As a saver, I have a personal interest in higher interest rates: I earn more. But as a conservationist and environmentalist, I know that low rates enable a certain kind of long-term thinking. Now, while rates are at generational lows, circumstances are perfect for thinking long-term.
About twenty-five years ago (as an example of long-term thinking), I had a whimsical investment idea: Buy some cheap land and plant hardwood trees. The trees wouldn’t be ready to harvest for 100 years or so, but it would have been a cheap investment with (eventually) a fairly large payoff.
It takes a certain perspective to make such a long-term investment. I call it a whimsical idea because I’d never have been able to enjoy the financial return. I was already in my mid-20s at the time. Even if I’d selected the hardwoods for quick maturity, they wouldn’t have been ready until I was well into my 90s.
But although it takes a long view to justify an investment like this, it also takes something else: low interest rates.
Analyzing a long-term investment
Economists have a framework for analyzing investment decisions — a formula for calculating what you’d be willing to pay now for a benefit that arrives in the future. They call it present value.
You can use it to answer questions like whether it’s better to pay $8 for a compact fluorescent bulb that’ll last 5 years, or pay $15 for one that’ll last 10. The math is a little complex, but the underlying principle behind the formula is simply that if you didn’t pay the money out now, you could invest it in something else.
In the light bulb example, suppose you had the $15. You could buy the $8 bulb and then invest the remaining $7 in a 5-year CD. As long as the CD earned at least 2.71% interest, it would have grown to enough to buy a new $8 bulb to replace the old one.
The calculation is very sensitive to the interest rate. If you could earn 14% on that CD, it would only make sense to pay $12.15 for that longer-lasting bulb. On the other hand, if your CD is only going to earn 1%, it’d make sense to pay $15.61.
The key here is that high interest rates make you less willing to pay more now to get something later.
If your timeframe is long — if you’re thinking in terms of benefits for your children or grandchildren — then this effect quickly makes it unreasonable to spend any money for their benefit. How much would you pay today to return $1000 a hundred years from now? If your discount rate is 5%, then you’d only pay $7.60. (This is true for exactly the same reason that compound interest makes small investments grow huge in the future. When rates are high, even a huge payoff in the future is only worth a small investment now.)
So, this brings us back to planting some hardwood trees. A 40-acre plot might be able to grow as much as 20,000 trees which might be worth $500 apiece at maturity, yielding $10 million in timber. So, how much would you pay now to receive $10 million 100 years from now?
Well, if the appropriate discount rate is 3.8% (the current rate for a long-term treasury bond) it would make sense to pay $240,000 now to return $10 million in 100 years. Currently, that makes it a pretty good deal: You can get recently clear-cut land for just a few hundred dollars an acre, and seedlings cost less than $1 apiece, so your initial investment could be as little as $60,000. When rates are as low as they are now, growing a forest is a sound investment.
But suppose interest rates were 14%, like they were just thirty years ago. Can you guess what the present value of $10 million in 100 years would be at that discount rate? Answer: $20.39. That’s enough money to buy about 25 seedlings (but no land).
A lot of long-term projects got shelved thirty years ago because they make no economic sense in a high interest-rate environment.
With interest rates once again low, now is the time to think long term. Now is the time to make investments that might not pay off for a generation or two. Now is the time to buy land, to improve it. If you’re building, build to last.
Long-term thinking is good for the environment and for conservation. It makes sense to pay more for things that last, instead of cheap throw-aways. When short-term thinking rules, no one would consider planting a forest just because they might want timber 100 years from now — when rates are high, even a huge future return is discounted away to nothing.
But until rates are high again, put aside short-term thinking. Think long-term.
Example long-term investments
Besides planting a forest, here are some other examples of long-term investment ideas:
- If you own land, now is a great time to make permanent improvements to its contours. Something like digging a pond, drilling a well, or building a berm may only provide a small benefit, but it’s a benefit that will persist for years — potentially for generations.
- Any purchase that you make with the notion that it will save you money over time — a high-efficiency furnace, triple-glazed windows, an energy-star refrigerator — is a better investment when rates are low.
- Installing home power generating capacity (a photovoltaic system or a windmill).
- Planting fruit or nut trees, berry bushes, or grape arbors.
Some of those are what I call non-financial investments, in that they provide their return in the form of peaches or kilowatts or anything other than cash. Investments of that sort are often inherently long-term. They also often don’t meet a strict economic test, when rates are high. If you can invest the $15,000 that a home power system might cost to earn 7%, the $1000 in interest will buy a lot more electricity than the power system would produce. If rates are closer to 1%, non-financial investments start looking a lot more attractive.
Photo by Rachel the Cat.