When my 5-year-old son gets a loonie, he thinks he is rich, but my 8-year-old daughter quickly corrects him. To her, rich is when you have $100.
For some of our older clients with health issues, they don't know what to do with their money because there is nothing they want to spend it on. (I know that others will have many suggestions for them.)
This outlines the basics of what we call the "lifetime value of a dollar." In a nutshell, the lifetime value of a dollar theory suggests that $1 has a very different value to you at different stages of life, and therefore shouldn't be valued as being equal across your lifespan. I am not talking about inflation and how it generally makes a dollar worth less in the future. I am talking about how precious and valuable a dollar is to you today versus in the future.
A dollar is very highly valued by a child, is valued much less by a 20-year-old with some disposable income, has greater value for a 40-year-old with high expenses, and then becomes less valuable for people as they get older. This assumes the individual has more than enough to meet personal needs in retirement. For someone struggling to make ends meet, a dollar will never be meaningless.
In the depths of 2008, we relearned that cash is king. Companies ground to a halt because they couldn't get access to capital. It wasn't a case of paying 5-per-cent interest vs. 8 per cent. For that brief, scary moment, many companies couldn't function because there was no capital available. At that point, the value of a dollar was very high for many companies and for many people.
For readers who have a mortgage, kids and lots of other expenses, the constant challenge you face is whether you should put a dollar away for your retirement or spend it now. It is rarely an easy decision but the lifetime value of a dollar philosophy can help.
We see many clients who, as a result of an inheritance, pension or lower expenses, will be much wealthier in their senior years than they have ever been before. When we can lay out the numbers in a reasonably conservative fashion for the next 30 years, it often becomes clear that the precious dollar of today is better spent than saved for the future, when it will be of much less personal value.
When these decisions are done without planning, however, they can be a little dangerous. Everyone knows people who live for today and don't have a plan for the future. What the lifetime value of a dollar philosophy does is to help people whose future is in very good shape to live a little more for today.
The lifetime value of a dollar theory can help answer these questions:
• How much should I contribute to my pension plan from my paycheque? Often there is company matching, which is great, but can my cash flow handle not receiving the extra cash today?
• Should we go on a much-needed vacation or save the money for retirement?
• Should I gift money to my children or grandchildren if a dollar is worth much more to them at this point than it is for me?
• I am healthy today but I may only have five or 10 years of good health remaining. Should I spend more in the next five to 10 years while I can still enjoy it?
• Should I draw more out of my RRSP now, even though I will get taxed highly on it? The alternative is to make do without money now, but likely have a lot more cash when I am in my 80s.
• I am sure I can make 10 per cent a year on an investment, but the money will be locked away for seven to 10 years. Should I keep access to my money and only earn 2 per cent a year?
• Should I take out equity from my paid-off house so that we can spend it now - even though it might cost us extra interest? It might not pay off in the long run, but we need the cash today.
What the lifetime value of a dollar comes down to is a philosophy of wealth management that takes into account not just rates of return, but how best to line up your lifetime cash flow needs. While it definitely incorporates the science of improving rates of return, it doesn't place returns ahead of personal needs and lifetime balance. In a nutshell, it is about using the wealth you have and will attain to have the best life you can.
While many advisers have never heard of this concept or discussed a version of it with their clients, it is worth raising this idea with your planner. The general adviser philosophy is to encourage more saving and less spending. It is worth thinking about and asking yourself whether you would adjust your spending and saving strategies if you applied a lifetime value of a dollar approach to your thinking.
Benjamin Franklin is said to have stated the following: "The use of money is all the advantage there is in having it."
With the concept of lifetime value of money, it can help you to use your money to your best advantage across your lifetime.
Ted Rechtshaffen is president and CEO of TriDelta Financial Partners, a firm that provides independent financial planning advice. He was vice-president of business strategy at a major Canadian brokerage firm and found that the interests of the client were often not aligned with the interests of the adviser or the interests of the company.
This is part 14 in a series that looks inside the financial services industry at what advisers tell their clients and - more importantly - what they don't.
Other articles in Ted Rechtshaffen's Adviser Secrets series: