Finance Principles Applied to Life

True principles often find a way of showing up in many facets of life. Here are three basic (and interrelated) principles of finance and economics that I believe can be applied to our personal development.

(1) The principle of compounding interest.

Put simply, the principle of compounding interest is that–all else equal–more frequent compounding periods (i.e., the number of times that interest will be calculated in a given period) equal higher returns. Consider the following example.

A magical genie walks up to you, and offers you a choice. You can either receive a single dollar bill that will earn interest of 1%, compounded each day, for the next five years (“Option A”) or you can choose to receive $1 million right then and there (“Option B”). What do you do? I’m sure, given the leading nature of the example, that you surmised that the “correct” answer (the one that yields a higher total value) is Option A. Consider that:

  • In year 1, Option A amounts to a mere $37.41. Option B, on the other hand, affords you $1 million.
  • In year 2, Option A amounts to the better, but still small, amount of $1,413.
  • However, by year 5, Option A has transformed your $1 into more than $76.2 million.

How is it that a single dollar becomes so valuable? The first day 1% interest is calculated on the $1. That means, on the second day, 1% interest is calculated on $1.01, and so on. The power of compounding is in the exponential growth that occurs from applying the same growth rate to an ever larger balance. And our lives are much the same way.

When I was in third grade, I began participating in our school’s presidential fitness test. Being an athletic young buck, I had scored well on many of the other fitness tests such as the sit-and-reach, pull ups, and shuttle run. The last fitness test was a mile trial. The fateful day arrived to complete this test in our PE class, and our teacher blew the whistle. I took off at a full sprint, and led the pack for about two-thirds of the way through the first lap. Then I hit a wall. I had never run a mile before, and not being prepared for the sort of conditioning required to run a fast mile, I walked/slowly jogged the remainder of the race. I ended up running the mile in 9 minutes and 21 seconds. I vividly remember my time because I am a very competitive person, and at that time it stung that my best friend (an avid runner) had posted a time of 7 minutes and 12 seconds and beaten me by more than two minutes.

Given my competitive nature, I hated getting beat so badly by my friend and other classmates. So every day that summer, I ran a one mile loop from our house to my elementary school and back. Slowly but surely, my times improved, each day building off the slightly increased stamina I had developed from the previous day. That next year, I was one of the fastest in the school (and ran a 6:29 mile). Running that 6:29 mile ultimately led to me being selected for a selective youth cross country team that qualified for the junior olympics in Reno, Nevada. And all because I ran a mile every day that summer.

Henry B. Eyring, a leader in the Church of Jesus Christ of Latter-day Saints, and someone who I respect greatly, has stated, “Time passes at a fixed rate, and we can’t store it. You can just decide what to do with it – or not do with it… Time is the property we inherit from God, along with the power to choose what we will do with it… Your inheritance is time. It is capital far more precious than any lands or houses you will ever get. Spend it foolishly and you will bankrupt yourself and cheapen the inheritance of those who follow you. Invest it wisely, and you will bless generations to come.”

I believe this is true. We can choose to invest our time through consistent, productive habits, or we can choose to spend it on things that bring short-term happiness or pleasure, but do not yield any long-term benefits or growth. Consider the benefits of consistent studying or accumulation of knowledge, regular exercise, practicing daily spiritual habits, and small, but regular, acts of service or kindness for your friends or loved ones.These consistent habits compound over time into massive personal value and growth.

(2) The principle of opportunity cost.

The principle of opportunity cost is that there is a cost of foregone activities. Investopedia states, “Opportunity cost refers to a benefit that a person could have received, but gave up, to take another course of action. Stated differently, an opportunity cost represents an alternative given up when a decision is made…In investing, it is the difference in return between a chosen investment and one that is necessarily passed up.”

