Why Now is the Time to Think Long-Term
Published on - October 18th, 2010 (Modified on - October 19th, 2010) (by J.D. Roth) This is a guest post from Philip Brewer of Wise Bread. Brewer also writes science-fiction and fantasy stories. Previously at GRS, he shared how to live a rich life on a budget.
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.
Thinking long-term
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.
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It’s posts like these that remind me why Mr. Brewer is one of my favorite writers. I had no idea he did sci-fi and fantasy too.
I’m definitely into thinking long-term, and a lot of my friends and co-workers think I’m crazy for it. I don’t know that I’d be willing to go as far as planting trees I wouldn’t be around to harvest, but it’s certainly food for though.
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Good point on interest rates. Nice post!
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Nice analysis. Throw in the good possibility that we’ll be facing a much less friendly inflation environment down the road gives even more force to borrowing today and investing for the longer term.
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Did you take into consideration the effect of inflation during that 100 year period? Historically inflation has been 3%.
Also there is no effect of compounding in planting hardwood trees.
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Agree with Raghu Bilhana #4: when doing this sort of calculations, inflation becomes a real factor. If we for a moment set it at 2.5%/year over the next 100 years, to have $10M in 100 years you only need about $850K now, and keep up with inflation. However, in that scenario, the $10M also won’t buy you more then than the $850K does now.
Then there’s the matter of different goods going in different directions price-wise. Oil is likely to be a lot more expensive in real terms in 100 years compared to now, while electronic computers have become way cheaper as well as more powerful in the last 60 years. If you are in a situation where the price of specific goods have a large impact on the outcome (what if everyone uses synthesized hardwood that comes at then-$1 per cubic kilometer in 100 years?) then this, too, becomes an important factor in determining whether an investment makes financial sense.
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Great post, really interesting perspective.
Doesn’t this also require confidence that rates will remain low during virtually the entire period of the investment? If rates are 3% today and I sink $200,000 into some land and seedlings, then 5 years from now, rates skyrocket to 14%, wouldn’t I be kicking myself? I’d be unable to liquidate my long-term investment, and I’d be missing out on 14% gains.
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While I’m going to have to spend more time to fully understand how the interest rate analysis works here, it does make sense that interest rates would have a big impact on long-term vs short-term investments. It seems to me though that long term thinking should always be a part of the equation, regardless of interest rates. We can’t predict the future, but we can try to do the things that will have a positive impact on our financial lives regardless of how rates change over time.
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Raghu wrote: Also there is no effect of compounding in planting hardwood trees.
Ha! This is one of my favorite GRS quotes of all time.
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Kevin, I guess the argument would be, that inflation would also influence the relative value of that land and seedlings, and at the least, it would keep up with inflation so it would be wash.
As far as predicting, it does seem like the price of prime land and wood has been increasing, but I’m not a fortune teller. One thing that may go up is the cost of harvesting and transporting the trees (lumber) if gas prices go the way they are predicted. Overall it doesn’t seem a terrible bet, as long as one can afford the property taxes needing to be paid before the gain is realized. That’s why the land should be used more than just long term gains if possible (pumpkin patch, etc).
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But what about the sub prime crisis? The low interest rates of the early 2000s encouraged risky speculation and no long term considerations. I would argue that low interest rates discourage long term investments.
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great example with the light bulb…BUT , what if you could invest the 8 bucks in a light bulb while still having that 8 bucks work for you? basically your money would be doing double duty!
this idea is the essence behind Becoming your own bank. probably the smartest thing to do with your money right now.
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I don’t know if it makes any sense to talk about the growth of a hardwood tree as “compounding,” but you certainly can’t argue that they don’t grow.
However, I was ignoring inflation for a reason: it’s built in. The price I gave for hardwood timber is the current price. One hundred years from now, hardwood timber will sell for whatever it sells for then, reflecting a hundred years of inflation. (Over the past hundred years or so, hardwood prices have gone up faster than the rate of inflation. No guarantee that they’ll do so in the future, but that’s the way I’d bet.)
