Monevator is one of the personal finance sites that I read fairly frequently. They have a fairly good weekly column that includes a number of interesting links, both about personal finance as well as on other topics like psychology or recent news events. The article I read yesterday begins as follows:

Unlike every other personal finance blogger around, I’ve started 2020 wondering whether it’s time I spent more money.

I would not call myself a personal finance blogger, but I had thoughts along similar lines when planning my budget for 2020. Eventually, I decided yes, and expanded the budget at the end of the planning session (and this is already after a 50% increase over 2018). My reasoning was not too different from the author’s (and the logic behind having a need for such an argument was similar as well – saving, which is a form of delaying gratification, seems to come naturally as a default to me).

In theory at least, I can work out how much £1 spent today would cost me in retirement if I was to do that at 65 if I make some assumptions. There are 37 years to go there, and if we use a 4.5% real (that is, accounting for inflation) return that becomes about £5.10. In other words, I could buy roughly five times the number of goods I could today, if I was willing to wait 37 years.

However, a large problem with excessively delaying gratification (both for money and in general) is that the expected benefit may not materialise – this is known as an interruption risk. These risks can typically take two forms:

1. Collection risk, where the projected reward doesn’t actually become available. In context this means that the £1 I invested doesn’t become the inflation-adjusted equivalent of £5.10 37 years down the road.
2. Termination risk, where the person delaying gratification does not get to benefit from the projected reward, even though it did become available. In context this means that although the £1 I invested does become £5.10 (or more), I don’t survive 37 more years or I do but my ability to use it is limited or hampered for some reason.

The former could arise for various reasons, as my projection was dependent on a 4.5% real return assumption. This is in line with the past 119 years – in fact that was slightly higher at 5%, though I would use 4.5% because of platform and fund fees (see Credit Suisse’s 2019 Global Investment Returns Yearbook). This pattern may not continue going forward if there are large, value-destroying events (e.g. faster than expected climate change effects, nuclear war). Even if the pattern continues, I might not be able to get this return for more local concerns (e.g. aggressive investment taxes as part of left-wing policy, if my fund of choice turns out to be poorly managed).

The latter is also very relevant. The author mentions that he’s “within striking distance of 47” and is concerned about planning 40 years ahead when using a compound interest calculator; I’m probably between fifteen or twenty years younger, and the pessimist (or realist?) in me also gets uneasy about putting 40 in that box, let alone the analogous 55-60 (e.g. see James 4:14 – whether you’re a Christian or not I think the sentiment is relatable). Even if I do make it there, it’s possible that I’d be in less of a position to enjoy the money, for time or health reasons. If I had my current financial state at the end of National Service in Singapore, for example, that 9-month period before starting university would have looked quite different and I would have done more things, some of which I’m not in a position to do right now because of work (e.g. I’d probably have done a two-month round-the-world trip).

I am still intending to be mostly frugal and saving a fair amount. Travel will likely be the largest source of expenses for me – flights and hotels are not cheap. I also spent quite a lot of money on clothing last year, though I’m trying to avoid that as I’m running up against (reasonable) storage limitations and there are quite a number of clothes that I haven’t worn for a while. Thus my plans are nowhere near as far as the author’s claim that he’ll make little effort to grow his wealth. I don’t think I’m in a position where that would be responsible, in that my current savings/portfolio are nowhere near enough to be sufficient for retirement.

I’ve noticed that there has ended up being a string of primarily financial posts. This was not intentional, but there happened to be lots of interesting material related to finance that has come up over the past few weeks. Also, a disclaimer: I am not a financial advisor and am not offering professional financial advice. Conduct your own due diligence or seek an advisor if necessary.

The UK government announced its Budget for 2018/2019, though with the caveat that it might be subject to change in the event of a no-deal Brexit (which looks a bit more of a risk each day). I’m a UK taxpayer, and thus changes in relation to tax and relevant allowances interests me; tax is my largest expense every year. As an expatriate I don’t have recourse to public funds, so I’m less aware of the changes pertaining to benefits and universal credit. The list below is far from exhaustive; readers should consult a more detailed guide like MoneySavingExpert or even the Budget itself if they want more details, or this Which? article if they’re considering optimising their tax affairs.

