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 = ?
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.