Update: I made a True Cost of Holiday Shopping Calculator to go along with this saving idea.
There are so many temptations in our consumer-driven society. I mean, I already have an iPod Mini and I still want a iPod shuffle! And who doesn’t need another banana case? One of the ways I keep myself from spending too frivolously, other than the frugalness instilled by parents of limited means, is to keep in mind the magnificent wonder of compounding.
For instance, say you didn’t buy the $10 impulse item and instead put it into a stock market index fund, earning a reasonable average of 8% each year. After one year, you’d get $10.80. After two, you’ll have $11.64. Not very exciting. But in thirty years that $10 will turn into over $100! Now that is that $10 widget worth $100? Or in my case, that $100 iPod Shuffle worth $1,000?? I think not. I like to use 30 thirty years because by then I’ll be 56 and ideally retired, and “saving” an extra thousand here and there will definitely help that happen. It also leads to the nice 10x factor.
A handy way to do compound interest in your head with other rates is to use the popular “Rule of 72”. The rule of 72 states that in order to find the number of years required to double your money at a given interest rate, you can just divide the interest rate into 72. For example, if you want to know how long it will take to double your money at eight percent interest, divide 8 into 72 and you’ll get 9 years.
It also works backwards. If you want to double your money in four years, just divide 4 into 72 to find that it will require an interest rate of about 18 percent. This also means that a person with a credit card balance and a rate of 18% will, ignoring minimum payments, have their balance double in four years! Ouch.