Income and Take-Home Pay

• Personal allowance has increased from £11,600 to £12,500 and the higher rate (40%) band has increased from £46,350 to £50,000.
• National insurance thresholds have risen; the start of the 12% band has increased from £8,424 to £8,632 (by £208), while its end has increased from £46,834 to £50,024 (by £3,190).

I was aware that the Conservative manifesto had pledged to bump the personal allowance and higher rate thresholds to these levels by 2020, so this is one year early. These increases seemed fairly generous – although I will be paying more in NI (notice that £2,982 is now taxed an extra 10 percent and £208 is now taxed 2 fewer percent – in other words I’m paying £294 more) the income tax saving looks pretty good, especially in nominal terms. (Whether Brexit wrecks the value of the pound further is another separate concern.)

A separate consequence of this is that the 62% marginal band has extended to £125,000 as well, as there’s more personal allowance to lose. Regardless, the changes are certainly positive.

In general, with inflation being positive, the value of a pound decreases over time. Thus, thresholds should be increased nominally at least in line with inflation if the goal is to implement a ‘neutral’ policy. I haven’t been keeping track of the history of these levels, but the roughly 7.75% bump in the thresholds is certainly well above inflation (and hopefully above two years of inflation – since the thresholds will be frozen next year).

Other Income Sources

• The Personal Savings Allowance remains at £1,000 for basic rate taxpayers, £500 for higher rate and £0 for additional rate.
• The Dividend Allowance remains at £2,000 – note that dividends in a pension or ISA do not count against this limit. Dividend tax rates are unchanged.
• The Trading and Property Allowances remain at £1,000.
• The Rent-a-Room scheme threshold remains at £7,500.

Most things held pretty steady in nominal terms (which means they’ve gone down slightly in real terms). That said, if interest rates continue to go up the savings allowance thresholds might quickly become relevant to me (obligatory hello to Marcus). I’m considerably further from the dividend allowance threshold, though again that’s something to watch out for if the markets decide to be exuberant. I haven’t been using the other allowances, though if an opportunity comes up that could be a possibility.

Securities and Assets

• The ISA (tax-advantaged savings account) limit remains at £20,000.
• The Capital Gains Allowance was increased slightly, from £11,700 to £12,000. Tax on capital gains is unchanged.
• The Lifetime Allowance for pensions was increased in line with inflation, from £1.03M to £1.055M.

Not too much to say here. The markets haven’t been so friendly so there’s certainly no extravaganza of crystallising significant capital gains this time around. To be fair, much of my gains in the 2016/17 tax year centered around massive pound weakness. ISA allowance being held where it is is a bit of a damp squib as I max it, but to be fair it is still very generous.

Consumption Taxes

• VAT standard rate remains at 20%.
• Air Passenger Duty (APD) remains flat for short-haul flights, but rises by RPI for long-haul flights (roughly £2 for Y, £4 for premium cabins).
• Fuel duty is frozen.
• Alcohol duty is frozen for beer, “most cider” and spirits. Duty on wine and higher-strength cider increases by RPI.
• Tobacco duty increases by RPI + 2%. I don’t smoke, so don’t know too much.

Owing to how it’s calculated RPI tends to be higher – and it’s a little frustrating / naughty that most payments coming out of the Treasury (e.g. planned bumps in income tax/pension allowances) seem to be CPI indexed while those going in tend to be RPI indexed. The main reason suggested for the double standards is legacy technical debt, but that doesn’t seem to explain why the inconsistencies seem to consistently resolve in favour of the exchequer.

The APD change garners revenue for the Treasury, though it’s a little sad as APD is already incredibly high compared to aviation duties in other countries. That might actually increase the attractiveness of routing through Zurich or one of the German hubs when I fly the London-Singapore route.

For comparison, long-haul premium cabin APD ex-UK will be £172. Singapore’s duty is about S$47 (about £27); Zurich weighs in at CHF 35 (also about £27) and Munich at EUR 42 (about £37).

I guess I’m mildly affected by the alcohol duty change as I do drink wine, but I don’t drink a lot so the impact is very minimal. I’m not currently affected by the fuel or tobacco duty changes.

