by elmads

Introduction

This is a hypothetical question that some would think as a useless exercise. I couldn’t blame them because this a highly impossible scenario to happen, but what others don’t actually see is what lies beneath this question.

It delves deeper into our own personal money decision making skills relating to our lives. Go ahead and read the question again. Now, take the question seriously and think of it as a real life scenario, which one will you choose?

Everyone who sees this will automatically have various chain of thoughts in their mind. Some will do an immediate mathematical calculation, while others think about their current life circumstance and base their answer from it, but only a few will do both.

Money is a medium of exchange. It doesn’t order people how they should use it, instead it’s the people who dictate how should money move about its business.

Have you ever wondered why there are different perception and relationship of every individual in this world relating to money? some has a positive outlook, others in the middle, while some with extreme disgust and anger for it. When in fact money has always just been a tool for exchange, an inanimate piece of paper, metal and digital number, nothing more and nothing less.

Our relationship and views about money is strongly connected to our individual collective experiences, beliefs, culture, upbringing, and environment. Despite the indifferences in our money opinion, everyone will still completely agree in one aspect of it, that we need money to sustain our fundamental necessities of life, such as food, water, clothing and shelter. Anything in excess is a blessing, and a lack there of can cause pain and suffering.

So which one will you choose? A million now or 5k for the rest of your life?

To make things clear, I’ll breakdown it down to mathematics first, then individual circumstances

We’ll first take into account this information: It would take 16 years and 8 months, or exactly 200 months for the $5,000 to reach $1,000,000.

We’ll also have 2 individuals: Person A who chose $1,000,000, while Person B who took the $5,000 monthly for the rest of his/her life.

NUMERACY

1.) Time Value of Money (Simple Interest) – A dollar today is always worth more than a dollar tomorrow.

Scenario: Person A & B having both decided to put all of their received money in a savings bank account giving 2% interest per annum. Additionally, we have Person C who’ll just save the money in a jar.

Factors to consider: Time horizon – They’ll put money in the bank for 30 years before they withdraw it.

• Person A will immediately deposit his received $1 million in the bank
• Person B will also deposit the $5,000 in the bank every time he/she receives it monthly
• Person C $1 million in a Jar.

After 30 Years

• Person A will have $1,600,000 (a 0.62x increase)
• Person B will have $2,358,000 (a 1.84x increase)
• Person C will still have the same $1,000,000 (no changes)

How come Person B had more at the end of the 30 years period? This is because Person B reached past 17 years, and as what I’ve written previously. It would take 17 years to reach a million if we just save $5,000 a month forever. The downside of the “1 million now” is it is finite, while the other isn’t.

Person A, though receiving $20,000 yearly via his/her bank’s saving rate would still yield poor results if he/she will not be adding money on top of his/her initial deposited amount. The downside of simple interest (which banks utilize with their savings accounts) is it doesn’t put interest in the previous interest it generated.

On the contrary, if Person A used his/her $1,000,000 and invested it on an investment vehicles that uses the power of compound interest, then his/her money investment narrative would substantially change overtime.

Person C who just saved it somewhere in his/her house would just still have a million.

In summary, you’ll have a decent return whatever you chose between the million or $5,000 a month as long as you let it work even in a bank savings account utilizing simple interest. Contrary to what Person C did, which he/she just saved the money without putting it into work.

2.)Time Value of Money (Compound Interest) – A dollar invested today is always worth way way way more than a dollar tomorrow.

In the previous example we used simple interest. In this section, we’ll now be utilizing the power of compound interest by investing in a low cost index fund. “What is a Mutual Fund?”

The scenario we’ll be using is the same one we used previously. The only difference is, Persons A & B will be investing their money in an low-cost index mutual fund, while person C will still save his/her money in a jar.

After 30 Years

• Person A will generate $7,114,257.05 (A 7.11x increase, from initial the $1,000,000 invested in year 1)
• Person B will attain $5,667,647.18 (A 3.15x increase, this is from year 1 to year 30 accumulated money invested totalling $1,800,000)
• Person C will still just have $1,000,000 (no changes)

“What is the difference between Simple & Compound Interest?”

Let me bring these narrative in a real life setting.

Person B is the majority of people in this world. We work in exchange for an income, our time and effort for money.

There are some individuals who allocate a portion of their salary for investment purposes. For most of them, they start at their mid 20s or their 30s which give them more than 30 years of investing time horizon. They invest a portion of their salary consistently each month (if possible) for a long period of time on a low-cost index fund (Passively investing). This is the Cost Averaging Investment Strategy or also known as Drip Feed method (I’ve discussed these in my articles titled: “The Popular Investing Strategies” & “The Cost Averaging Investment Strategy”).

Whereas, Person A is the few number of people who has a sizeable amount of money to invest. This approach is called Lump Sum investing, where a person invest a large amount of their net worth in one go, on assets they completely understand. Lump Sum investing will give us larger returns in the long run than the drip feed method, only if the asset we own will increase overtime. (See area chart above)

Then Person C, are the individuals who’ll not make their money work for them at all. This doesn’t mean that they made the wrong choice, because each and one of us has our own individual circumstances.

