*This is the first of a two-part series on calculating the value of your job, specifically the present value of your future potential earnings. Part one covers the math of how to calculate present value of future earnings and the implications for those on track for a normal retirement at age 65. Part two will cover the implications for people looking to retire early or downshift their careers and improve their lifestyle. Please read my earlier post on understanding present value for additional detail.*

## Introduction

One of the core concepts of present value is that for a given discount rate, a stream of cash flows can be turned into a lump sum and vice versa. If that concept is unfamiliar, just think about the Powerball jackpot. You can take a lesser amount and get all the money today or as a series of payments over the next 30 years that adds up to the advertised number. At some interest rate, the value of the money today is the same as the value of the money over time.

While none of us ever realistically have a shot of winning the lottery, it’s important to illustrate the concept. Why? Because there are any number of cash flows that can be thought of as a lump sum, including the one I want to talk about today: earnings from your job.

For most of us mere mortals, our ability productively work and earn an income likely represents our largest financial asset. While you wouldn’t necessarily include it in your net worth, there is value there that you can realize over time as you trade waking hours for a paycheck.

Others have written about this concept in some form before, namely the White Coat Investor here and here, along with USA Today. Those were mainly geared towards why you need disability insurance or to guard against burnout in order to protect the asset’s value. I agree with that sentiment, but wanted to focus more on actually valuing that future stream of earnings. In other words, how much is all your future earnings power worth today?

## How to Value Your Future Earnings Potential

In simple terms, your future earnings can be represented as what you’re earning today, with raises each year until you retire. That stream of cash flows is what is known as a growing annuity and can be valued using the following formula:

The four inputs you’ll need are:

**First Future Payment.**What you expect to make for the first period in the future. In other words, your current pay multiplied by one plus the growth rate. This is a quirk of the annuity formula, which assumes payments happen at the end of the period. If you just input your current pay, it would give you present value as of last year. You can use either gross or net pay, but realize that if you use gross, you’d technically need to include the negative present value of future taxes using the same formula. It should go without saying: the more you are making today, the higher all your future earnings will be worth (and the more you’d be giving up by retiring early or downshifting careers).**Rate per period.**The discount rate you select to bring future cash flows back to the present. Think about this as the numerical equivalent of time value of money. The lower the number, the more valuable your future earnings will be today.**Growth rate.**Your anticipated rate of increase in your annual pay. The increase in the annual payment works to offset the loss due to time value of money. The higher the growth rate, the higher the present value. You can have growth greater than the discount rate, but only if you have a finite number of periods. Otherwise the future growth completely outweighs time value of money and present value is infinite!**Number of periods.**The (finite) time between today and when your earnings will stop, i.e. retirement, early or otherwise.

If you plug those numbers into the formula above, the output is the present value of the your future earnings stream. Let’s look at a deliberately simple example:

Patty is a 22 year old who just got her first job out of college and has no assets or liabilities. She expects to work until she retires at age 65 (43 years of work). Her job pays $40,000 per year and she expects to earn a 3% raise each year she works. We’re going to select a discount rate of 2% too. Here is the result using the formula:

The result: $2,147,444! In other words, a recent graduate with nothing to her name other than a willingness to work is theoretically worth more money than a lot of people getting ready to retire. It’s amazing when you think about it that way.

## Future Earnings are a Depreciating Asset

While it’s great to see future earnings can be worth so much, don’t forget that this is actually a depreciating asset. Eventually you won’t be able to work anymore, at which point your future earnings potential will be exactly zero. Let’s look at our example above, but now see how the value of future earnings changes over time.

At age 22, the present value of future earnings is the ~$2.1 million we calculated above. It stays relatively stable through her twenties and early thirties, but starts declining after that. The pace of the decline picks up in her forties, and then even more in her fifties. At about age 55, half of the value has eroded with the remaining half disappearing in the last 10 years before retirement.

Why do we see the rate of decline increasing over time? It has to do with the interaction between time value of money and the number of periods remaining. In early years, you have lots of periods remaining, each of which gets a little more valuable as it moves closer to the present. That largely offsets the loss of the current period when it falls off (it moves into the past).

Think about it this way: at age 22, a dollar that Patty will earn at age 65 isn’t worth that much since it’s so far out in the future. At age 23, it’s still not worth a lot, but it is worth more than at age 22 because she’s one year closer to earning it. That same logic applies for every other future year. At the same time, a dollar Patty earned at age 22 is irrelevant to her future earnings at age 23, because she’s already earned it.