50p Coin

• The Royal Mint will produce a 50p coin to mark Brexit.

I’m somewhat of a Brexit bear and remain one (pun not intended). Taken at face value, the inscription (“peace, prosperity and friendship with all nations”) is at least one way in which I could see it possibly having a shot at working out – and assuming Brexit does go ahead is what I hope the government will do.

However, the quote is adapted from Thomas Jefferson’s inauguration speech as US President. The continuation is “entangling alliances with none”, which is in some ways apt if the UK is concerned with the EU’s ever closer union – though I’d think the US and UK in a modern-day context certainly are allies!

Conclusion

In terms of personal impact, the Budget felt very much like a constructive or at least benign continuation of previous Budgets. That said, I realise I say that from a point of privilege in that I view the status quo as manageable. I’m aware that there have been changes to benefits (notably, universal credit) which have made some worse off.

Somewhat related to the previous post on paydays, I had lunch and then coffee with another friend, and for some reason our discussion turned to personal finance as well. Unlike the last time, I was the one starting with the view that deviates from conventional theory this time.

Suppose you have a choice between two savings accounts. One account pays 2% AER and the other pays 1% AER – so £10000 invested for a year would earn £200 in the first account but only £100 in the second. Should you allocate 100% of your savings to the account that pays 2% AER?

In general, if all other things were held equal, there probably isn’t much of a reason not to allocate everything to the 2% account. However, the standard for all other things has to be high. In practice, I can see quite a few scenarios where there may be legitimate reasons to allocate some money to the 1% account.

One possible reason could be terms of access. Clearly, if the 2% account is a fixed rate bond only allowing access to the money after some amount of time while the 1% is an easy-access account, that provides a clear reason. If one wishes to maintain an emergency fund, for example, the fixed rate bond is probably best avoided even if it pays higher interest. Some savings accounts, while not having a fixed term, place restrictions on withdrawals in terms of frequency or advance notice in exchange for higher rates – again, be careful about using these accounts to park an emergency fund.

Another reason could involve how the accounts compound. The annual equivalent rate (AER) refers to how much money one will have after a year. However, if one wants the funds together with some interest before one full year, then precisely how the accounts pay interest becomes significant. If the 1% account compounds monthly while the 2% account compounds annually only, then between one month and one year after the start date the 1% account has more withdrawable interest. This is a variant of the access problem, though this focuses on access to interest as opposed to the principal. This may seem a little short-term minded, but could be interesting if one is engaging in stoozing or has other pressing financial commitments.

The amount of money one has is also relevant. Financial institutions can fail; in this case, the UK’s Financial Services Compensation Scheme (FSCS) guarantees up to £85,000 per depositor per authorised bank/building society. There is thus certainly a case for keeping not more than that amount with each bank; if one was fortunate enough for one’s savings to exceed £170,000, finding a third bank seems reasonable. I’ve never seen cash as doing the heavy lifting as far as growing my portfolio was concerned. I’d collect interest as available, but would prioritise safety. If the accounts were held with the same provider, of course, then this argument falls down – even if one has multiple accounts, the FSCS limit is on a per-bank basis. In fact, one has to be careful as some bank brands do share authorisations – meaning that an individual will only get the protection once even if several of these banks fail.

In general, the inconvenience that might be caused by failures is something worth considering as well. The FSCS compensation only applies if the bank is suitably authorised; even if one’s balance is fully covered by the FSCS, claims can take one to four weeks to process. I think I’d be much more comfortable having at least a nontrivial amount in a separate account (two to three months’ expenses, ideally) if possible.

Customer service is another factor. I’d probably prioritise that more significantly for more complex products – however, for a savings account it would still be useful.

Furthermore, there are other principles which individuals might find important. MoneySavingExpert on its savings account best buy tables has a section for highly-rated ‘ethical savings accounts’. The criteria Ethical Consumer (which MSE works with) include concerns like tax avoidance and funding of climate change, though I don’t necessarily agree with all of them (“excessive director’s remuneration”, in particular – if someone is that valuable it seems unethical to me to artificially depress their salary). Similarly, Islamic banking is necessary for adherents, since interest is forbidden in Islam.

