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.”
Example
Let’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 amounts
Name | Amount | Deferral Period | Payment Period | Annual Rate of Increase | % Upside |
Other inc. #1 | $68,000 | 1 | 30 | 0% | 60% |
Other inc. #2 | $1,000,000 | 30 | 1 | 0% | 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
