The Value Framework You Need To Be Using

Why the new iPhone 12 really costs $32,000

Jan 03, 2021

black iPhone on wooden table — https://www.pexels.com/photo/space-gray-iphone-5s-1294886/

Hey Millennial Wiz Fam, Happy New Year! I hope this finds you all healthy and happy as we enter 2021. For all the new readers, welcome 😊. I’m thankful to have you here as we embark on our financial journey together.

In this week’s post, I go over a few of the most eye-opening fundamental concepts that convinced me to become a stronger advocate for both my own and others’ financial savviness. These concepts should hopefully reframe the way you think about spending and the true value of your money heading into 2021!

And no, the subtitle about the new iPhone’s price is not click-bait and I’ll explain why.

Time Value of Money

The concept of ‘value’ is taught in business classes pretty early on. In the context of this blog post, it specifically integrates the dimension of time into the value of money. This concept is simple – it states that $1 today is worth more than $1 in the future due to its earning potential. In a basic example, would you rather have me hand you a $100 bill today, or 6 months from now? I hope you elect to have that $100 today.

The earning potential here for that $100 I gave you could be in the form of any investing strategy like a savings account, stocks, or certificates of deposits (CD), and can yield an average return of anywhere between less than one percent to 10% yearly (conservative estimates here) depending on your choices.

Compound, Compound, Compound

Now that we’ve established that identical sums of money are more valuable now than they are in the future, it’s time to introduce the only force in this universe stronger than the Infinity Gauntlet in the hands of Thanos: compound interest.

Compound interest is the driving force behind the time value of money and is superior to a regular simple interest calculation. Why? Because in addition to giving you X% on your initial investment, it also gives you the same X% on the interest that you accrued at the end of the compounding period (in this case, yearly).

For a more fun example, imagine that you are a kid that received $100 for Christmas in your stocking. Now the deal here is that you can keep that $100 in the stocking without touching it, and every year, “Santa” will come by and in addition to coal, will give you 5% of whatever is in the stocking.
After year 1, you receive $5 (5% of $100).
After year 2, Santa sees $105 in the stocking ($100 initial + Year 1 Interest $5) and gives you another 5% (5% of $105) = $5.25.
Your total is now $110.25.

As long as you don’t remove any money, the interest rate stays the same, but the total sum that Santa uses to calculate 5% from is always going to be greater than the original $100 that we started with. Thus, compound interest!

Rule of 72 (or, 69.3 if you prefer)

Without having to calculate compound interest with the formula, we can estimate the amount of time it takes for us to double an initial investment at a fixed rate of return with something called The Rule of 72. [1] It’s essentially a shortcut to demonstrate the effect of compound interest. All you have to do is take 72 and divide it by the rate of return and it will give you an estimation of the amount of time that it takes to double your initial investment.

There’s some logarithm based math in this estimation that shows that 69.3 instead of 72 gets you a more exact answer, and if you’re interested, feel free to take a look here. 72 was chosen because it was the nearest integer with many factors, and it gets pretty close, so we’ll use it here.

Table of values showing years to double an initial investment over time using the rule of 72 — https://www.wsj.com/articles/the-genius-behind-accounting-shortcut-it-wasnt-einstein-1497618000

The iPhone Example

You might now be asking why I’ve dramatically stated that these simple concepts could alter your perception on spending, so here’s the evidence.

Over the last decade, an investment into something like the SPDR S&P 500 ETF (SPY) that tracks the S&P 500 has had an average return of about 10%. [2]. But instead of investing in it, let’s say you want to buy the new iPhone 12 for $1,000. Pretty pricey, but you’ve justified it by saying you need 5G TODAY. Like RIGHT NOW. So you go out and purchase it. Here’s what that iPhone is actually going to cost you over time using the rule of 72 (or 69.3 based on your preference). Spoiler alert: it’s definitely more than $1,000.

$1,000 invested at 10% return per year
Rule of 72 says it will take (72/10)=7.2 years to double your money
If you are 24 years old today, that iPhone actually cost you around $32,000 by the time you turn 60
$1,000 -> $2,000 -> $4,000 -> $8,000 -> $16,000 -> $32,000

Why This Matters

The bottom line is this — foregoing the iPhone 12 (or any other items you don’t truly need) and investing it properly could get you a nice car ($32,000) when it’s time to retire!

Thinking about spending any amount of money in this compounding interest framework allows you to really see the lost “earning potential” of purchases you make today. This way of thinking about the value of money has stopped me from buying lots of fun things like the latest MacBook pro, a new phone every year, and the latest and greatest sneakers, because I am able to understand that it costs way more than the sticker price at the store.

I hope taking into consideration the TRUE cost of making a purchase makes you think twice before making impulse buys, and upgrading technology that you either don’t need or won’t use more than a few times!

Thanks for reading, and see you in next week’s Millennial Wiz Newsletter!

Please comment below with your questions, thoughts, and personal experiences. I’d love to hear from you!

Millennial Wiz