Individual Circumstances

1.) Living Pay check-to-Pay check – choosing the $5,000 a month for the rest of your life is a no brainer option for you, why? because if you took the $1,000,000 upfront you will only be able to sustain your basic necessities of life for approximately 17 years. Well, this is still dependent on your own lifestyle, either it can be enough for you, for more or less than 17 years.

2.) You still have money left every month after paying for your basic necessities of life and financial responsibilities – This is where you can choose either the $1 million or the $5,000 monthly forever. If your salary is enough to sustain your life, then acquiring and learning financial management is a must, because having it in your arsenal of skills will substantially dictate your financial life moving forward.

3.) Your salary covers both your wants and needs, and you still have excess cash – This is a definite go for you to opt for the $1,000,000 and make that money your employee.

Nevertheless, if you’re not willing to learn the life skill of money management (personal finance & investing), either you can just let someone else handle it for you, or invest it passively in a low-cost index mutual fund, then just leave it there for more than 30 years if possible. No matter what your degree, or profession is, always learn even the fundamental knowledge and skills of money management.

“You can’t opt out the money game in life, you’re always gonna have to play it, no matter what your profession, so learn how to play it well.”

– Lauren Templeton

Age

People always forget how important our age is on our financial journey. Let me explain this by asking you a question.

Do you think a 23-year-old young adult who just entered the work force has the same energy, money and time as a 65-year-old individual who will start his state based retirement life? 🙂

Our priorities dictate how we handle and allocate our resources, our money. And our age strongly influences it as well.

A lot of individuals who know how to make their money work for them will always choose the $1 million, and it’s not surprising to know that most of them are in the working class, ages 20s-50s.

The main reason here is because they have time on their side. They have time to compound that 1 million.

Nonetheless, there are also some who’ll prefer to take the $5,000 a month as it is the safer bet to sustain the rest of their life. This would be common for individuals at the 3^rd or 4^th quarter of their life.

These are the people at 60-years-old and above. An age where once reached, would most certainly experience the following: our energy is past our former glory, strength, endurance and health slowly declines, and gone are the times where our bodies can handle long hours of physical work.

Financially, this is also the reason why it is very important to have a stable source of income without requiring labour anymore, and this is where investing (passive income sources) has been one of the answers, if not the main solution to the ageing problem.

What would I personally choose?

I’ll opt for the 1 million. Here’s my plan with it.

1.) Invest the whole million in assets that I understand.

2.) I’m currently in my 30s, and I plan to let that million compound by itself up until I reach 60 years of age. This will give me approximately 30 years of investing time horizon.

– I’m aware how much I’ll need to sustain my projected lifestyle from 60 years old to 90 years old (if ever I’ll reach that age). Therefore, I know how much should I grow that million. This has been made possible with my Inflation Adjusted Retirement Calculator, which I’ll share it to you as well. See blog link down below.

“The Inflation Adjusted Retirement Calculator Part 1”, & “Part 2”.

3.) Subsequently, once I reach 60-years-old, I’ll move my investments in good liquid assets that could give 3%-5% returns per year, either with banks, bonds, or dividend companies with strong and durable competitive advantage. (I’ll most probably choose the last, if ever there is an opportunity to find such company during that time).

That 3% would give about $200,000 a year with a principal of $7 million. I got the $7 million from the 7% annual investment rate of return example from the “Time Value of Money (Compound Interest) – A dollar invested today is always worth way way way more than a dollar tomorrow.” portion of this blog.

4.) I’ll continue to pursue my calling, my passions and purpose while still working to sustain my basic necessities of life. I’ll continue to pay it forward, and keep on learning and growing.

My goal is not to stop working, my goal is to continue to work forever, serve others and still not get tired to do it even if I’m in the 4^th quarter of my lifetime already.

I don’t want money to have those fancy vacations, and certainly not to use it buy fancy stuffs that I wouldn’t even need, and most definitely not to use it to flex power, status and belittle anyone.

I accumulate wealth for the sole purpose to buy me more time to do what really feeds my spirit. To purse the purpose that has been given to me by God, to give value, and help others through finance & investing.

I know this sounds cliché and plain. At the end of the day, it’s and will always be my real intention, It’s the real me.

To Sum It Up

In making financial decisions, always review your own individual circumstances. Your age, your priorities today and your possible priorities in the future, plan ahead, simulate your financial future, make computations and most importantly have a long-term mindset.

Numeracy gives us logic and reasoning, Self-awareness help us with completely understanding our true selves (Persona, Shadow, Animus/Anima & Individuality), while financial literacy gives us the strategies and the actions we can take moving forward.

So, if ever you find yourself in a scenario of receiving a large sum of money, such as if you win the lottery or inheritance. Step back and think about the steps you would need to consider first before making your own financial decision of saving, investing and spending that money.

Always choose to learn and grow.

Knowledge is my Sword and Patience is my Shield,

elmads

This blog is for informational purposes only and not a Financial Recommendation. Not all information will be accurate. Consult an independent financial professional before making any major financial decisions.