Have you just won the lottery? Or maybe you've come into some other kind of windfall where you now face the same dilemma that the lottery winner does: should you take the money all at once or spread out over a number of years?
The key to answering this question lies in comparing the effective rates of return that you could receive from investing the amount of the lump sum against what you would be getting if you opted for the annual payout plan. The best choice is to select the option that provides a higher rate of return.
The problem though is that while it's pretty easy to find out what a typical range of annualized rates of return are for a typical investment in the stock market, it's not so easy to figure out what interest rate you're getting from the annual payment option, even though you know how much it will pay out each year and how many years the money will be paid out. The reason why is because the math it takes to get the answer is horrendous! (And we're not even factoring in taxes!)
That's why we here at Political Calculations' have stepped up to provide our newest tool, which you may use to find that effective rate of interest! Just enter the amount of the lump sum payout, the amount of the annual payments you would receive and the number of years the payments would be made - we'll take care of the rest! (Warning: It's best to use actual numbers rather than guessing - it doesn't take much to throw the results out of range!)
Now, all you have to do is to compare this rate of return against the historical best, worst and average rates of return from an investment in the stock market. For the 20 year payout period default entry in the tool above, these rates of return for an investment in the S&P 500 index are:
- Worst case: +1.6%
- Average: +9.4%
- Best case: +19.2%
The figure to use for comparison is the average rate of return - the best and worst rates of return are provided simply to illustrate the extreme ends of the possible range.
HT: Oak Road Systems for the math!
Previously on Political Calculations
- Revisiting the Lottery
Our improved tool for determining what the prize needs to be to make the lottery worth playing!
- The Cost of Risk vs. Benefit
- Our original tool for finding whether the benefit (the grand prize in the lottery) is worth the price of a ticket when the odds are taken into account.
Welcome to the blogosphere's toolchest! Here, unlike other blogs dedicated to analyzing current events, we create easy-to-use, simple tools to do the math related to them so you can get in on the action too! If you would like to learn more about these tools, or if you would like to contribute ideas to develop for this blog, please e-mail us at:
ironman at politicalcalculations
Thanks in advance!
Closing values for previous trading day.
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