To conclude, there are quite a number of reasons why one might not actually want to put 100% in the higher interest bearing account. Of course it makes sense ceteris paribus (if all other things were held equal), but that seems unlikely in practice. The standard for all other things being held equal here is high – the access conditions, compounding conventions and bank account provider all need to match (and that isn’t even an exhaustive list).

I met a friend for a meal on the weekend, and among other things my friend mentioned that at his company, there was an internal debate over whether payday should be moved forward. This wasn’t a debate on the financial ability or willingness of the company to do this, but was instead focused on individual workers’ preferences.

My initial reaction was a bit of surprise. I wondered why this was even a debate, as I believed the answer should almost always be yes. This reminded me of the standard time-value-of-money question that I wrote about just over a year ago; being paid the same amount of money slightly earlier, mathematically, seems like an outright win. The UK hasn’t had negative interest rates yet – and even in a place like Switzerland where bank rate is negative, this isn’t typically passed on to most depositors.

Cash flow might be a problem if one considers the dollar-today-or-more-tomorrow question; however, this shouldn’t be an issue in this set-up. Valid cash-flow scenarios remain valid even if payday is brought forward. In a sense, an early payday creates additional options; it shouldn’t invalidate any existing ones.

With a bit more discussion and thought, though, we found that there were indeed valid reasons as to why one might not want payday to be shifted forward.

First, although the mathematical argument makes sense, there are some edge cases around tax liability. If one’s salary is close to a marginal rate change and a payment is pushed across a tax year boundary, the amount of tax one pays might change (and can increase). 

Also, although we speak of interest as an upside, how much benefit an individual can actually realise may be significantly limited. Some bank accounts pay interest based on the lowest balance on any day in the month, meaning that being paid a few days early yields no benefit. Even if interest is based on the average daily balance, the upside is also in most cases small. For a concrete example, 2017 median UK post-tax earnings would be about £1,884.60 per month. If one was getting paid three days early and storing that into a high-interest current account yielding 5% APR, the additional interest wouldn’t be more than about 30 pence.

Moving away from purely numerical considerations, there are many other plausible reasons too. Clearly, departing from an existing routine may affect one’s own financial tracking. I find this alone to be a little flimsy (surely one’s tracker should be adaptable to variations arising from December and/or weekends?). That said, if one is unlikely to derive much benefit from the money coming early (and it seems like in most cases there indeed wouldn’t be much benefit), the change would likely seem unnecessary.

Another scenario could be if one has many bills or other payments paid by direct debit, and cannot or does not want to pay all of them. In that case, deciding precisely where the money goes could be significant – for example, if one is faced with a decision to lose fuel or premium TV in winter. This is probably not the right system to handle a situation like that, but if one wishes to only make some payments then an unexpected early payday could mess the schedule up. Somewhat related might be joint accounts in households where there are financial disputes.

Taking advantage of an early payday also requires self-control. Consider that if one is living paycheck-to-paycheck, while an early payday might ease financial pressure, it also means that the time to the next paycheck is longer than normal (unless that is also shifted forward). This needs to be dealt with accordingly.

If you’d ask me whether I’d like payday to be shifted forward, I’d almost certainly say yes. Our discussion went to a further hypothetical – would you take a 1% pay cut to have your entire salary for the year paid on January 1st?

From a mathematical point of view, you would be comparing a lump sum of dollars paid now, or (for simplicity) twelve payments of dollars paid years from now. Assuming that you can earn interest of % per month and using monthly compounding, after one year we have

If we set these two to be equal and solve for , we get a break even point of . This computes out to an APR of about . This is higher than best-buy easy access accounts at time of writing (MoneySavingExpert identifies Marcus at 1.5%). You can beat this with fixed-rate deposits, and probably beat this through P2P loans, REITs and equities – though more risk is involved.

I think I could see that being a yes for me, though I’m not entirely sure I’d have the self control required to manage it properly!

