Boiling Frogs

This is the second in my Present Value series, and the first in which I’ll be looking at other’s claims which seem to make sense at first glance, but are terribly misleading under closer examination. I pick these examples not to prove others wrong, but because taking present value into consideration substantially changes the terms of the debate. My first post elucidates on the concept, and how to calculate it.

Vanguard seems to be one of the better thought-of investment management companies — they’re client-owned, low-cost, have high customer satisfaction, and seem to be the most honest of the options. I’d agree with all the previous points; it’s where I have most of my money.

So I was surprised when I came across their Power of Compounding flash video which completely ignores present value, and therefor presents a much more positive picture of compounding, benefiting, of course, Vanguard.

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In my newly-minted capacity as a financially-responsible person, I’ve been reading a lot of personal finance blogs and other resources. And there’s one very big point that everybody seems to be missing — “present value” or “the time-value of money”. It was the first and most important lesson in my university’s Intro to Finance class, and something that needs to be in the back of everybody’s mind, especially when they’re talking about money over long periods. Otherwise, you’re not comparing apples to apples.

Essentially, a dollar today is worth more than a dollar next year. (Or, Helga, if you’re in 1920’s Germany, a mark today is worth more than a mark in 10 minutes.) The cause is inflation. If your dollar buys a loaf of bread today, and bread inflation is 5%, then that dollar will buy only 95% of a loaf next year, 90.2% the year after, and 85.7% in two years, and 59.8% in 10.
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