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PaperclipPerfector  1yr ago (text post)   4498 thread views

Small-Scale Question Sunday for November 5, 2023

Do you have a dumb question that you're kind of embarrassed to ask in the main thread? Is there something you're just not sure about?

This is your opportunity to ask questions. No question too simple or too silly.

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I still don't get it. We're talking about concrete value of money invested, and what it is now, vs what it will be in 7 years. You seem to be talking about some sort of philosophical experiment about what money might hypothetically be worth if we accept certain premises, or something.

I was initially as perplexed as you were, but it seems the crux is present value, which in this case is precisely the amount handed to you today.

But @ulyssessword said:

The value of $10M with 7 years of compounding (accessible in 7 years) is exactly $10M

It seems like either he's saying that after 7 years of $10M collecting compounding interest it's worth $10M for some reason, which is wrong, or he's saying that he doesn't believe in calculating value of predictable future values of money, which seems like an esoteric argument for philosophical purposes, without real-world application. Maybe that 2nd argument is the present value argument, but I still don't get it, or don't understand why it's a useful argument at all, unfortunately :(

Are you sure you are not confusing the Future Value with the Present Value? The present value of $x today, is x. It's future value is the present value compounded over the hold period.

The discount rate you should use to convert between the two should probably be your expected rate of return. If you really want to get into it, it's possible that the expected rate of return and your personal discount rate are different. If you believe even in a very weak form of the Capital Asset Pricing Model though, you should still discount that excess return back to the risk-free rate, because the difference should explained by the difference in risk (Lots of details about the Capital Market Line omitted). Or, put another way, all assets have the same effective discount rate to a risk-neutral measure. The conversion should not depend on the assets you plan to hold over the period.

I'm not sure. Why did @ulyssessword bring up net present value into a conversation to contradict @f3zinker talking about the future value of what $10M would be worth in 7 years?

My interpretation of @ulyssessword is that we can either reject or assume @f3zinker was being hyperbolic when he said:

Doesn't know the value of 10M USD with 7 years of compounding.

Because the value of 10M USD today, that we can access in 7 years, with 7 years of compounding (in a reasonable asset selection, etc.), is 10M today. It's tautological. There's no calculation involved. It's the same as saying "Doesn't know the value of 10M USD."

A slightly uncharitable interpretation is @f3zinker was taking a cheap shot that people are too stupid to understand compounding, and @ulyssessword was taking a cheap shot that the person complaining about people being too stupid to understand compounding doesn't even understand the time value of money.

The investing aspect of the original scenario was irrelevant to the value of the initial compensation, but presumably the hold and investment was meant to work around the fact that the person in the original scenario might not have the cognitive skills, knowledge, or life experience (yet?) to manage a nest-egg of that size wisely. I suppose some would argue that most people don't have those skills and thus this things like separate retirement accounts, trust funds, pensions, social welfare programs, etc.

Edit: To further clarify, I do actually think it's confusing because people in the investing world almost exclusively talk about present value when they say "value" unless future value is specified. In every-day usage people can be very slopy about the difference, and it doesn't help that things like the lottery jackpot are quoted in pre-tax future value terms. I'm also not making the claim that the uncharitable interpretation is what either poster actual intended, I'm trying to explain why there would even be a back and forth on the topic.

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