“Today’s program looks at accounting for the future. Mike, many decisions we make involve money or resources either received or spent in the future. Investing, taking out a loan or going to college are good examples. When faced with these futurist decisions, are there special factors we need to consider?”
“There really are, and I think if someone sat down and thought about it they would know this. For example, if you’re considering having a salary, let’s say, of $50,000 in 10 years you know that’s not the same as $50,000 today because in 10 years you’re going to have inflation. Even if it’s at the rate of two percent a year that’s going to take 20-25 percent away of your purchasing power.”
“Also economists would argue you need to factor in the fact that if you have the money now you can always invest it and create more money in the future. So those are the two main reasons why economists say if you’re comparing money in the future to money now, or really money at any point in time, you need to put them on the same level by doing something called discounting.”
“Now I’m not going to get in the weeds about discounting, but simply what it says is you pick an interest rate, and usually these interest rates are given to you, at which you discount future dollars. So for example, if you’re discount rate is three percent you would say that a dollar a year from now is only worth 97 cents today. A dollar two years from now is worth 94 cents today, et cetera. And that simple technique will allow you to compare dollar amounts over time.”
“It doesn’t matter if they’re dollars you’re paying or receiving, and as one example of this if you look, for example, at college education. If the individual goes to say a four-year public college, maybe they spend $60,000 going to that. They might say, ‘My gosh, was it worth it?’ Well if you look at the on average future additional earnings of a college grad versus a high school grad, and you even discount that money, it turns out to be worth about a million dollars today. So clearly in that example going to college is well worth it, and discounting shows you how to prove it.”
Mike Walden is a William Neal Reynolds Distinguished Professor and Extension Economist in the Department of Agricultural and Resource Economics at North Carolina State University who teaches and writes on personal finance, economic outlook and public policy.