Sure we would all choose take it today, but there is a finance theory behind why you may want to take it today. Ever heard of the expression a dollar today is worth more than a dollar tomorrow but less than a dollar yesterday. Well if not, now you have today we look at the time value of money. What the time value of money calculation and the principle means is that a dollar today is not equivalent in value to a dollar tomorrow or a dollar yesterday. It is a very simple principle to understand, but can have big ramifications in your retirement planning.
Now what do I mean it can have big implications in your retirement planning. For starters you want to make sure you are putting away as much as you possibly can live without. Start as early as you can, if you can start in high school and stick with it PERFECT!! If you start investing younger you can invest smaller amounts to see the magnified returns later in life, remember compounding? But if you wait till you are later in life you can sock away 4 times as much and still not catch up to the returns that the young person saw. Start early and you can put time value of money to work right away, as you are able to increase the future value of your dinero (the extent of my Spanish after 5 yrs of classes) either through some type of investment vehicle or some type of interest bearing account. Don’t get scared by what I am going to show you next!
PV or present value= the value at time 0 or now
FV or future value= the value at time n (see below)
i = the discount rate, or the interest rate at which the amount will be compounded each period
n = the number of periods could be years or could be months.
Let’s do a quick calculation to see what the value of the cool million dollars that we won is in 5 years assuming 6% interest rate and discounted annually.
PV = ?
FV= $1,000,000
i = 6%
n = 5 yrs
PV = 1,000,000 x (1+0.06)-5
PV = 747,258.17
The cool million that we would receive in 5 years would be worth $747,258.17 in today’s dollars! I hope you would still take the million today and run.
Financial concepts can be fun when you look at in perspectives like this or with your retirement. Save early, save often, save what you can!
Tomorrow I will be hosting a blog swap with a fellow pf blogger. Make sure to come check out the best investment advice my fellow blogger has ever received.
Ahh, a math geek! I love me a math geek…especially when the math has to do with loads of money! Right now, we are putting everything we can into getting out of debt, but we need to work on that savings ASAP….like yesterday.
@ Yesssssss I am…It is amazing what math can do for you. I don’t know why more people don’t like math. I loved your article on DIY the more you can DIY the more money you can save…and run more calculations like this…and see what you saved how much it would be worth in the future. 🙂
I’m not sure why anyone would be willing to wait if they won a big lump of cash. Unfortunately young people usually do not think this way about saving for retirement. They figure that while they are young they might as well take advantage of their spare cash for personal enjoyment. There is often a mentality that they will make much more money later in life and can worry about retirement savings later.
@ Jeremy – I know I was that way…I got my first job and went right out and go myself a new car…thought I deserved it. I did however have my 401k set up first though!
Man, I honestly can’t tell you whether I could wait. A million now would be hard to pass up!
@ Nell – exactly…it would be burning a hole in my pocket before I even received it…what would you do with that million??
I would always want to have that money now. Value of money depreciates with time 🙂
Chris, you are doing a very good job of spreading financial awareness. Articles like these are very good for those new to this field
@ Karunesh – thank you for the kind words. The thing is most of us know this stuff but they do not know the financial terminology behind it. Most know a dollar today is worth more than a dollar tomorrow, but they don’t know it is because of the time value of money concept! Thanks for stopping by. I see you got the comment function working on your site. To jump off subject…Do you create all those graphics on your site? Your site is very creative…it must take you forever doing each post.
Hi Chris,
I have included this post at my website weekly roundup #2.
Yes, I create my drawings myself, that too using a mouse. It takes time but I get a chance to be funny so I like that 🙂
@ Karunesh – I love your drawings they are great, you are very creative. Thanks a lot for the inclusion! 🙂
It’s articles like these that make me realize I really need to do an updated budget to start saving more for retirement. As soon as our house closes it’s the next “thing” on my to do list. Saving a little more now will have a much bigger payout in the future.
@ Kari – I knew back in February you were looking for a house, have you found one and are you close to closing? Just make sure you don’t keep putting off saving or you will be socking away so much more money.. 🙂