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$1 Million Dollars Today or $5,000 A Month For The Rest Of Your Life: Which Is The Better Choice?

Which would you choose?

 

When considering this question, many of us would have two main reactions. Some of us may think it isn’t worth our time thinking about this fairy tale situation, while others may start daydreaming about what we would be doing with the money.

The thing is, it’s not just about which fictional situation we’d prefer to be in, or even how wisely or carelessly we’d spend the money. Simply knowing our answer to this question will enable us to better understand our emotions and manage our finances.

This is regardless of the amount of money we’d be managing – be it a few thousand dollars in savings or an inheritance worth several hundred thousand dollars. Here are five key considerations we should be thinking about to actually make better financial decisions.

# 1 Our Age Today

Our age matters when trying to decide between taking $1 million today or $5,000 every month for as long as we live. If we’re 20 today, we’d have close to 60 years to live (considering a life expectancy of 80 years-old). In contrast, if we are 60 today, we’d only expect to live another 20 years.

This will impact 1) how much we’d end up receiving over our lifetime if we chose to get $5,000 each month and 2) how much our $1 million can compound into in various investments over our lifetime.

Here’s some quick maths:

These are some assumptions we’ve used.

  • We have a life expectancy of 80 years old. Life expectancy in Singapore is 84 years.
  • We don’t ever spend a single cent of the money.
  • We invest every cent.
  • Our investments compound at 4.0% per annum.
Age Today Number Of Years We Invest Total Value ($5,000 every month) Total Value ($1 million lump sum) Superior Choice
20 60 $14.9 million $10.5 million $5,000 every month
40 40 $5.9 million $4.8 million $5,000 every month
60 20 $1.9 million $2.2 million $1 million lump sum

 

If we look at the situation from the point of view of the total value we would receive in our lifetimes, we would typically choose to receive $5,000 every month when we are younger, but the $1 million lump sum as we get older.

This outcome is quite logical – despite having a very long period of time to invest, and compound, choosing the $1 million lump sum translates to lower total value over our lifetime. Instead, choosing to receive $5,000 a month delivers more in absolute terms. For example, if we received $5,000 a month from age 20, we’d actually be getting a total $3.6 million till the age of 80, and this isn’t even including any investment returns.

Read Also: How Much Do I Need to Save Before I Can Start Investing?

However, one very important point to note is that we should not automatically think receiving more over a longer term will always be the better decision. Here are just two scenarios, of many, that could drastically change the outcome of our decision.

# 2 The Amount We Have To Invest Every Month

Instead of receiving $5,000 a month, imagine we received the median take-home pay in Singapore – this amounts to $2,900 a month in 2017. With all other assumptions remaining the same, we’d choose to receive the $1 million lump sum no matter how old we are.

Age Today Number Of Years We Invest Total Value ($2,900 every month) Total Value ($1 million lump sum) Superior Choice
20 60 $8.6 million $10.5 million $1 million lump sum
40 40 $3.4 million $4.8 million $1 million lump sum
60 20 $1.1 million $2.2 million $1 million lump sum

As we can see, that by reducing the monthly sum by $2,100, we will be confronted by vastly different outcomes.

The actual figures don’t really matter here. What this shows is that if we’re going to save, and invest, less each month, it may cost us very dearly in the long run. Anything we spend on today, we’re just taking away from ourselves in retirement.

# 3 Our Rate Of Return

Consider a second situation – instead of achieving a return of 4.0% per annum, we increase to 7.5% per annum. For reference, Singapore’s Straits Times Index (STI) ETF, has delivered a return of 7.5% per annum since 2002.

Age Today Number Of Years We Invest Total Value ($5,000 every month) Total Value ($1 million lump sum) Superior Choice
20 60 $65.1 million $76.6 million $1 million lump sum
40 40 $14.7 million $18.0 million $1 million lump sum
60 20 $2.8 million $4.2 million $1 million lump sum

Again, we can clearly see that our rate of return will greatly affect what is considered “the better choice” for us. By increasing our returns to 7.5% p.a., our $1 million lump sum turns out to be the better choice regardless of the age group we are at.

Read Also: 6 Investments In Singapore That Provide Guaranteed Principal And Returns

This shows that if we can earn several percentage points higher on our investments, it can greatly improve our retirement nest egg. It is even sufficient to beat out receiving a much higher amount of money over the long-term.

# 4 Financial Knowledge

Another factor that cannot be ignored is our financial knowledge. What we do with the $1 million in lump sum or what we do with the $5,000 each month is crucial to making the right decision.

If we are able to invest, then the $1 million in upfront cash would be the better option in many cases. However, if we’re unable to invest – either because we simply do not want to learn or may end up squandering the $1 million lump sum rather than invest it, we may be better off taking the $5,000 in monthly payouts.

This table shows how much we would receive, in actual payouts, without making any investments.

Age Today Number Of Years We Invest Total Value ($5,000 every month) Total Value ($1 million lump sum) Superior Choice
20 60 $3.6 million $1 million $5,000 every month
40 40 $2.4 million $1 million $5,000 every month
60 20 $1.2 million $1 million $5,000 every month

Financial knowledge is critical in being able to make the best decisions for ourselves. In the case we know we may end up blowing our retirement nest egg or making awful investment decisions with unscrupulous family members, friends, or advisors, we may be better off just taking the $5,000 in monthly payouts.

# 5 Security

Security is very important when making such a decision. This includes security for ourselves and our family. For ourselves, we need to trust that we’d actually get $5,000 a month for the rest of our lives, which could be up to 60 years, in the scenarios, or even longer. A trusted institution, like the Singapore government or global insurer may deliver on this promise. However, 60 years is a very long time, and even trusted institutions can get into financial distress during this period of time.

For our family, we need to bear in mind that a full life, till the average life expectancy, is not a guarantee. If we choose to take $5,000 a month for the rest of our lives, it’s limited to our lifespan. This means if an unfortunate circumstance befalls us, our family members may be left at risk.

Inflation is another factor we need to consider. $5,000 today may not amount to much in 60 years, especially if there is rampant inflation. However, a solid investment today will likely be able to cover for inflation over a long period of time.

Read Also: 4 Investments That Naturally Hedges Against Inflation In Singapore

Understanding Your Financial Situation

At the end of the day, each of us would face very contrasting financial situations in life. Ultimately, the best choice for one person may not translate to the best choice for another person. This is true even if we face the exact same situation in life, but just have less knowledge or confidence about investing and managing money.

This is why you need to understand your financial situation and assess your competency before making life-changing decisions that will impact you and your family in the long-term.

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