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Okay, let’s not lose sight of the fact that the grove of hardwood trees was just an example. What I find interesting is the “reverse” look at the effect of interest rates. In the financial world, we often talk about the power of compounding … and calculating the present value of a future benefit is the same concept … just applied in the opposite time direction.
A common-day example is the approach so many retailers use to sell everything from cars to furniture. They don’t talk about the true cost – just the amount of the monthly payment. And those consumers who are only interested in buying as much as their credit will allow, never stop to realize how much that purchase is actually costing them. Taking such an example and calculating how quickly that consumer could make the purchase with cash by saving that same monthly payment at the current interest rates would be quite revealing.
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Very interesting. The example on how the interest rates affect what would be a good investment for the land had quite an impact.
I guess in the end, there are so many variables in terms of investment returns that you have to be able to handle the ups and downs if you are going to invest for the really long-term.
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@everyday tips, that is what your parents taught you about investing…”you have to take the ups and downs.” This is outdated. I’m sorry to be blunt but this fact has to be realized. It is very clear that losses within an investment have a far greater impact than the gains.
It is no longer necessary or wise to risk any of your money in any way (unless you’re so wealthy you could care less). Realizing moderate, conservative returns with no losses is far more beneficial than riding a roller coaster of gains and losses.
Why do you think that northwestern mutual “all the sudden” started advertising their permanent life insurance product? The reason is simple, people are sick and tired of losing money in any way.
Becoming your own bank (which utilizes whole life as a vehicle) is THE BEST way to never lose money. Again, sorry to be blunt but i’m rather passionate about this topic.
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Perhaps, even better, the ideal solution would be to buy land in some remote place and live the life of Thoreau on Walden pond. This way, there would be little need for money and material wealth, thus making you “rich” with no concern over the value of the trees, compounding interest or inflation.
“Most of the luxuries, and many of the so-called comforts of life, are not only indispensable, but positive hindrances to the elevation of mankind. With respect to luxuries and comforts, the wisest have ever lived a more simple and meager life than the poor. The ancient philosophers, Chinese, Hindoo, Persian, and Greek, were a class than which none has been poorer in outward riches, none so rich inward.” ~ Henry David Thoreau
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Hey Kent, I am not an expert on Thoreau but from what I have read he was by no means self-sufficient. He had family and community support that enabled him to live in the woods and philosophize, and not work for a wage.
Most of us here, I think, are in the position of earning that cabin in the woods for ourselves … nobody’s handing it to us. In order to buy land you have to have money.
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Regarding the comments above on inflation, hardwood is a raw material and it indirectly goes into calculating the rate of inflation. It’s not a stock or a bond. If 40 acres of hardwood trees is worth $10M today, and assuming that hardwood trees rise in value proportional to the general rate of inflation, then in 100 years the trees will be worth $10M in 2010 dollars, which will be equal to something more in nominal 2110 dollars (assuming net inflation over the next 100 years). You can’t predict what the value of hardwood will be relative to a general basket of goods in 100 years. But it’s not like anyone will force you to sell your 40 acres for what they would have been worth the year you planted them. If there’s a valid criticism here, it’s only that this investment is not diversified. So, don’t sink all your money into hardwood. This doesn’t really need to be said.
I’m not sure I agree with the compounding criticism either. It’s the relative rate of return that matters, not the ability to “compound” the interest (which increases the rate of return). It seems that the author likely considered compounding when doing his comparison calculations for interest-paying bonds. If he didn’t, then there’s a mistake.
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Although, I will add that there are costs associated with owning and maintaining land. And of course there’s a risk of forest fire, pest, flood, climate change etc. So the future value of the 40 acres of mature hardwood trees should be discounted by some degree.