Opportunity costs is all about the most basic of economic concepts: trade-offs. When you make a choice, you forgo other options. Some choices may be less permanent and easily reversible (e.g., my decision to go to Chipotle instead of sweetgreen for lunch) and some may be more permanent (e.g., my decision to major in accounting). I’m very grateful for my accounting degree–it has afforded me incredible opportunities. However, the simple fact is that my decision to study accounting did have a cost: choosing to major in accounting was at the cost of getting a degree in computer science, or math, or political science (all degrees I would have also enjoyed immensely). While it is certainly not impossible for me to go back to school, the cost of doing so now is significantly higher than when I was a sophomore in college, when I made that decision. That doesn’t mean my choice was a bad one, but it does highlight that some decisions we make come with an opportunity cost that may be more “sticky” or permanent. I have found that when I consider the costs of my decisions, it often helps ground me in what really matters.

Admittedly, opportunity cost is also often best measured in hindsight, because it is difficult (if not impossible) to measure the exact costs of our decisions. Nonetheless, our consideration of previous decisions and our analysis of the result of those trade-offs, can inform our future decisions. Take a common time-thief: Netflix. I could choose spend my night watching an hour of Netflix (and believe me, I often do) or I could choose to invest my time by reading, sleeping, exercising, meditating, or many other activities. While Netflix and reading are certainly not mutually exclusive activities, time is a scarce resource that cannot be multiplied. As your life starts to get busier, you inevitably have to choose between investing your time in one activity or another. I often find myself working long hours at my current job… thus, when I choose to watch Netflix, I’m not simply losing an hour of my time, I’m losing the opportunity of using that time for any other activities that could have replaced it.

(3) The principle of net present value.

The principle of net present value is that capital is more valuable today than it is in the future. Embedded in this principle are the concepts of compounding interest and opportunity cost, because receiving capital in the future reflects an implicit opportunity cost of not being able to productively use that capital now. For example, if you offered me $100 today (and I knew that I could invest that $100 at a 5% rate of return), for you to make me an offer to pay me in a year that I would consider equivalent to your original offer of $100 today, you would have to offer me $105 to compensate me for that “time value of money.” This is why, when valuation experts or investment bankers value a company, they “discount” future cash flows at the compounded cost of capital or required rate of return (the time value of that money).

In the context of my life, I refer to this principle as the “decide/act now” principle. Neil A. Maxwell stated, “Act now, so that a thousand years from now, when you look back at this moment, you can say this was a moment that mattered—this was a day of determination.” He also noted that, “The truth is that ‘not yet’ usually means never.” I can think of many decisions that I put off–justifying that I would “do it tomorrow,” but then tomorrow never comes, or comes much later.

For example, last August, I went through some personal experiences that had left me feeling alone and frustrated. I was pretty down, and my mom had suggested that I see a therapist. I was resistant at first, and kept telling myself that next week I would put a plan in motion to sit down with a therapist and chat about my situation. This occurred for a good three months, until the middle of November. One day, during work I finally acquiesced and scheduled an appointment. And sure enough, my visits with the therapist did help me to get some stuff off my chest and move past that difficult experience. After realizing this, and seeing that I was able to off-load a lot of the emotional baggage I had been carrying, I was frustrated that I hadn’t acted on the advice months earlier, and lightened my load sooner. 

In sum, these three basic finance principles of compounding interest, opportunity cost, and present value can inform our decisions, and influence our actions. I hope to apply these principles more fully in my life and would encourage you to do the same.

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The beginning of my remarks…

My freshman year at Brigham Young University, I created a blog with the effort to put some of my ideas on paper (digitally). I wrote about things that I am passionate about–from politics to BYU sports… and for those of you who know me, you understand that I can be very passionate (sometimes too passionate) about my ideas, political stances, and even random gizmos and gadgets that I think need to be invented. So I am at it again, this time with a brand-new webpage because I wanted that fresh feeling you get when you start a new semester or a new year. I would liken it to the fresh chalkboard, blank notebook feeling. You know, when you have a 100% in class for the one homework assignment you turned in and received a 5/5 for. So these are my ideas…my “remarks” as it were. I hope you enjoy them.

(and I hope that you catch that remark is Kramer spelled backwards).