Time Value of Money Family Economics & Financial Education Take Charge of Your Finances

G1 © Family Economics & Financial Education – Revised March 2009– Saving Unit – Time Value of Money Funded by a grant from Take Charge America, Inc. to the Norton School of Family and Consumer Sciences at the University of Arizona Time value of money  Time value of money -- Money to be paid out or received in the future is not equivalent to money paid out or received today.

G1 © Family Economics & Financial Education – Revised March 2009– Saving Unit – Time Value of Money Funded by a grant from Take Charge America, Inc. to the Norton School of Family and Consumer Sciences at the University of Arizona Compounding interest  Compounding interest -- Earning interest on interest.  “Make your money work for you.” Developed because compounding interest causes money to make money. $1,000 Invested Compounded Annually at 10% Interest Rate 1 Year2 Years $1,104.71$1,220.39

G1 © Family Economics & Financial Education – Revised March 2009– Saving Unit – Time Value of Money Funded by a grant from Take Charge America, Inc. to the Norton School of Family and Consumer Sciences at the University of Arizona Simple interest  Simple interest -- Interest earned on the principal investment. Principal -- The original amount of money invested or saved.  Amount invested x annual interest rate x number of years = interest earned. Ex. 1,000 x 0.10 x 2=$200 $1,000 Invested at 10% Simple Interest Rate 1 Year2 Years $1,100.00$1, $1,000 Invested at 10% Simple Interest Rate 1 Year2 Years $1,100.00$1,200.00

G1 © Family Economics & Financial Education – Revised March 2009– Saving Unit – Time Value of Money Funded by a grant from Take Charge America, Inc. to the Norton School of Family and Consumer Sciences at the University of Arizona Three factors affecting the time value calculations  Time  Amount invested  Interest rate

G1 © Family Economics & Financial Education – Revised March 2009– Saving Unit – Time Value of Money Funded by a grant from Take Charge America, Inc. to the Norton School of Family and Consumer Sciences at the University of Arizona Time  The earlier an individual invests, the more time their investment has to compound interest and increase in value.

G1 © Family Economics & Financial Education – Revised March 2009– Saving Unit – Time Value of Money Funded by a grant from Take Charge America, Inc. to the Norton School of Family and Consumer Sciences at the University of Arizona A little goes a long way  Sally Saver puts away $3,000 per year in her IRA account earning 10% - she does this for 10 years then stops.  Sally accumulates $1,239,564 by the age of 65.  Ed Uninformed waits until he is 28. He must contribute $3,000 to his IRA account earning 10% for 38 years.  Ed accumulates $1,102,331 by the age of 65.

G1 © Family Economics & Financial Education – Revised March 2009– Saving Unit – Time Value of Money Funded by a grant from Take Charge America, Inc. to the Norton School of Family and Consumer Sciences at the University of Arizona Amount invested  Investing only a small amount a month is better than not investing at all. Ex. At 8% interest, invested at age 17, one dollar per day will become $17, by age 65.  The larger the amount invested the greater return a person will earn.  Always pay yourself first. Savings should be a fixed expense.

G1 © Family Economics & Financial Education – Revised March 2009– Saving Unit – Time Value of Money Funded by a grant from Take Charge America, Inc. to the Norton School of Family and Consumer Sciences at the University of Arizona Amount invested continued  Rule 70% Spent 20% Saved 10% Invested  Flexible expenses can be decreased in order to increase the amount a person is able to invest.

G1 © Family Economics & Financial Education – Revised March 2009– Saving Unit – Time Value of Money Funded by a grant from Take Charge America, Inc. to the Norton School of Family and Consumer Sciences at the University of Arizona The costs add up ItemAverage Yearly ExpenseFuture Value Eating lunch out 5 days per week at a cost of $5-$10 each time $1, $2,600.00$55, $110, Daily candy bar$365.00$15, Monthly gym membership at $38.00 $456.00$19, Monthly hair cut at $25.00 per month $300.00$12,  The future value problems are calculated for an 18 year old person investing at 8% until age 65.

