But until human civilization reaches that point, investing in growth and capitalizing on compound interest remains a seemingly attractive option.


I definitely can’t claim to be an expert investment advisor. However, chances seem pretty damn good that parking your $250 in a broad index fund (whether it be mutual fund or an exchange traded fund) is a much better long-term use of your money than random gifts for 10 people. Just be sure that the fund has low management fees. Rake sucks in poker. Rake also sucks in investments.


Going beyond parking just $250, if you’re employed by a company offering a 401k with matching, are you taking full advantage of the tax-deferred investment opportunity (assuming your 401k plan gives you access to some broadly invested funds)? If you’re not employed by a company offering a 401k, are you being disciplined and investing a little bit of every dollar that comes your way? If not, then there’s no better time like the present to get started – because the earlier you start, the more time there is for compound interest to do the work.



May Your EV Always Be Positive!


Tony Guerrera

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Feel free to repost this as long as you include the following author box (including hyperlinks):


Tony Guerrera is an established poker author, an instructor at PocketFives Training, a member of Team Moshman, and host of the popular poker strategy podcast, Killer Poker Analysis. Tony blogs about decision optimization on and off the felt at KillerEV.com.


  



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