If I offered you £500 today or a guaranteed no-risk £1,000 in a year’s time, what would you take? Think about it for a second, as your answer shines a light on your financial psychology.
I’m sorry to say this isn’t a real offer, but a simple poser I posted as a Twitter poll a little while ago (I’ve been meaning to write it up ever since, and finally did over the festive break). In fact I did three different variants, to see if changing the amounts changed people’s responses, and indeed it did.
(I’ve put these in financial order rather than the order of the tweets.)
Today's Twitter poll 2: if you won a prize and could choose £50 today or a (cast iron legit guaranteed) £100 after a year. Which'd you take— Martin Lewis (@MartinSLewis) October 13, 2016
Today's Twitter poll: if you won a prize and could choose £500 today or a (cast iron legit guaranteed) £1000 after a year. Which'd you take— Martin Lewis (@MartinSLewis) October 13, 2016
Today's Twitter poll 3: if you won a prize and could choose £50000 today or a (cast iron legit guaranteed) £100000 after a yr. Would u take— Martin Lewis (@MartinSLewis) October 13, 2016
The key fact here is there’s no solvency risk (ie, you’ll definitely get it whatever you choose) and once you factor that in, looking at it from a clinical financial perspective – the vast majority of people should wait, but few will.
The smaller the amount, the more people want instant gratification. The argument there I suspect is likely “an extra £50 in a year isn’t worth the wait, I may as well have the cash now”. Yet this is clearly an emotional decision rather than a clinical one. After all, money has a fixed value – £50 is £50.
A financial optical illusion
We all judge money in context, rather than, perhaps as we should do, in the abstract. Most people would be willing to travel across town to get a half-price dress or suit saving £100; but wouldn’t make the journey to reduce a £100,000 mortgage by £100. But the gain from both is the same.
I’ve written before on how to avoid natural behavioral biases and thus how to make good financial decisions. However, I thought it would be fun to analyse this narrow question in detail. Of course the big question when analysing what decision to make is…
Can you turn £500 into £1,000 in two years?
I ran a similar question to this on my Facebook page way back in 2011. Then, I also asked people if they took the cash early, what they’d do with it. I want to run through some of the choices people made.
- I’d take £500 now and save it
The most popular option was to grab the £500 now but save it. Yet ‘do the math’. The top savings interest on this amount over a year currently is 5% with the Nationwide FlexDirect bank account. This would mean after a year you’d only have £525.
- I’d take £500 and put it in premium bonds
A few were enamoured by putting it in premium bonds as there’s the chance of winning a giant sum. While true, the chance is miniscule.
According to www.premiumbondcalculator.com at current odds the probability of winning £500 or more on £500 over two years is just under 1 in 1,000, meaning 999 in every 1,000 would be better waiting.In fact, it shows over the two years, the vast majority (67%) of people putting £500 in win NOTHING.
- I’d take £500 and invest it
For those who wanted to invest it, it’s worth remembering that unless you’re looking to keep money aside for five years, it’s often a high risk gamble. To bag the roughly 40% annual growth that compounded brings you £1,000 in just two years is a MASSIVE ask that’d involve high risk investing – so be as prepared to end up with £250 as you are £1,000.
Investing isn’t my expertise so (back in 2011) I asked market guru Justin Urquhart Stewart of Seven Investment Management what he’d do: “You’d be bonkers to risk money in the market, when you’ve a guaranteed no-risk way of doubling over two years”.
- I’d take £500 and pay off debts
My constant mantra is “always repay high interest debts before you start saving”. Yet even with £500 debt on a hideous 30% credit card, it would cost you £350 over two years in interest; by waiting you’d still be £150 better off.
Of course there are some high-cost credit options that have higher interest rates than that, but they tend to be very short term and payday loan costs are capped. Having said that, as the amount of interest here is likely to be closer to £500, and clearing debts a valid aim, if your rates are as high as this, it’s worth looking at.
- Take £500 and use it to stop bank charges
Here the financial mathematics does add up. If you’re regularly getting bank charges for busting your overdraft limit totalling £100 a month, if the £500 could get you under the overdraft limit, the amount it saves you in fees could easily be more than £500 over two years. The same is true with mortgage or other bill defaults which carry substantial financial repercussions.
It’s worth remembering this: far too many people try to repay their credit card with their bank account money (ie, overdraft), though bank charges for going over your overdraft can cost far more than credit card interest.
NB: This argument actually has some real-world relevance. The new Government Help to Save scheme promises those in work on lower incomes a 50% boost on their savings; recently I gave evidence to the House of Commons on this and warned that it may mis-prioritise some people’s finances as they’d be better off clearing expensive bank charges and debt.
Don’t forget inflation
While I’ve been comparing £500 with £1,000, actually whenever you’re thinking about cash over the long term, you need to factor in inflation too – the rate prices rise.
Currently the Retail Prices Index, which is the most representative, is 2.2%, meaning what £1,000 buys today will cost roughly £1,045 in two years IF rates remain that way (worth remembering if you’ve cash in the bank and are deciding whether to buy something now or wait).
On this basis, wait for the £1,000 and you’re only getting the equivalent of around £955 at today’s prices. And your own personal inflation rate may be higher (see the Office for National Statistics Personal Inflation Calculator). But even taking that into account, for most people the answer’s still very clearly… wait for the cash.
It’s not all about money though
The number crunching shows it’d be worth waiting to take the £1,000 for ALL but those in serious financial trouble. Yet there are some more human factors to take into account…
- You could be hit by a bus. It’s important to factor this in: it means you need a ‘risk premium’ for waiting – in other words the extra cash given needs to outweigh the risks of not being around to get it. Though for all but the very old or ill, I think the risk of expiring in the next two years is far outweighed by the £500 extra cash.And hey, I’ll be generous, if you do die before I give you the fictional money, I’ll ensure your dependants get all the fictional cash…
- Instant gratification. We’re a ‘gotta have it now’ generation, and for many the joy of extra cash now – to spend or to reduce financial stress – is simply too attractive to wait. It’s one reason we’re so badly in debt as a country.
- You’re on the up. It’s worth recognising your own finances may have improved in two years’ time so the joy of using £500 now may outweigh getting £1,000 in two years if you’ll have much more disposable income then (or vice versa).
For me, though, I’d wait. You?