Happy new year to my 2 fans! If you’re reading this and you’re not following me, check out my other two articles and give me a follow if you like my stuff. I plan to continue my writing style of short informal articles on things I’ve been thinking about that week.
While I didn’t make any new years resolutions this year, I did make some 4 year and 10 year goals after graduating from college last year. One of my 4 year goals was to have $100k in liquid capital. I thought this sounded reasonable as I am making an engineer’s salary and such a goal would only require me to save $25k a year on average.
I’ve been living at home with my parents for a little while now, since August. While socially, it’s complete hell, my monthly burn is close to zero. Sure I’ll buy my parents dinner once in a while and buy some liquor, but that’s really about it. Even when I was living in San Francisco spending ~$1,600 per month on rent in a tiny little room, I was eating mac n’ cheese and hot dogs every night and saving a lot of cash. Because of this I would say I was on track to achieve my goal; however, the more I reflected on what I was doing, I realized I was making a big money mistake.
Getting Comfortable with Debt
I always liked the idea of one day buying a new car and paying for it in cash. In fact, I’ve kind of assumed anyone who takes out a loan to buy a car is either poor or at the very least over-extending themselves, but I’m beginning to see this is completely off-base. Two things I didn’t understand at the time were the opportunity cost of money sitting in the bank and my irrational fear of debt.
Starting with a fear of debt, let’s first acknowledge a simple fact of finance. Low interest rates and high inflation benefits the borrower. If you can get a loan at 2% annual interest and inflation sits at 2%, in a way you’ve achieved free financing. Our FED, while maybe doing a disservice to the economy, is doing everything in its power to keep interests rates low. You can get a car loan for 2.5% and sometimes 0% for 24 months. Why should you pay in cash when you can take advantage of free financing?
On the opportunity cost of money sitting in the bank, if one were to save $40k to buy a new car outright, they sacrifice all the earning potential that $40k had. Not only do they lose out on that $40k’s chance to earn in that moment, but also for all the months of time spent accumulating it. For all the months you’ve been saving money, it could’ve continually earned interested and compounded instead of sitting in a checking or even savings account at 0.02% interest.
When it comes to growing money, increasing the principal is a far better lever than increasing the interest (for those who don’t know, principal is some initial investment). We are in a war against time to increase our principal as fast as possible. Carving out just a few hundred a month and allowing it to earn interest is far better than keeping it liquid to avoid debt.
Me wanting to keep $100k in a checking account just to say I had six figures in the bank would’ve been a very foolish endeavor. A better goal might be to contribute $500 a month to a brokerage account that if sufficiently diversified will at least match inflation at ~2% a year. In this way, taking out a car loan to contribute more cash toward a growing assets is thinking more like a rich person.
Avoid Geometric Thinking
Humans are pretty illogical creatures and we make bad decisions all the time. It’s not our fault, we’re practically still chimpanzees from an evolutionary time perspective. But one of these illogical particularities I’ve noticed in myself and others is geometric thinking when it comes to bargaining.
We all love a good sale and will fight tooth and nail to achieve a 10% discount on a $100 purchase. However, most people would never dream of asking for an additional $10 off a car purchase in the $20k range, because what’s $10? But $10 is what we seem to get bent out of shape about for a $100 purchase. $10 is $10 and we shouldn’t care about percentages or ratios.
Being Pennywise and Pound Foolish
If you take time to cut up grocery store coupons that save $2 here and there or stay in flea bag hotels to save $40 a night, but don’t negotiate the interest rate on a loan, you’re picking up pennies in front of a steam roller.
A few things. First is the cost of your time. Is your time really worth sitting down and cutting out coupons or scouring the web to find cheap hotels? Our time is worth far more, especially when we’re younger. Go research the idea of being a “time billionaire”. The abridged version is that Warren Buffet and Bill Gates would both trade places with a poor yet young person.
Second, what’s your convenience worth? This is similar to your time, but something that I’ve started doing is paying a premium for direct flights. Sure I could save $100 by having a connection or two, but I would rather pay extra to avoid the stress connections bring. I’ve flown enough times in my life to encounter delays and cancelations, and it’s simply not worth the anxiety to save a bit of money when I could just get on the plane and focus, read, or relax.
Lastly and probably most importantly, arguing for a couple basis points off your home loan rate has a far greater impact over your lifetime than any grocery store frugality would. Understand what your big levers and small levers are and forget about your small levers!
Conclusions
I’m probably missing a couple things and my mental model is most likely incomplete, but I’m going to try to execute my money decisions with this type of thinking and see how it goes. As an example, I’ve decided to forgo paying off my student loans quickly and am instead taking that cash and putting it into my brokerage account.
It’ll be interesting to see how this article ages and what things look like in a decade. For now, I’m earning around 15% a year in the stock market, and I’m trying to put more and more money towards it all the time. We’ll see if keeping my bank account numbers small is the right move.