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@4 Raghu Bilhana + 16/17 Brian
The example uses the FUTURE value of the hardwood in 100 years and the calculation is to determine how much you should pay for it in PRESENT dollars. Your average rate of return should account for current interests rates, estimated interest rates, as well as inflation for best results. But if one were truly psychic, they’d just win the lottery and get it over with instead of waiting 100 years.
The example is saying that $240k is the present value of $10 million 100 years from now, assuming an average rate of return of 3.8%. Therefore, you are compounding your initial investment of $240k @ 3.8% interest for 100 years to arrive at $10 million. Therefore, with the assumption that your average rate of return will be 3.8% over the next 100 year period, the break even point for this investment is $240k. If you get an offer for less, then you profit, more and you lose. If interest rates go up, you lose, if interest rates go down, you win.
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@Steven
If you were psychic and won the lottery, you’d still need to know where to put your winnings — trees or treasury bonds.
I think what’s throwing me off is where the $10M figure comes from. If that’s how much 40 acres of mature hardwood is worth RIGHT NOW, then it’s probably a poor estimate of the future value of 40 acres of mature hardwood in 2110. But otherwise I think we’re on the same page.
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Thanks for the long term approach post, I ponder things like this daily.
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As a wood lot owner, I would harvest the some of if not all of trees for pulp wood in the short term instead of waiting for the trees to reach full maturity beyond my lifetime, particularly if the market for pulp wood is good. Call it profit taking. You can get a decent ROI now and with this strategy, perhaps get 2 or 3 more pulp wood harvests before Pearly Gates time. Thinking and planning long terms is good, but within reason. 100 years into the future is not reasonable. There are too many pitfalls which could derail those plans and unless you have an exit strategy or two, you could wind up with virtually nothing at the end of that time. (A single ice storm can turn a potential gold mine of a wood lot into free fire wood for the community). Much like people who invested in Lehman Bros or Washington Mutual stock wound up with zilch if they didn’t get out in time, believing that those stocks would rebound or that the market “always goes up” long term.
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This new math is killing me!
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Hi, I disagree with Raghu wrote “Also there is no effect of compounding in planting hardwood trees.”
The compounding effect will be reflected in the price, and will acutally be a compounding of the inflation rate over time.
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Terrific article, as usual.
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I think that now is always the time to think long-term, or we should be thinking with long-term thoughts with almost everything we buy, except for maybe food.
Buying a new electronic? How long will/should it last?
A new investment? How long till I see my return?
Extra income? How can I build for my future?
Putting a long term slant on things can never be bad, in my opinion…
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Planting trees as a long-term investment is an interesting idea, but consider an alternative. If you instead invested that $60,000 in a diversified portfolio earning an average of 7% per year, in 100 years it would be worth $52,062,979.53 (compounding annually), and with less risk.
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@Brian
$10 million is the estimated worth 100 years from now.
The $240k figure is how much you need now to invest now to get to $10 million in 100 years at an average rate of return of 3.8%.
Typically, one takes X amount of money and applies a Y% rate of return for Z years to get the future value of X dollars today.
This exercise is taking that formula and going in reverse. Taking future value of X dollars in 100 years, and figuring how much it’s worth today.
@Walter
Hey hey, one concept at a time. =p
The formula isn’t that easy to adjust for something like that, so lets get everyone on the same page before confusing them again. =D
But seriously, the question you pose there is the same predicament folks getting near Social Security retirement age. Do they start collecting less earlier, or wait to collect more later on.
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paying off loans like a school loan is also a decent option at this time. Paying that money down early is like getting your interest rate back in earnings
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the catch is still determining what is important to oneself in one’s own investment future.
per re: “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.”
