OK, here’s the question as it was posed:
"If you won a prize and were given the choice between getting £500 today or £1,000, but it’ll be paid in two years (from a very safe company so no chance of it going bust), which would you choose? And why?"
Around 4 in 5 people choose the £500 option (see people’s responses) and most responded very quickly, so I assume answered instinctively. And why not? It’s only a fun question on Facebook.
Yet while it’s hypothetical, it raises a huge number of interesting points about how we think about cash and it’s actually a good indicator of financial attitudes. Let’s start by looking at it in purely financial terms:
- The impact of inflation. The Retail Prices Index is currently at 4.8%, so if rates remain that way, what costs £1,000 now will cost roughly £1,100 in two years. On that basis by waiting for the £1,000 you’re only getting the equivalent of around £910 at today’s prices.
- Take £500 now and save it. Even at a massive 4% for a non-taxpayer (see top savings), at best the account would give you £540 in two years. So, on that basis, delayed gratification easily wins. Someone suggested putting it in premium bonds as there’s the chance of winning a lot. While that’s true, the chance is miniscule. According to www.premiumbondcalculator.com the probability of winning £500 or more is 0.124%, which is just over 1 in 800, so for most that’s a loser too.
- Take £500 and invest it. Of course, you could take a risk with the money in the that it grows more quickly, yet to get the roughly 40% annual growth (compounded) you’d need to have £1,000 in two years is a massive ask that’d involve high risk investing and you’re just as likely to end up with £250 as you are £1,000.
- Take £500 and pay off debts. If you’ve high interest debts paying them off will certainly outperform saving (see repay debts with savings). Yet even with a 30% credit card, it would only cost you £300 over two years to keep the debt, not as much as the £500 gain by taking the grand.
- Take £500 and use it to stop bank charges / bill defaults. This is the main area where the financial mathematics shows you could beat the £1,000 by taking the £500 now. With some bank charges at £30 a pop, if this money gets you within your overdraft limit, the amount it saves you in fees could easily be more than £500 over two years. The same is true with mortgage defaults, or defaulting on other bills, which have substantial repercussions.
- Take £1,000 in two years, and borrow it now. One person suggested getting a 0% for spending card, using that to build up £1,000 of debt, which you can then repay when the prize comes. For the disciplined, financially savvy this has some workable benefits in terms of getting instant gratification as a form of stoozing. In fact, what you’d need to do is get the card, spend on it, make the minimum repayments and then balance transfer after a year to another 0% card, though you’d pay a fee at that point.
On this basis, for all but those in serious financial trouble, it’d be worth waiting to take the £1,000.
Yet there are some more human factors to take into account:
- You could be hit by a bus. If that happens, you don’t gain from waiting. In financial terms you would require a risk premium for waiting, ie, extra cash. Yet for all but the very old or those with very poor health, I would think the risk of going in the next two years is far outweighed by the £500 extra cash (in other words it more than covers the risk premium).
- Instant gratification. For many people having the joy now of extra cash either to spend on or to reduce financial stress is simply too attractive to wait.
- Personal circumstances. Your own finances may have improved by then so the increased utility from gaining £500 now may be more than getting £1,000 in two years when it has less impact on disposable income or lifestyle (vice-versa is also possible of course).
Overall, even looking at it in such a cursory way (I’m sure others will have many more points), there are a wealth of situations to take into account.
For me, though, I’d wait. You? And what if I’d asked about £5,000 and £10,000 rather than £500 and £1,000, would that change things?