Clue: Mocha Frappuccinos, cable television, a beer tab, a $10 movie ticket, dinner on the town. If you answered "things that are nice but not essential to your everyday life" then you would be on your way to a successful round in the '$25,000 pyramid winner's circle'. Certainly there are psychological benefits to treating one's self. But any informed investor knows that there is an opportunity cost in taking gratification today instead of delaying it for tomorrow. The intellectual investor's job is to discern what expenditures are worthy of today's dollars and which ones can wait for your future fortunes. And that can be difficult to distinguish.
Let's say that you told the average person, as they are walking into a movie theatre, that they could see that $10 movie that they came to see today or they could have perhaps $40 worth of today's purchasing power in 30 years time. Now economically there's no contest; yet overwhelmingly you would here the same refrain: "Hey bud, I came here to see "The Expendables 2", not to sit around for the next 30 years". To be sure, they have a significant point. But finding the balance between consumable contentment and postponing purchases is indispensable within an investment strategy. Despite the movie example, quantifying the benefits of delayed gratification can often be beneficial to one's investing mindset.
Take the five items I initially listed. Say $4 for a frappe 3 times / week, $50 a month for cable, a $15 beer tab twice a month, a $10 movie once a month and a $30 dinner every three weeks. That equates to about $2,200 for the year; which we'll understate as $2,000 for illustrative purposes. Now in no way am I advocating that one should remove all of the niceties from there life. I am simply suggesting that there is a cost to what we enjoy. Then again, perhaps you can "have your cake and eat it too": write an article a week for a year at SeekingAlpha.com and there you go, you have an extra two-thousand bucks.
If you contribute $2,000 a year into an investment that returns 8% annually, you would have about $518,000 in 40 years time. It should be noted that this scenario works on the assumption of zero volatility and does not make inflation adjustments for contributions. On the other hand, if you took that same $2,000 and spent it on lattes, cable, booze, movies and food then you would have exactly $0 in 40 years time. Granted your enjoyment level might be greatly elevated, but as described one doesn't need to cut out all of their additional expenditures (or any of them for that matter). More realistically, one might spend that extra $2,000 early in life, say for the next 10 years, and then start to invest in their older, wiser years. If you invest nothing for 10 years, then invest $2,000 a year for the next 30 years at an 8% annual return you would amass about $227,000 forty years from now. Again this is assuming no volatility and keeping a level contribution.
That's substantial when you think about it. For just a $20,000 nominal investment difference there's a $291,000 investment value difference. Or assuming steady annual inflation of 3%, that's about an $89,000 difference in today's purchasing power for an investment difference of less than $20,000 (in today's PP). But we can't spend capital appreciation. Well we can, but we can't spend capital appreciation without depleting our ownership stakes.
So allow us to shift our focus towards the somewhat more predictable dividend income. Assuming the same 40 year time horizon, if you invest $2,000 in the first year and then increase this contribution by 3% each year, reinvest dividends, have a 3.3% current yield and your dividends grow by an average of 6% each year then you would generate about $33,200 in annual dividend income in 40 years time. Or more comparatively, about $10,500 worth of annual income in today's purchasing power. How do I know this? That's a good question and I'm glad you asked. Below I have included a screenshot of my "Retirement Planner 7":
Granted, retirement planners 1-6 don't exist, but I thought it was a bit catchier with the seven. It should be noted that the 3.3% current yield is assumed in all years, including reinvestment. Additionally, the 6% dividend growth rate does not take into account volatility, taxes or frictional expenses. But for illustrative purposes it works just fine. In fact if you look at companies like Procter & Gamble (PG), Coca-Cola (KO), McDonald's (MCD), PepsiCo (PEP), Kimberly-Clark (KMB) and Johnson & Johnson (JNJ) then our yield and growth considerations may in fact be understated to a degree. Basically the spreadsheet details each dividend income stream separately, grows those incomes at equal rates albeit different timelines, reinvests dividends at the specified yield, sums the yearly payouts and discounts them for assumed inflation appropriately. Also, I'm not sure if you noticed or not, but I "hid" years 17 through 24 to display the bottom of the spreadsheet.
Using this model moving forward makes scenario analysis a relative cake walk. Incidentally, given a 3% yield, this portfolio would be worth about $1.1 million or $339,000 in today's purchasing power; but we're not really concerned about that.
Allow us to compare the $10,500 worth of today's purchasing power income due to a 40-year investment to a scenario whereby one makes no investment at all for the first 10 years. Then in year 11 they invest $2688 (the same as our 40 year income assumption) and grow this contribution by 3% a year. In 40 years time one would be receiving about $16.8k in annual income or about $5.3k in today's purchasing power. This is with the same 3.3% cover-all yield and 6% dividend growth assumptions. Just like our beginning example there is a less than $20,000 investment difference in today's purchasing power, but a $5,200 difference in income during year 40. At say a 3.3% yield, that's an extra $157,000 required to make-up the difference.
Imaginably, the more that you invest (or decide not to invest) the more radical the difference will be. For example if you index $5,000 contributions to assumed inflation you will have about $83,000 in income or about $26.2k in today's purchasing power. This compares to just $42,000 in income or about $13.3k in today's purchasing power with no investments for 10 years and then the same investment for the next 30 years.
If you contributed $10,000 a year, indexed for assumed inflation, then you create about $166,000 in income or around $52,500 in today's purchasing power. This compares to "just" $84,000 in income or about $26,000 in today's purchasing power by waiting 10 years to make the same investments. In general terms, over a 40 year time period, the value of investing for the full time instead of taking the first 10 years off, translates to roughly double the amount of retirement income. Or perhaps another way, one would have to double their contributions if they waited 10 years to invest instead of investing today to create the same amount of future income.
Assuredly there will be a great many of you that will bring up the issues of "wanting enjoyment now" and thinking "that's great, but I don't have that much time". To the first point I am simply suggesting that one should quantify their personal expenditures against future investment opportunities. Doing so will likely clarify how much certain items truly mean to you. To the second point, I would agree that the math dictates that time along with effort are the best drivers towards financial fulfillment. But this just means that a greater emphasis has to be placed upon the effort bit. This can be in the form of cutting expenses or generating more funds, but neither is likely to be a quick or easy process; take solace in the fact that the end goal is neither unattainable nor particularly set in stone. I wish you time, effort and perhaps a bit of insight.