Understanding the Time VALUE of Money in the Things We Purchase
Disclaimer: Please read the entire post. The first half may be confusing…but just keep going. It will make sense in the end!
Most of us understand how money compounded builds on itself to create additional money (if not, there will be a post in the near future regarding this). What some of us fail to realize is the value of the money we put into use to purchase everyday items. To maximize savings (and thus allow more money to compound), many people skimp on Quality of the products they buy, in favor of Price. What we should be looking for, however, is Value in the products we buy. There is a simple (theoretical) formula for Value. Here is how I perceive Value:
Quality / Price = Value
(Don’t worry if you hate formulas, I am just using this to make a point)
What we are seeking is overall value. The above statement simply says that as quality goes up and as price goes down, value increases.
How does this affect our daily lives? The answer is that instead of seeking the lowest prices, we should be seeking the highest values…high quality things for a low price. This does not always mean buying the lowest price in a particular category, and (to me anyways), it rarely means buying the highest price.
Let’s get to some examples. If you had a choice between a $1,000 car and a $2,000 car…which would you choose based on price alone? Now let’s say the $1,000 car is a 1994 Nissan Maxima, and the $2,000 is a a 2010 Nissan Maxima (let’s assume all other factors are equivalent). You would now obviously go for the 2010 model.
The above example is rather extreme, however, we should look at everything we purchase with the same thought process. So why would we rather have the 2010 car? Because we perceive that the 2010 car will last much longer (at least ‘$1000′ longer) than the 1994 vehicle.
Now, let’s use an everyday example. Let’s say you had the choice to purchase a $15 board game, and a $70 board game (see Andreas’s comment by clicking the link). Without knowing anything about either game, we would assume that the $15 board game is a better value. However, if we say that we only get 1.5 hours of entertainment from the $15 board game, yet we get 35 hours of entertainment out of the $70 board game, then we would clearly see that the $70 game is a much better value (using the above formula Quality / Price = Value):
$70 board game (35 hours / $70 = Value 0.5)
$15 board game(1.5 hours / $15 = Value 0.1)
Now all this is theoretical. I don’t assume anyone, including myself, would want to figure up the actual value of everything we purchase. Actually if we tried, we would not be able to predict the ‘quality’ factor because it is usually hard to assign a value to quality in advance.
What we can do is predict value by predicting quality. Since we usually know the price, that part of the equation is set. To predict quality, we would have to do our research (Consumer Reports, or other means of product reviews). Businesses make money because quality is not quantitative. If it were, then instead of having a price tag, everything would have a ‘Value Tag’and consumers would go for the highest value. Basically the wildcard of marketing would be taken completely out of the mix.
So what does this mean to us the consumers? Don’t purchase things based on cost alone. Purchase things based on perceived longevity and perceived usefulness. Purchasing high-value products is key to long-term wealth. And that’s the lesson for the day…
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