I overheard a conversation a few days ago on the near-impossibility of retiring by forty. It is understandable (consider 40 in relation to standard benchmarks for retirement – a private pension can be withdrawn at 55 and the state pension is given at 65, and these numbers are trending upwards). I’m not sure I agree, though; there exist quite a number of examples of people that have done this [1, 2]. Meta-analyses disagree (against: [3], in favour: [4]). It’s true that internet and media sources may perhaps not be reliable, but in any case one can perform the relevant analysis.

Even given the option, I’m not certain I would take it. It’s arguable that I had a taste of retirement for the two-odd months in between submitting my Masters thesis at Imperial and starting full-time at Palantir, and I didn’t find it that easy to fill my time after a while. I’d probably stand a better chance now, having reignited a couple of interests in things apart from computer science.

Anyway, let’s get to analysis. One simple way of decomposing this problem can involve

1. Figuring out the amount required before retirement is feasible, and
2. Figuring out the required savings rate to reach the result obtained in step 1.

For the first point, there is a well-known 4% rule. Suppose you withdraw 4% of your portfolio in the year when you retire, and then adjust your withdrawals for inflation every year. Then, your portfolio will last for at least 30 years in 96% of historical scenarios. I have some issues with this, biasing in both directions.

I think 4% seems lower than is reasonable, for several reasons:

• The idea that one blindly draws the stipulated salary even when the market is down seems absurd. Really, one should factor in market returns when making one’s decisions about income, as in [5 – note, technical!].
• The study assumes that the portfolio alone supports the retiree; yet, a side hustle of some kind may be relevant, and at least in the UK the state pension could kick in once the retiree reaches 65 (or whatever the age is at that time).

Yet, there are certain reasons to adjust the figure upwards too:

• The life expectancy of someone who’s 40 is probably higher than 30 more years (especially one who’s considering retirement at 40!), hence that’s not enough as a baseline.
• The study used the US markets, which have been performing very well. Of course, one can decide to use exclusively the US markets, but that tends to introduce currency risks too.
• The study in question does not account for fund and platform fees. These can be kept quite low (I estimate my own portfolio operates at about 0.22%, and some of this is by choice because I hold some active and smart-beta funds, along with indices that are a bit more exotic) but invariably chew into returns.

It seems like it’s a reasonable rule of thumb, though I wouldn’t treat the figure as authoritative.

One needs to estimate asset returns and inflation for both parts 1 and 2; this can be partially simplified by working everything in real terms, though there is a risk that owing to high inflation increasing one’s savings in line with inflation can prove untenable. Typically, one relies on historical data; for instance, UK stocks have returned about a CAGR of 5.2% from 1900 to 2011 [6]. Post-retirement sequence of returns risk can prove troublesome, although the variance might indeed be smoothed out over a longer period.

Notice that assuming one starts from zero and using the 4% or any constant-percentage model, the only factor after the asset returns and inflation rate have been factored in would be your savings rate – the level of expenditure needed is a function of this. I guess one could introduce another factor for decreased spending upon retirement! An example of a concrete calculation (inclusive of a link to a spreadsheet) can be found in [7]. Using the examples there (5% real returns, 4% withdrawal rate) and bearing in mind that I have 14 years till I’m 40, that clocks in at a smidge above 55 percent.

For an individual, though, there’s probably a somewhat easier method to determine if a retirement by 40 or early retirement is feasible:

1. As above – figure out the amount required.
2. Given one’s past saving and investment patterns, estimate the amount one is likely to have at 40 if one continues to behave in the same way.

Of course, we need to make the same assumptions involved in figuring out the value computed in step 1. We also still can’t get away from estimating inflation or market returns in step 2. However, the previous calculation for step 2 assumes a constant savings rate; with this method it is a lot simpler to adjust the model to account for events peculiar to one’s own situation (such as long CDs maturing, stock options, vesting of bonuses, known large expenses etc.).

We then compare the figures in steps 1 and 2; there is of course some wiggle room. I think there’s a distinction to be drawn between deciding that one is financially independent and pulling the retirement trigger, though that’s perhaps a separate discussion topic. [8] I certainly would be interested in the first, but not the second at this time (and, hopefully, even at 40).

