Question

Kim just won the $1 million lottery. She has two choices for how she can receive her winnings. She can either get a lump sum payment of $630,000 today (after taxes), or she can receive her $1 million winnings in equal yearly payments for 20 years.

Which of the following actions should Kim take that would make the best use of her winnings long term?

A.
Accept the lump sum payment and deposit it into a savings account.
B.
Accept the yearly payments and invest in bonds each year.
C.
Accept the yearly payments and deposit the payments into a savings account.
D.
Accept the lump sum payment and invest it in a diversified portfolio.

Answer 1

Answer: The best choice for Kim's long-term financial benefit would likely be:

• D. Accept the lump sum payment and invest it in a diversified portfolio.

Here's the reasoning:

Time Value of Money: The time value of money principle suggests that a dollar received today is worth more than a dollar received in the future due to the potential for investment returns and inflation. By choosing the lump sum, Kim can immediately invest the money and potentially benefit from compounding returns over time.

Investment Opportunity: By investing the lump sum in a diversified portfolio, Kim has the potential to earn higher returns compared to a savings account or bonds. A well-diversified investment portfolio can provide the opportunity to grow her wealth over the long term.

Control over Investments: With the lump sum, Kim has more control over her investments and can adjust her portfolio to suit her risk tolerance and financial goals. This level of control is not as readily available with the yearly payments.

Inflation Consideration: Over a period of 20 years, inflation can erode the purchasing power of fixed yearly payments. A lump sum investment approach has the potential to better hedge against inflation.

While the other options might provide some level of financial security, investing the lump sum in a diversified portfolio generally offers the greatest potential for long-term growth and financial stability. However, it's important for Kim to consult with financial advisors and make informed decisions based on her individual financial situation and goals.