Your Time Period Matters

Avoid this common fallacy that makes your analysis Trash Bandicoot

Would you rather invest in a 1 year guaranteed return of 6% or a 5 year guaranteed return at 5.75, given those are the only 2 options?

Which is financially better? How did you decide that?

Before getting into the answer, this is a common issue you see in life.

If every investment or use of money had the exact same time horizon, it would make the decision easy. You could pick the choice that was optimal for your selection criteria pretty quickly.

But life is never that simple. Instead every decision you have likely has a different period of time. And with multiple decisions to be made, you start getting into a large combination of possible overlapping timelines creating different permutations.

People have a tough time mentally understanding how quickly combinations can scale. If you have 2 objects, A &B, you can arrange them in 2 ways AB or BA.

If you have 3 objects A, B, & C you can arrange them in 6 ways: ABC, ACB, BAC, BCA, CAB, or CBA.

4 objects is 24 ways. 5 objects is 120 ways. 6 objects is 720 ways. If you have lots of choices to order the way you do them, you quickly get into a huge number of options.

The regular person may have credit card debt, mortgage, car payment, can invest in equity in 401k, Roth 401k, IRA, Roth IRA, or taxable brokerages, can buy fixed income in the same accounts, and has other uses for the money. If you order those choices of where to focus you get a huge number scenarios you could choose.

Businesses also run into a similar problem. When making your plans on which projects to invest in, you may have:

• Project A takes $1mm investment and expected returns $1.5mm in a year

• Project B takes $3mm investment and expected returns $4.5mm in 3 years

• Project C takes $10mm investment and expected returns $12mm in 2 years

• Project D takes $2mm investment and expected returns $4mm in 10 years

But the business only has so much capital to deploy and has its own 5 year plan for capital usages. Therefore, it runs into the same issues of limited capital and needing to choose between different investments with different time horizons.

Luckily, we can leverage some of the theory developed in the business world to help inform us how to handle different time horizons in our personal finance.

Yet, in the personal finance space, so many people fundamentally don’t understand how to compare different time horizon choices that they come to absurd conclusions.

Much to my enjoyment - once you understand a little bit about comparing different time periods, you will understand why so much of the ‘advice’ out there is fundamentally flawed and absolute trash bandicoot