I think the point should be that more of us take into consideration our choices from a viewpoint other than what is best for our own personal future. Some of us take other things into calculation that are not a direct effect to ourselves or our pocket–or where experience flies contrary to promoted fact– in spite of this blog’s point of considering yourself and your own finances first…i.e. you have to answer questions like whether it is better to pay $8 for a compact fluorescent that does not last as long as promised in old city wiring, has mercury, and at this point in development, is more toxic to the landfills than it is saving in electricity…make sure you are weighing the total cost. Granted, this may not be an issue in investing in a tree farm, but it would be if your tree farm came at a price, like selling the lot the local boyscouts camp on to you, instead of keeping it open for the community. You may not care, but someone does. Care is as important as costs, which your experience underlines but only as far a tree farm is an unconventional projective investment. Just like squiggly lightbulbs are not the end all be all of lighting in spite of the lightbulb and green party lobbying, monetary numbers are not the end all of whether an investment makes sense to an individual regardless of potential profit.
no matter what you are talking about, the numbers are never as objective and neat and tidy as presented. You must count personal care to costs. And when you are dealing with decades into the future, this is more important. I expect the makers of DDT and asbestos siding expected a nice long term investment too.
The story of Scrooge would not be as timeless as it has been if it didn’t resonate truth. Just so you know though, it is legally EASY to wipe out an investor’s portfolio (really people, take it from someone in the back end of the industry, it is NOT secure money) but I expect someone would need troops to wipe out a tree farm.
When it comes to long term assets, I do subscribe to the wisdom of holding a property in one’s hands as opposed to a piece of paper. There is a better chance that land will still be there when that bank, or company, or allocation disappears in a cloud of red tape 25 years from now (a moment of silence for Lehman, please).
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This question sort of ties in. As far as savings and interest rates go, I got a small lump of money and wondering whether I should start a retirement account with it (long-long term) or a savings account that I will withdraw from for a big purchase within the next couple of years (short-long term)
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The inflation subject is an interesting one. Others have commented that compounding doesn’t occur with trees but inflation does making the real value of your forest pretty small. What is overlooked is that if inflation occurs the cost of lumber, and thus, trees goes up. Natural resources are fairly protected against inflation. Additionally if the interest rate goes to 14% inflation is probably at 12%, so you are protected from the high interest rate periods that are sure to arise over your 100 year investment period. The real risk with this particular investment is what happens when 100 years from now we are no longer using hardwood as a building material, or it becomes illegal to cut down trees because there are very few left. Of course that’s a pretty minimal risk based on today’s best known information.
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As a big fan of Phillip’s work, I was excited to read this. Overall, it kind of left me thinking, huh??? I get the math but using a 30-yr treasury rate to justify a 100-yr investment seems to be (relatively) short sighted. I think the average 30-yr treasury rate for the last 100 year may be a better gauge.
On another note, is anyone else annoyed by some of the not-so-subtle sales pitch posting going on around here? If I wanted to become my own bank, I would google “becoming my own bank”. And I don’t care how passionate you are about it. I’m passionate about feeding my family too…
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WOW! Lots of great comments! What I would consider is the chance that the family who inherits this land may not at all be interested in the long-term ROI and would sell to the highest bidder…especially if a development project comes calling.
It’s all too speculative, but a fun exercise nonetheless. I, too, would think that a fire or several years of drought could set the plan to a skidding halt. But you would insure it… And you’d still have the land…
Thinkinnnnng …..
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I’m a homeowner and our average monthly bill is around $125 give or take $25. I’d love to install a wind turbine if it would work efficiently and cut our costs. I have no clue and would like to avoid days of research and defer to a professional if it is viable cost wise to try this project. I know there may be green grants or special financing available but again have no clue about total costs, pay back venues such as years to return investment and options for even more then one turbine. We are in a bit of a forced wind tunnel because of wall and home placement so we have abundant resources. Any heads up information would be very helpful.
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Trees not compounding?
I beg to differ. Trees will put out seedlings which become more trees. You do nothing and the trees produce more trees. Nature takes care of the compounding argument.
In fact, this thesis highlights the very “nature” of compounding!
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