When I’m lecturing to students I like to ask them how much a $100 pair of shoes costs. The most common answer is $100 plus tax. Would you believe me if told you it could be as much as $1,376.46?
A basic truth in finance is that when you give your money to someone else they get to use it, not you.
As a 20-year-old, if you convinced yourself not to buy the shoes, and invested it instead — with an assumed rate of return of 6 per cent — you’d have $1,376.46 by the time you were 65 years old.
Now, some of you are going to start thinking about taxes and inflation and those are valid considerations but there are ways around that. The important thing here is that every decision you make with money has a current effect and a future effect.
No one has a limitless amount of money. The money you earn either works for you, or it works for someone else.
If you earn $60,000 per year, your net income after taxes, CPP & EI contributions is about $48,000. Your effective tax rate is 20 per cent so that $100 you’re spending on shoes required you to earn $125 ($125 – 20 per cent = $100). If you live in Ontario you would also need to pay HST of 13 per cent and since that tax is paid with after tax dollars, that means it actually costs you another $17.50. So now those shoes have cost you $142.50 of earnings.
If you took the $142.50 of earnings, and put it into an RRSP for 45 years at 6 per cent you’re now at $1,961.46!
Albert Einstein said, “Compound interest is the eighth wonder of the world. He who understands it, earns it…he who doesn’t …pays it.”
Now, I just want to say that I’m not against buying shoes, and I don’t want you to stop living and horde all your money, but I do want you to think about all those things that you may not need but buy anyway.
When we start to look at all the ways people mishandle money or have money taken from them, we can start to see why being aware of how things work is so important.
I’ll leave you with this thought. If you’re paying $25 per month in bank fees, assuming 6 per cent growth over 45 years, that’s equivalent to $73,678. Using our very conservative 20 per cent tax rate, that means that you have to earn over $90,000 just to pay your bank fees.
I wonder if those shoes ever go on sale?