Time Value of Money – Episode 347

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[00:01] Welcome to the Prosperity Podcast. On this episode of the Prosperity Podcast, we’re going to be talking about time value of money. Now, if you don’t understand what that means, I promise by the end of this episode, you will have a lot clearer perspective and you’ll understand a few things that will help you gain leverage with your money. Is that a good promise? Yes. And I love covering this because it’s one of the biggest mistakes made in personal finance, not only by our clients, but by the advisors that my husband’s company, Truth Concepts, serves. And we just came off three days of sharing a lot of Truth Concepts wisdom with a whole room of financial advisors. And I’m just continually shocked how easy it is, and I’ve done it myself, to look

[00:54] at a financial decision and forget about the time value of money. And what’s interesting is we do this in our lives all the time. You know, a good example that Todd always shares is every single person listening to this podcast that’s, say, over age 40 probably stood up in the front of the car when they were a child with their parents barreling down the road. I’m one of those. I was too. And so we take that statement out of time and we think, oh my gosh, that’s horrible. What were your parents thinking? That’s like child abuse. Well, it was totally common then. The concept of a seatbelt never existed. And of course, our parents thought they could just throw their arm out and keep us safe from crashing through the front windshield.

[01:44] And because it’s taken out of time, it seems so bizarre. So that’s what happens with dollars. And it’s really, really easy to make mistakes, in particular around a lot of different discussions about personal finance. But one in particular that I’ll bring up as an example is the 15 year versus 30 year mortgage discussion. So if you’re curious about this, I have a book called Busting the Interest Rate Lies and there’s audio print and Kindle available. And it goes into extreme amounts of detail about the 15 year versus 30 year mortgage discussion. And the biggest problem that is out there in the marketplace around this discussion is the lack of time value of money as it relates to interest. So let me see if I can boil this down in a way verbally that people can handle.

[02:39] And then again, I’ll encourage people to go grab the book because it is easier if you can actually see it on a calculator. The setup is so many times we want to take a look at something like the 15 year mortgage discussion and we want to just add up all the interest payments. So, of course, the saying out there is that you’ll pay less interest on a 15 year mortgage than on a 30 year mortgage, right? Have you ever heard that, Spencer? Absolutely. That sentence, that single sentence is factually correct. You will pay less interest on a 15 year mortgage if you just add up all the interest, then you will pay on a 30 year mortgage if you just add up all the interest. But that’s completely forgetting the time value of money.

[03:23] And if you are talking about money more than one day, the time value of money needs to be included. And so what happens is you have this cumulative amount of interest, which is interest plus interest, the first payment plus the second, et cetera, et cetera, just all added up. The way to add the time value of money is to compound all those interest payments at an interest rate. Time value of money is associated with an interest rate. So we have to add up all the interest payments at, say, 5% or whatever we’ve chosen as our cost of money amount, the interest rate figure that we are going to apply to the dollars. That’s what gets us the time value of money. And, you know, this time value of money thing, I mean, we learned this

[04:13] in junior high and high school. It is a fairly basic economic concept. And unfortunately, it’s way too often left out of personal finance. And so when you add the time value of money to the cumulative interest cost, then you get a compound interest cost. And now you can compare apples to apples. It’s still a little difficult because we have a different time frame. We have 15 years and 30 years. But that time value of money must be included. And there are way too many times when we just add up all the interest payments and we forget the time value of money. So I think one, what we’ll do is we’ll put a link to the calculators inside of the show notes so that, you know, everyone’s going to have

[05:01] their specific use case and they’re going to want to type those numbers in. But as we go and cover the subject, let’s start at the root. Why is it that most financial articles and financial experts don’t talk about time value of money? Is it because they don’t know? Or is it because all of a sudden, when you factor that in, their product or service doesn’t really add up to snuff? I’m going to hope it’s the former. And I truly think in many cases it is because I’ve seen financial advisors who I know personally, and they have a heart of gold, and they absolutely want to be doing the best thing for their clients. And they’re excluding the time value of money. So I know how easy it is to do. Just how easy it is for us to say,

[05:49] oh, my gosh, those parents in the 1960s were horrible by not having their kids in car seats, seat belts, et cetera, et cetera. So this taking things out of time is a normal thing for human beings to do. And when we do it with our dollars, what we are calculating are just fun facts. Like the total amount of interest on a 15-year mortgage without the time value of money is just a fun fact. It has absolutely nothing to do with anything. And it’s certainly not a helpful, fun fact. And so by adding the time value of money in, you get the whole truth, the complete truth. And it’s just not an easy thing to do. And you’re right. There are times that when you add in the time value of money, a particular strategy that somebody may have been recommending

[06:38] now becomes inaccurate and not as beneficial the way that they were recommending it because time value money is included. Yeah, absolutely. And when I think of just like a linear expression of two points, so the first point being simplicity and the second being complexity, I think that it’s easy for most financial people or any of us to take a snapshot of the 15-year versus 30-year mortgage and then be happy with that and make that quick assumption, which is really not accurate. But then on the level of complexity, which we’ve covered in other episodes, is you’ll often hear people talking about getting a mortgage and then pulling out a home equity and then making mortgage payments with your home equity

[07:23] to create this monstrosity of complexity. And that’s on the other side of the paradigm. And what you’re doing is you’re trying to get away from both and really just look at the truth and get away from all of the stuff that may overwhelm us or from burying our head in the sand and just taking the most simple piece out there. Well, and just to bottom line it, if somebody is having a mortgage discussion right now, please, please do a 30-year mortgage, preferably a fixed mortgage because interest rates are so low, and do not consider doing a 15-year mortgage or a prepaid mortgage or any of the other fancy as you brought up home equity credit line shenanigan type mortgages that are really not telling the whole truth.

[08:10] If you’re seeing a presentation and you don’t understand it, please send it to me. I will help you with it. And again, the bottom line is just do a 30-year mortgage and don’t prepay it. Put those dollars, if you have a desire to get out of mortgage debt sooner, we could argue that that may not be the most efficient financial thing, but for whatever reason, if your peace of mind is overriding that, then you’d be so much better just saving up all those extra dollars outside and then paying off the mortgage in one fell swoop rather than putting essentially extra principal payments in which is all a 15-year mortgage is. Yeah, that’s very, very well said. And for listeners, if you haven’t heard it before,

[08:47] the email address to send those questions, those presentations would be hello at partnersforprosperity.com. And that’s an email address set up exclusive for podcast listeners. It goes straight to Kim and you get an answer. So if you happen to be in the middle of that right now or you know someone that is, send them over there and that way you can get an answer to your question and you don’t have to worry about it anymore. So hello at partnersforprosperity.com. Great conversation today about time value of money. And again, I’ll make sure to put those links to the calculators so that all of us can be looking at the truth, the whole truth and nothing but the truth. How about that? Sounds great.

[09:24] Thank you, Spencer. Thanks listeners. Thank you for listening to the Prosperity Podcast. To take control of your money and have it work for you, visit us at partnersforprosperity.com. If you liked this episode, make sure you subscribe and leave a review.