How Much Does $1,000,000 Today Cost?

How much would you pay annually in order to receive $1,000,000 today? This question is often a good measure of risk tolerance. For the purposes of this article, I am considering this the same as asking how much would you need in return annually if you paid $1,000,000 today. For me, it is around $50,000/year. I had a debate with a friend recently who said that he would demand closer to $75,000 due to long term S&P returns, ignoring points like inflation and risk. This all started from a debate about whether you should take $50,000/year for 20 years or $1,000,000 instantly if you won the lottery. No rational person can make an argument for $50,000/year but the argument moved on to what dollar value would make you change your mind.

Time Value of Money

Would you rather have $1 today or $1 a year from now? Each of you nodded at the $1 today. How about $1 today or $1.02 a year from now? I still expect most of you to have nodded at the $1 today. How about $1 today vs. $3 a year from now? Now everybody should be nodding their head at the $3 a year from now. Whether you actively recognize or act upon it, everybody recognizes the time value of money. Cue obligatory reference to the Stanford marshmallow test which shows appreciation of delayed gratification as an indicator of future success in life. Tying in with many of my earlier posts, this is part of the reason that I am very debt hungry. So long as I am young and employed I want as many dollars today to be able to leverage compound interest for the future.

How do you manage the cashflow?

How do you manage the cashflow?

Market for Risk Tolerances

In the comments below or in a thought experiment, think about the question at the top: specifically, how much would you need per year for you to pay $1,000,000? I think you’ll find there’s a wide variety of choices with the majority coming in around $20k-$75k/year. Whenever an econ nerd such as yours truly sees disparate preferences for risk, I smell an arbitrage opportunity or the ability for a market to exist. For example, if you think you’d take $20k/year and I’d take $75k/year, somebody should pay person A $25k/year for $1,000,000 and then take $70k/year from me. All three of us gets better off (person A by $5k/year, me by $5k/year and the arbitrageur by $45k/year). There should be a business model about this!

There is.

Enter annuities and life insurance. Insurance companies business model revolves around differing measures of risk sensitivities. For example, if you have employer-sponsored health insurance, you are often given the option to choose between basic, advanced and a premium option. This is just a dressed up way of measuring a customer’s risk preference and using the differences to provide the best service possible. When somebody says that annuities are a rip-off (in my opinion, they are), they are often referencing that they just have a different risk preference. If I had to pay $1m for a $20k annual annuity, I would say no. There is a pocket of the population that would say yes, however. How do annuity (life insurance) companies manage a guaranteed small outflow of dollars with interspersed large injections of capital from annuities? With life insurance of course! That model guarantees small inflow of dollars interspersed with large outflows of capital at paying out policies. And, similarly, it allows people to self-select based off of their risk preference, choosing whole life, term as well as a variety of other options.

Are most of them ripoffs?

Yes. But, then again, I have a different risk profile.

Cheers,

Cameron Daniels

Tweet about this on Twitter5Share on Facebook1Share on Google+0Share on Reddit0Share on StumbleUpon0Email this to someone

Comments

  1. freeby50 says

    I’d probably pay about $50k. I could use the $1m to pay off mortgages and come out ahead paying $50k a year rather than our current monthly mortgage payments.

  2. krantcents says

    I never liked annuities because of the fees and expenses. I do believ in multiple income streams because things can happen.

  3. says

    Interesting question. It surely depends on your time of life and on how you pay for the roof over your head. If $1 million would pay off expensive loans, it might be worth more than the 4% one ought, theoretically, to draw down from such a fund were it invested.

    Let’s say you were willing to pay $40,000/year to get a million bucks, and with it you intended to pay off a mortgage that’s costing you more than 40 grand. In that case, your mortgage would be costing upwards of $3333 a month.

    That’s an exorbitant amount for a roof. Wouldn’t most people be better off to downsize or move to a less expensive venue? Not so much as a matter of living within your means, but as a matter of not behaving ridiculously?

    A friend of mine sells annuities. While I wouldn’t dream of remarking to his face that I think they’re a rip, once I did ask him about the facts that they tie up capital and that their fees are pretty high. His response was that he would not recommend that clients use all or even half of their assets to fund an annuity. His people tend to have plenty of money, and so they use, say, 10% or 20% of savings to fund an annuity that provides a base cash flow to cover living costs. Then the “gravy,” as it were — money for traveling or just living higher off the hog day to day — comes from returns on other investments.

  4. JT says

    One consideration to think about is the tax consequence. $50k a year is much more tax friendly than $1M in year one. Spanning 20 years the effect is minimized by the time value of money, but even still, in some cases it can make sense to take an annuity for exactly this reason.

Trackbacks

Leave a Reply

Your email address will not be published. Required fields are marked *