What’s the Present Value of Your Accumulated Savings?

If
you are not an actuary, you may not be familiar with present values.
This basic actuarial concept is integral to determining your Funded
Status (the present value of your household assets/sources of income
divided by the present value of your future expected spending) using the
Actuarial Financial Planner (AFP) workbooks available on this website.
By entering relevant information in the input section of our
spreadsheets, the AFPs will calculate your present values and your
Funded Status.A present value (or current value) is the
discounted value (using an assumed discount rate, or rates) of a future
payment or stream of payments determined as of a specified date (the
valuation date). In the AFP spreadsheets, the discount rate used to
calculate present values is the assumed rate of investment return for
either risky assets/investments (Upside Portfolio) or non-risky
assets/investments (Floor Portfolio). The current default Floor
Portfolio discount rate is 5% and the current default Upside Portfolio
discount rate is 8%. Some household assets/investments may not be
either 100% or 0% risky and some spending liabilities may not be 100%
or 0% essential. In these situations, the discount rate will be adjusted
to reflect the percentage Upside for the specific asset/investment or
the percentage Essential for the specific expense. For example, a
default discount rate of 6.5% will be used to discount future asset
investment payment streams that are inputted as 50% Upside or expenses
that are inputted as 50% Essential, a 7.25% discount rate will be used
for an asset/investment inputted as 75% Upside and a 5.75% discount rate
will be used for an expense that is inputted as 75% Essential.
Discounting future payments in this manner to determine present values
is consistent with the two-bucket approach discussed in our post of November 5, 2023.From time to time, we are asked how the present
value of one’s household portfolio (Accumulated Savings) is calculated.
When we reply that it is simply the current value of the household’s
portfolio, we sometimes receive some push-back. Those who push back
sometimes argue that the discounted present value of the future stream
of payments that can be generated from their accumulated savings should
be greater than the current value of their accumulated savings. Others
suggest that in addition to including the current value of accumulated
savings in the present value of their assets/investments, they should
also add the expected future income generated by such accumulated
savings as “other income.” To these folks, we say, don’t double count
your assets, just input your current accumulated savings in the
appropriate cell, and this value will be included in the present value
of your assets.Let’s take a look at an example of why you should
simply enter the current value of your accumulated savings in the
appropriate input cell called “accumulated savings.”ExampleLet’s
assume Bill has $1,000,000 of accumulated savings that he has
determined is invested 60% in risky investments and 40% in non-risky
investments. Let’s also assume that Bill is using the default investment
return assumptions, so his accumulated savings are expected, under the
default assumptions, to generate annual income of $68,000 per annum 6.8%
per annum (.6 X .08 + .4 X .05) X $1,000,000] at the end of each year
if he does not touch his $1,000,000 principal. Let’s also assume that
Bill plans to do this for 30 years and cash in his $1,000,000 principal
at the end of the 30 years. We can use the AFP to determine the present
value of this stream of payments by using the other income cells and
inputting the following amountsNameAmountDeferral PeriodPayment PeriodAnnual Rate of Increase% UpsideOther inc. #1$68,0001300%60%Other inc. #2$1,000,0003010%60%The
PV Calcs tab shows us that the present value of the Other inc. #1
payments above is $861,049 and the present value of the Other inc. #2 is
$138,951 for a total of $1,000,000, the same present value as obtained
by simply inputting the current value of the accumulated savings. This
same result would be unchanged for other periods of deferral and assumed
investment returns (where the discount rate is set equal to the assumed
investment return).If Bill enters the above payment streams in
addition to entering the current value of his accumulated savings, he
would be double counting this asset. Therefore, we recommend that users
simply enter their accumulated savings in the appropriate cell and not
enter amounts relative to accumulated savings in other income cells.
Following this procedure will result in the correct amount being
included in the present value of household assets