One can even switch the method up a bit further:

1. Figure out the amount one is likely to have at 40 (step 2 above)
2. Figure out the withdrawal amount one can derive from that. Decide if that’s feasible.

Again, we don’t get away from assumptions concerning inflation or market returns. Deriving values in step 2 gets tricky; one can always use the 4% rule or assume some other constant factor. It’s worth saying (for all of the methods) that building in fudge factors to leave some leeway for underwhelming market returns is probably a good idea, since getting back into the workforce after a long spell of early retirement might prove difficult.

Personally I’m very fortunate that this should be possible if I decide to push hard on it. It’s difficult to say though – past performance is not an indicator of future performance, and I’m at a point where I’d say my past spending is also not an indicator of future spending. I think I’m pretty frugal, but don’t entirely fancy maintaining the same degree of strictness I’ve been running with in my university years throughout. It’s certainly possible, but also definitely not easy, and I’m not sure it’s what I’d want to do.

I sometimes pick up my groceries at Iceland (the supermarket, not the country). When I was there today, I noticed a bunch of frozen pizzas which were typically on sale at £1 now on sale at 2 for £2.50. I thus bought zero of them, opting for a substitute (that turned out to be pretty good!). This is one example of a shortcoming of the generally accepted way of measuring inflation (via a consumer price index).

Inflation refers to an increase in general prices of goods and services (in numerical terms). With the devaluation of the pound after the Brexit vote, I’ve experienced imported inflation (because a pound buys fewer dollars/yen etc., and overseas suppliers of goods want to be paid in their currency).

Of course, one problem is how one measures “general prices of goods and services”. Typically, inflation is measured via changes in a consumer price index. This is an aggregate of the prices of a supposedly representative basket of goods and services. The basket is reviewed periodically, as some goods become more (or less) frequently consumed. For example, in the UK, this is managed by the Office for National Statistics. The 2016 basket is listed here, and changes included the addition of video game downloads and removal of nightclub entry.

Of course, individuals’ spending patterns can be very different from the “average”. One can imagine a personal inflation rate that could be very different from CPI. For example, I don’t drive, so a significant increase in the price of cars might not affect me very much. (There could be some knock-on effects, e.g. if the cost of minicab rides increases.) Similarly, an increase in the cost of recreational boats (which are part of the basket) would have little impact on me. Conversely, I consume a fair amount of potatoes, so a cost increase there could have an outsize impact on me…

It probably won’t, actually. If potatoes become expensive, I will eat fewer potatoes and more rice or noodles.

Something similar actually happened after the Brexit vote. I used to enjoy an occasional instant ramen treat from the Japan Centre in London. However, with the pound falling almost 20 percent against the yen in the wake of Brexit (from 160 to about 130), prices were increased significantly. In many cases, this exceeded the 25% cost increase, perhaps because they wanted to avoid further increases if the pound fell further. GBPJPY is now about 149, but the GBP prices haven’t moved, possibly for the same reason. In any case, I’ve switched to eating more of other forms of carbohydrates.

Note that the above doesn’t always work as goods actually need to have a reasonable substitute. Medical services, (possibly imputed) rent and education come to mind. There are opportunities for geographic arbitrage here (e.g. travelling to Brazil as a medical tourist, living in an RV or attending university in continental Europe respectively), but these tend to have higher barriers to entry.

This is the key intuition behind chained CPI; it aims to account for people consuming different goods and services as prices change. This is currently being considered in the US as part of Trump’s tax reform (and would, in the future, save the government money by reducing tax bracket adjustments – chained CPI would be lower than CPI).

Of course, computing chained CPI is a hard problem. For example, there was a parasite problem in salmon farms in early 2017, causing supply to fall. (Again, this was another instance where my consumption habits changed.) Is trout an acceptable substitute? Cod? Chicken? Tofu? Any kind of food? I’d answer yes to the first and kind-of to the second. For the last three, that would probably only be the case in emergency circumstances. There were similar problems with an iceberg lettuce shortage in early 2017, and yet people continued to buy them in spite of prices almost tripling.

Furthermore, one typically only gets to witness substitution effects after the fact. If the price of lettuce triples, it’s difficult to predict how many people would switch or partially switch to substitutes. In practice, statistical offices usually come up with a preliminary estimate and then revise it when they have more data available.