G1 © Family Economics & Financial Education – Revised March 2009– Saving Unit – Time Value of Money Funded by a grant from Take Charge America, Inc. to the Norton School of Family and Consumer Sciences at the University of Arizona Interest rate  The percentage rate paid on the money invested or saved.  Higher interest=more money earned $1,000 Invested Compounded Monthly Interest Rate1 Year5 Years10 Years 4%$1,040.74$1,221.00$1, %$1,061.68$1,348.85$1,819.40

G1 © Family Economics & Financial Education – Revised March 2009– Saving Unit – Time Value of Money Funded by a grant from Take Charge America, Inc. to the Norton School of Family and Consumer Sciences at the University of Arizona Risk  A higher interest rate generally has a greater risk. Risk -- The uncertainty of the outcome of an investment.

G1 © Family Economics & Financial Education – Revised March 2009– Saving Unit – Time Value of Money Funded by a grant from Take Charge America, Inc. to the Norton School of Family and Consumer Sciences at the University of Arizona Fixed interest rate  Fixed interest rate -- The rate will not change for the lifetime of the investment.  Having a savings or investment plan with a fixed interest rate guarantees a specific return but can provide a moderate risk. If the average interest rates rise, the amount a person earns from this type of investment will not increase.

G1 © Family Economics & Financial Education – Revised March 2009– Saving Unit – Time Value of Money Funded by a grant from Take Charge America, Inc. to the Norton School of Family and Consumer Sciences at the University of Arizona Inflation  Another consideration with interest rates is ensuring the interest rate is higher than the rate of inflation. Inflation -- The steady rise in the general level of prices. Ex. If an individual has money invested at 4% interest and the inflation rate is 4%, the individual’s wealth will stay the same.

G1 © Family Economics & Financial Education – Revised March 2009– Saving Unit – Time Value of Money Funded by a grant from Take Charge America, Inc. to the Norton School of Family and Consumer Sciences at the University of Arizona Time value of money calculations  Present value PV=(FV)(1+i) -N  Future value FV=(PV)(1+i) N  Financial calculators may be used to complete these calculations.

G1 © Family Economics & Financial Education – Revised March 2009– Saving Unit – Time Value of Money Funded by a grant from Take Charge America, Inc. to the Norton School of Family and Consumer Sciences at the University of Arizona Calculation components  Present value (PV) -- How much money a person has today.  Future value (FV) – How much money a person expects to have in the future.  Interest rate (i) – The percentage rate paid on the money invested or saved.  Time (N) -- Length of investment Calculated by the number of compounding periods. (daily, monthly, or annually)

G1 © Family Economics & Financial Education – Revised March 2009– Saving Unit – Time Value of Money Funded by a grant from Take Charge America, Inc. to the Norton School of Family and Consumer Sciences at the University of Arizona Review  Compounding interest earns interest on interest.  Increased time=more interest earned  Higher principal=more interest earned  Higher interest rate=more interest earned

G1 © Family Economics & Financial Education – Revised March 2009– Saving Unit – Time Value of Money Funded by a grant from Take Charge America, Inc. to the Norton School of Family and Consumer Sciences at the University of Arizona What would you do? $ Invested at an 8% interest rate AgeAmount Earned 17$ $ $ $ $2, $4,  If participants choose to invest the money into an account earning 8% interest compounded annual at age 17 and leave the money invested until age 65, they will earn $4,

G1 © Family Economics & Financial Education – Revised March 2009– Saving Unit – Time Value of Money Funded by a grant from Take Charge America, Inc. to the Norton School of Family and Consumer Sciences at the University of Arizona What would you do? $ Invested at an 8% interest rate AgeAmount Earned 17$ $ $ $ $ $1,  What if the participant chooses to invest $30.00?