What if question

I was cruising the finance blog buzz on pfbuzz.com when I came across this question from BudgetsAreSexy:

“Would you rather have $500k now (no taxes, fees, etc) OR would you rather get 1 million ten years from now (no fees again)?”

I knew almost immediately what my answer would be. Mel was sitting/knitting next to me and had some thoughts on the subject as well.

Step3: "I would take the $500K now."

Mel: "I would have to agree there.  I mean, would the million dollars that you get in 10 years be equivalent to the million dollars of today?  Probably not.  And, according to a geezer who sits next to me at work, if you were to take a 20 year old and have them invest from the time they were 20 till they were 30 years old (and then stopped investing entirely), they would make a much bigger wad by retirement than someone who started investing from 30-40 years old.  Let's say they retire at 65... The dude who invested from 20-30 would have had his cash sitting longer in investments and accrued more interest than the 30-40 year old investor.  But, ya know, this is just one geezer's opinion.  Eh, but he's a geezer engineer, and they seem pretty on the ball.  Anyway... yes... I'm stealing Step3's limelight..."

Step3: "Wow, that's quite a response.... My line of thinking was a little bit simpler. What I really want from this whole finance thing is the freedom to do whatever I want. The $500K is no chump change, and having control of it now would be better in my opinion than getting a million 10 years from now. Mel brings up some good points, but her example is really an oranges to apples comparison. That adage is used to coax the young and poor to set aside money early."

Mel: "Agreed. And, I should have elaborated on my first statement earlier that "a million dollars 10 years from now does not equal a million dollars today".  I am pretty sure everyone got the inference regarding inflation, yadda yadda... And yes, the work geezers do their best to scare us whippersnappers into putting away cash... the thing I am scared of is: I was around for my coworker's daughter's birth.  I don't want to be around when she gets married! :) (Well, at work, anyway).  And yes, I also agree with the notion that having cash now to control as you see fit is "a fun thing to do"."

Step3: "From a purely investment perspective, and disregarding inflation, you would need to earn about an 8% annual return on the $500,000, which is very reasonable considering the stock markets average rate of return. But it is also more risky. Plus taxes on capitol gains if you were to take all of the money out at the 10 year point would be steep."

Mel: "This was interesting - I watched him do a simple calculation on interest earned over 10 years.  Averaging it out as 8% a year,  if you took the $500k now, you would end up at roughly $999,500...$500 off the mark of the $1M.  Ah, he is grasping for the keyboard..."

Step3: " I ran the inflation adjusted scenario. Interstingly enough, after 10 years, assuming 4% inflation and 8% rate of return, your final real value is almost exactly the same. Taxes would make the difference on your capitol gains. However, I'd still take the 500K now for the reasons stated above. Maybe it's just nerves about my upcoming change of job three years from now."

Mel:  "Word. Didn't you say you were going to mooch off of my emasculatingly larger salary? ;)"

Step3: "Step 1: Respond to ad on craiglist. Step 2: Marry Sugar Momma.
Step 3: Profit. "

Comments

[joey]

In every situation I can think of, as long as your rate of return is at least 8.0% (treating these "options" as a project), you will benefit more from the 500k today.

Net Present Value of 1 million at an 8% discount rate for 10 years is $463,000

[Paul]

In nearly all cases its better to take lumpsum now in these situations.

Especialy since often you can control the $$ in ways that may exceed the future value in some cases.

Also, you will more likley live better.