A Lesson on the Time Value of Money
What’s the best Christmas gift you’ve ever received?
I have been fortunate to receive some really nice gifts over the years but the most valuable gift I ever received was given by my parents when I was 16 years old.
If you read my personal story that shares why I choose a career in finance, you would quickly learn that I grew up in a wealthy community and thought that I was entitled to the same lifestyle as my friends, even though I came from a different socioeconomic background. This sense of entitlement lead to miserable Christmases where I expected to receive everything on my unreasonable list and would scream and fight with my parents when it didn’t get everything on my list. This cycle would repeat year after year. Did I not learn!?
Ironically, the year I received my most valuable Christmas gift was the same year I stomped up to my bedroom and slammed the door because I didn’t get the digital camera I asked for. Note, I did get the Tiffany & Co. necklace that was on my list but I didn’t also get the camera and I had never felt more cheated in my life.
Side not, I just have to laugh now as I reflect on this particular Christmas and put these words on paper. I absolutely sucked as a child. If my parents are reading this, I’m sorry, I love you and thank you not giving up on me!
Okay back to the story.
That Christmas I did not get a digital camera but there was an envelope with my name on it hiding in the Christmas tree. Inside I found a check for $500 made payable to “Custodian FBO Maureen”. When I saw the amount, I thought “Aha now I can buy a digital camera” but when I saw the payee line I was a bit confused. Seeing the confused look on my face, my father explained the purpose of the gift in more detail.
He shared with me, that because I worked over the summer as a lifeguard and and had earned income, I was able to contribute a Roth IRA. As a Christmas gift, he and my mom wanted to help me start this account by matching the money I saved from my summer job.
“It gets better”, my father continued.
The Rule of 72 and Time Value of Money
He explained that with a Roth IRA, this money will grow tax-free for the rest of my life and that I will never be taxed on it again. At this point in the morning, my dad whips out his time-value calculator (like the true math nerd that he is) and asks me “Do you know how much this is worth to you?”.
I probably made some mean remark like “It’s worth $500, duh.” being totally disinterested after realizing the money wasn’t for a digital camera. That’s when my dad started to punch the numbers on his calculator. He shared with me the Rule of 72 which predicts how often a value will double. An expected rate of return divided into 72 will tell you how many years until an investment doubles in size.
He shared with me that this Roth IRA was going to be invested on my behalf in an investment strategy that he expected to earn 8% per year on average. Using the Rule of 72, this account, assuming no additional contributions, would be worth…drum-roll please…
As if that wasn’t exciting enough, my dad went on to share that if I committed to fund this account every year with $500 from my savings, that one day I would be a millionaire. Now that stopped me in my tracks. I thought of all the things I didn’t get for Christmas that year that I could buy for myself when I was a millionaire. Again, I hate myself thinking back to this day and how I rejected this incredible gift and finance lesson given by my parents.
Fast Forward to Today
I am not a millionaire, yet, but my Roth IRA has now been invested for over 10 years and has been added to along the way. I am so thankful to my parents for teaching me such a valuable investment lesson at such a young age. The message wasn’t received immediately but it eventually hit home as I sat in my college investment and retirement classes.
For those of you who have kids that are working and earning a paycheck, consider opening and funding a Roth IRA for Christmas or other special holiday. For those of you without children, consider gifting yourself this valuable gift by investing in yourself and opening an investment account that meets your financial goals.