Bigness Bias

Have you also observed that many people behave as if not all dollars are created equal?  By assigning relative values to different moneys that in reality have the same buying power, they run the risk of being too quick to spend, too slow to save, or too conservative when they invest—all of which can cost them in the short or long run.

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As this chap can tell you, your bank account contains absolute dollars and not “percentages of”.  But human beings don’t think in absolute dollars.  They think in relative dollars.

ALL MONEY IS REALLY THE SAME!

But people still place too much emphasis on their out-of-pocket expenses (what they have to pay now) and too little value on opportunity costs (what they miss by not taking an action).  Or stated differently, people overvalue what they have (today’s salary) and fail to properly value what they could have (long term savings or the benefits of tax-deferred savings).

What do I mean?  Perhaps an example would help to explain:

Twins Andy and Mandy just graduated from college at 21 years of age.  Mandy, upon entering the workforce, immediately began contributing $50 a month to a stock mutual fund (an ETF Index Fund would be a better choice, but Mandy did not want to listen to her father) and continued to do so for the next eight years until she got married and found more pressing needs for that $50.  She left the accumulated funds untouched.

Andy, who married his college sweetheart immediately upon graduation and soon after started a family, didn’t start investing until he turned 29.  With the explanation,”Found no time for that kind of stuff earlier.”  Then he too contributed $50 a month to the same stock mutual fund and he continued doing so for 37 years until he retired at age sixty-five.

All told, Andy invested $22,200, whereas Mandy contributed just $4,800.

At age sixty-five, who of the two had the most money, assuming they earned an average of 10% p.a.?

Ta-taaa and drum rolls: It’s Mandy with $256,650 vs. Andy’s $217,830

What do we learn from that?

A) Failing to take small numbers seriously can have profound effects when stretched over time!

B) Failing to understand the benefits of compound earnings over time might spoil your retirement.

C) The best way to guarantee that you’ll have money in the future is to make money in the future.

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