Future value
Juan has a problem. His problem is that he has just won a $2.5 million lottery. By winning the lottery, he is now thinking about the time value of his money. In this sense, it's a champagne problem.
So, Juan has two options.
He could cash in on the current value, or
Delay gratification in exchange for a large payout at a future date
Let’s take a closer look at these options.
Juan could take the present lottery amount of $2.5 million, which is the cash in hand today.
Alternatively, he could opt for 25 annuity payments of $100,000 each, or the future value. This is the cash he will receive at the end of the payout period.
To calculate the future value of Juan's winnings, we would use the following formula:
FV = PV x (1 + i ) (n)
In the above formula, FV represents future value. PV stands for present value. The “i” represents the interest rate on the payout, and “n” is the number of payout periods.
The future value of Juan’s lottery haul looks like this:
FV = $100,000 x (1+0.05) (25) = $4,772,709.88
As we can see, Juan stands to make way more money by taking the payout of $100,000 each year over the next 25 years instead of the $2.5 million lump-sum.
If he takes the single amount lump sum, he loses out on future earnings. However, if he goes for the annuity--the periodic stream of cash flow--he will compound his interest rate and end up with more money. At $4.7 million, the annuity will almost double his original amount of $2.5 million.
Knowing this, would you recommend that Juan take the annuity. You probably would, especially if you believe in the saying “A dollar today is worth more tomorrow.”
I’ve been thinking a lot about how today’s small steps (present value) can compound into a large payout tomorrow (future value). When you’re busy grinding away with no big reward in sight, it can be tough to keep going.
It helps to fully appreciate the process. To think of the work as the reward, the journey as the destination, the climb as the mountain top.
Yet, it’s also true that today’s seemingly small steps are worth more in value tomorrow.
Looking at decisions in this light makes delayed gratification worth every bit of the patience it takes to do remarkable work.