As an individual who has responded to the substitution effect quite a few times, especially since I moved to the UK, I think chained CPI makes sense. For me at least, the substitution effect is real and powerful. It hasn’t received the friendliest of receptions in the US, at least in part for political reasons (it hits the poor and elderly hard, for various reasons). It does make sense to have a different metric to use for benefits or the state pension, perhaps more tailored to the relevant populations (should video game downloads, generally speaking, really go into an elderly CPI?). However, in general the chained CPI seems more accurate and I see no reason not to use it.

There is an apocryphal interview question I’ve come across several times:

Would you prefer to have a dollar today or a dollar one year from now?

I do technical interviews for software engineers. Hence, this isn’t a question I would typically ask candidates (even if at times I wish it was – it could be interesting to see how candidates react!). Although it naturally seems like it would fit in a financial context, it seems too easy to be used as a serious question.

Anyway, the answer I’d go for is “today”, because I could take the dollar and put it in the bank to earn interest. In practice, I’d invest the dollar. Furthermore, inflation is more likely to be positive than not, and this eats away at the value of the dollar. The idea that getting the dollar now is better is known as the time value of money. That said, I can also see legitimate cases why one might argue for “one year from now” – mainly centering around the idea that custody of the dollar is taken care of (assuming we allow this to be assumed!).

Conversely, if you asked me a slightly different question:

Would you prefer to have a dollar today or $100 one year from now?

I would probably go for the hundred dollars, because my investments are very unlikely to increase hundred-fold (unless we have hyperinflation) in a year. As before, there are legitimate cases why one might go against the grain of financial theory – cash flow issues, in particular.

If the amount is reduced a fair bit, such as to $1.09 (for me at least), then the decision gets more difficult. Using some kind of intermediate value theorem, there should be some value of r for which I’m indifferent to this question:

Would you prefer to have a dollar today or $(1 + r) of today’s dollars one year from now?

The conventional theory here is that if I got the dollar today, invested it for a year, and then have (1 + r) of today’s dollars, then I should be indifferent. I’m not sure I agree in practice. This is mainly because of the aforementioned cash flow issues. If 6 months on I find that I need the dollar, I can take it out and still keep the partial returns. You would need to give me an illiquidity premium. (Of course, I’ve assumed here that I invest in liquid securities.)

There is also another shortcoming of this question. The size of the capital relative to my net worth would also affect my answer. Rather interestingly, I think I would take the money early for small or large amounts, but consider waiting for medium-sized ones.

For small amounts, I would need to remember that a capital inflow is coming in a year’s time. The cost of tracking this could exceed the “premium” I derive from waiting. Conversely, for massive amounts, we start delving into the realm of diminishing marginal utility – if I could pick between $1 trillion today and $1.1 trillion this time next year, I’m pretty sure I’d pick the former.

Up to this point, we’ve also avoided what’s known as counterparty risk. The person offering the money might become insolvent within the year. This would bias people towards taking the money now, and is reminiscent of a well-known proverb (“a bird in the hand is worth two in the bush”).

Nonetheless, this practice of time discounting is useful when trying to assess the value of investments or securities, such as annuities or structured products. It is also frequently used in discounted cash-flow analyses, which are useful for determining if business ventures are likely to be profitable. I have not had to put this skill into practice yet, though (well, apart from the Computational Finance exam I did at Imperial).

In theory, these concepts should be applicable to other resources or assets which (1) appreciate over time, and (2) can accumulate in value without substantial effort. That said, I’ve struggled to think of assets outside of the standard “investment” universe (stocks, bonds, real-estate, commodities, private equity, collectibles?) that satisfy both criteria.

I did think of social capital (i.e. friendships, reputations) and human capital (for me, software development and other skills). They don’t seem to satisfy (2), though it could be argued that (2) is too strict. For example, by going about my daily routine, I already (hopefully) absorb more and better dev practices. Similarly, one needs to (well, should) do one’s homework regarding asset allocation and understanding one’s investments. Also, in practice to maintain one’s asset allocation one needs to rebalance a portfolio.