Wasting Your Money’s Time

A buddy of mine and I had a spirited political debate about a topic of supreme importance in the world. The topic of that debate is irrelevant to this post, but the bet we made will teach you something incredibly important about the time value of money. After debating this particular topic for a while, we came to a simple conclusion. My conclusion was that the event in question would occur in the next five years. My friend felt that the event wouldn’t happen for at least 15 years or more.

The idea of a bet was already stirring in my mind, as I saw the opportunity as it related to time value. My friend beat me to the punch though and said, “I’ll bet you 100 dollars that I am right.” I told him he had a deal and that we could split the difference in time to 10 years. I clarified the bet by saying, “If I’m right and the event in question occurs in the next ten years, you’ll pay me $100.” I further went on, “If you’re right and this event doesn’t occur within the next ten years, then I will owe you $100 at that time.” He happily agreed to these terms and that ended the discussion.

Think for a moment about what is wrong with that bet. Let’s assume for a moment that we each have a 50% chance of being correct. Given the nature of geopolitics, that estimate is probably not far off. I asked a few people what they thought about our bet. One person was fixated on the issue at hand, versus the actual monetary implications of the bet. Eventually that person came around to realizing the fiscal implication that my gambler friend had not. Another person I asked went down the same path and just concluded that my friend didn’t know what he was talking about. When I asked my co-contributor at JPCashflow.com, Peter, what he thought about the bet he immediately laughed and knew the proposition was a good deal for me.

Before I tell you why that is, let’s just look at the best and worst case scenarios. My friend’s best case scenario is that in 10 years, he will have the satisfaction of getting $100 if the event in question doesn’t occur. His worst case scenario is that he is liable for $100 tomorrow should the event we debated occur sooner rather than later. In contrast, my best case is that tomorrow night I might have a $100 steak dinner courtesy of my friend. My worst case scenario is that I have to give him $100 in 10 years.

What do you think the odds are of me getting a steak dinner for a measly $100 in 10 years? Even today, that’s probably a “table for one” proposition. Ten years ago, I probably could have swung it for $75 or perhaps even less. Some of you are probably shaking your head and saying “inflation”. That’s only part of the answer. What if I kept $100 in a savings account earning just 1% interest every year? It just sits there, waiting for my buddy to be right and for me to be liable on our bet. The value of that account would be $110.46 compounded over 10 years. Time value is not just an inflation issue. There is an opportunity cost.

My friend is potentially liable to me every day for $100 within the next 10 years. He can’t tie that money up in an investment that isn’t liquid and he stands a good chance of losing his ability to earn interest on it over an extended period of time. I on the other hand can wheel and deal my $100 in safe investments until it comes time to (potentially) give it to him. I will have accrued cash flow on the money during that time and ultimately the $100 bill I hand him is unlikely to be worth as much in the future as it is now.

The moral of the story is to always look at money through the prism of its time value and ability to work for you. This is how debt structured deals are crafted by the pros when they buy cash flow assets. The other variable we don’t talk much about in this post is risk. That variable must be controlled to a level that you as an individual are comfortable with. Perhaps the likelihood of success is your metric for judging risk or maybe it’s purely the amount of money at stake. Either way, come up with a plan that works for you and don’t make bad deals.

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