Would you rather have $2 million today or $4 million in 15 years?
In Part 1 we talked about Benjamin Franklin’s famous words “don’t put off until tomorrow what you can do today”. Today, however, we are going to look at it from a financial stance. Granted, most people won’t ever win the lottery, and when provided the option of a lump sum payment versus payments over a number of years, they wouldn’t have a clue what to do. Quite honestly, if you can’t answer the question you should probably take the money over the course of years.
That being said let’s assume the question presented is based on after tax income. Thus, we can take $2 million today, or $4 million in 15 years AFTER TAX!
At first hand the $4,000,000 looks pretty awesome! There is no way I could earn that much extra money in the next 15 years unless I become some serious broker, invent something that everyone must have, or win the lottery between now and then…(hahaha, see what I did there?)
However, let’s look and see if this is the right choice for us. We all know we have to look at what the true value of the dollar will be in 15 years, which means we must understand the “Present Value” and “Future Value” of this money. Meaning, once we take inflation into consideration, what is the value of tomorrow’s dollar today?
Well assuming that inflation averages 3.2% a year for the next 15 years this means that $4 million dollars in 15 years is the equivalent of receiving $2,476,715.35 today.
At first glance you probably already have an answer, taking the $4 million in 15 years. You might choose that because you are saying it has a present value of basically $2.4 million today, and the alternative choice was to only take $2 million today. What you must consider though is what today’s $2 million could grow to become.
For example, if you invest $2 million today and earn an investment interest of 8% every year for 15 years, adjusting for inflation at 3.2% means you would have a total amount of $4,102,969.62 in 15 years. Basically, you could have earned an extra 100k in 15 years assuming you spend no money, and make an 8% return every year.
This basically means, you could take home any dollar earned over the 8% earned because this is just extra moolah. In actuality, earning 7.83% on an initial $2 million investment for 15 years is the equivalent of receiving $4 million in 15 years.