Having a million dollars would be great, wouldn’t it?
Yes, of course it would be! For most of us, it’s not likely that we’re making that annually, but it’s possible that we might eventually save that much. Financial independence would be ours!
It’s always interesting to me how we read about the amount of money one could have, if you just saved X amount per year and earned Y percent rate of return. I do these calculations too, and have included such analyses here on Squirrelers as well.
The catch – which I regularly point out – is the time value of money. Why is it that we don’t read more about this? In my MBA program, it was one of the more basic, useful concepts that I learned early on. A dollar today is worth more than a dollar tomorrow, except when there’s deflation – which we don’t want of course.
Let’s say that someone is saving for a goal of becoming a millionaire in the next 5 years. If this is a realistic goal for you, that’s fantastic. Assuming 3% inflation, that million dollars in 5 years will equal $862,608 in today’s dollars. So, that original million dollars will be able to buy about $862,608 of goods based on today’s prices.
Calculation: $1,000,000 / (1.03) ^5
The thing is, the further your time horizon, the lower the purchasing power of that future $1 million becomes. Expanding the timeframe further, and keeping the same 3% discount rate, we can see this illustrated more clearly:
Present Value today of $1 million in 10 years = $744,094
Present Value today of $1 million in 20 years = $553,676
Present Value today of $1 million in 30 years = $411,987
All nice sums of money, but not the $1 million windfall that would meet the eye without discounting back these sums at 3%.
I really think that the concept of purchasing power, and how it erodes over time, is a basic fundamental of personal finance and planning for the future. People need to plan accordingly in terms of income, savings, and rates of return, in order to be able to plan for the future. My perception is that the average person out there does not think about this concept when planning for the future.
Of course, many people do absolutely no planning for the future in the first place, which is not good. We know better, being personal finance enthusiasts, whether we’re bloggers or not.
Questions for You:
At what point did the light bulb go on for you, when you realized the need to base future retirement funds on the purchasing power of the time at which you plan to retire?
Do you think that this is something that the average citizen out there really even considers?