In later years, there are fewer future periods with dollars getting more valuable, but you still have the same current period falling off. There just isn’t enough positive impact from increasingly valuable future periods to stem the decline from loss in number of periods.

## Implications for “Normal” Retirement

If the PV of your future earnings is an asset, you’ll need to replace it with something different over time if you want to stay even. What you replace it with is savings into an investment portfolio.

Let’s revisit the example above one more time. Patty starts out with $0 of actual net worth, but a present value of future earnings of $2.1 million. At retirement, her present value of future earnings will be $0, therefore she’d need a net worth of $2.1 million to be in the same place she was at age 22.

She could do that through a combination of savings and investment returns. If you assume she saves 20% of each year’s pay, which then earns 5% each year, her “total” net worth over time will look like this:

She stays pretty close to the same total level throughout her career. As the value of future earnings decline, the portfolio’s returns make up the difference. In order to achieve this, however, she will need to consistently save a meaningful portion of earnings and generate returns on her investments. Unfortunately, this means that people starting to save later in their careers, when a lot of earnings value has already been realized, will likely never catch up to where they started. Bummer.

In other words, if you are young with many productive years of work ahead of you, don’t squander the tremendous asset you probably didn’t even know you had. We’ll all have to hang up the spurs someday. Savings is how you transform a fleeting, depreciating asset into something durable and sustainable.

Be sure to read part two to see the implications of early retirement or downshifting careers have on the numbers.

*John started Present Value Finance in 2017 to share his experiences and insights on personal finance to help people make better decisions and take control of their financial lives. *

*He achieved financial independence in 2016 by walking away from the high stress world of corporate finance to focus on his family. He’s a husband, father, family CFO, and all around finance geek.*

*He uses Personal Capital* to track his spending, investments and investments for free and recommends you do too.*

** Affiliate link.
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I’ve must have missed the memo, I never heard of this concept before! What an interesting way of looking at work and time. It makes going back to school sound a bit more risky!

Not if going back to school jumps up your earnings potential! That could more than make up for the time off work to get the degree.

I think the bigger risk is for people considering retiring early or downshifting their careers (which I’m covering in part two). The preview is that doing either of those things means you’re voluntarily impairing a really big asset. You may have plenty of money already or really good reasons to do it, but you need to make the decision weighing al the pros and cons. Financially at least, this is a pretty. If con.

As a math nerd, I loved how you actually share the formula and charts. It’s an interesting way to look at job vs going back to school vs early retirement. Good stuff.

From one math nerd to another, thanks!

It’s an interesting way to look at it but the issue I have is money is just a unit of measurement for value. The value comes in the things you do. As such that value also follows a similar trajectory. So one can make the arguement the two balance out.

Love this! A creative explanation of how early investing helps, and a reminder that there is plenty of value out there for someone who’s still low on the totem pole and not earning a lot.

You gave me flashbacks to so many of my finance courses haha. About time I see this used for something I actually care about! Great article!

I love the charts! I’ll have to bookmark this page and come back it later. Some of the material I forgot from my finance classes

Don’t worry, I have to refresh my memory on the exact math all the time. The trick is to remember it conceptually and fill in the specifics as needed.

If you like the graphs here, I think you’ll like what’s coming in part 2.

This makes me want to break out my TI-83 calculator. Math nerds unite! Thanks for the insightful post.

“Savings is how you transform a fleeting, depreciating asset into something durable and sustainable.”

Brilliant, my friend. What a great way to start my day–pondering the intricacies PV.

Thanks Mr Groovy! PV is a really powerful tool once you figure it out.

Sounds like a strong argument for the importance of saving in your twenties. It would be interesting to show the implication of different saving rates at the start of her career. This would show the crossover point at which compound interest and persistence become more valuable than her future earnings, i.e. when her money starts making more money than she does. Could be a good visual of the impact that a 40% savings rate has over a 20% and demonstrate that increasing savings decreases the time to retirement in an exponential manner rather than linear fashion.

Good idea. I was just trying to find a savings rate that would keep the total consistent over time, so any rate in excess of that will mean savings value grows faster than earnings depreciate.

I always know I can count on having your ideas backed up with solid mathematical formulas from you! Great work as always!

Thanks Rocky. Did you check out part two yet?