Family Economics & Financial Education Time Value of Money Family Economics & Financial Education

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

$1,000 Invested Compounded Annually at 10% Interest Rate 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 Year 2 Years $1,104.71 $1,220.39

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 Year 2 Years $1,100.00 $1,200.00 $1,000 Invested at 10% Simple Interest Rate 1 Year 2 Years $1,100.00 $1,200.00

Three Factors Affecting the Time Value Calculations Amount invested Interest rate

Time The earlier an individual invests, the more time their investment has to compound interest and increase in value

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

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 $17,865.52 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

Amount Invested continued 70-20-10 Rule 70% Spent 20% Saved 10% Invested Flexible expenses can be decreased in order to increase the amount a person is able to invest

The Costs Add Up Investing at age 18 at 8% interest until age 65. Item Average Yearly Expense Future Value Daily cup of coffee at $2.50 $912.50 $38,704.46 Eating lunch out 5 days per week at a cost of $5-$10 each time $1,300.00-$2,600.00 $55,140.60 $1,10281.21 Daily can of soda or chips at $1.00 each or both a can of pop and chips $2.00 $365.00 $730.00 $15,481.78 $30,963.57 Daily candy bar at $1.00

Interest Rate The percentage rate paid on the money invested or saved Higher interest=more money earned $1,000 Invested Compounded Monthly Interest Rate 1 Year 5 Years 10 Years 4% $1,040.74 $1,221.00 $1,490.83 6% $1,061.68 $1,348.85 $1,819.40

Risk A higher interest rate generally has a greater risk Risk -- The uncertainty of the outcome of an investment

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

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

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.

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)

Review Compounding interest earns interest on interest Increased time=more interest earned Higher principle=more interest earned Higher interest rate=more interest earned