1. Time Value of Money
Financial Literacy

2. Time Value of Money
Time value of money – Because you can receive interest on any money you have, money received today is worth more than money received in the future
For example, if you have $1000 today and receive 10% interest, it will be worth $1100 in a year
If you receive $1000 in a year, however,
it is only worth $1000

3. $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 (notice that you get more in interest every year because you are receiving interest on your original investment and also on the interest you have earned)
$1,000 Invested Compounded Annually at 10% Interest Rate
$1000 after 1 Year =
$1000 after 2 years
$ (.1 x 1000) =
$ = $1100
$ (.1 x 1100) =
$ = $1210

4. $1,000 Invested at 10% Simple Interest Rate
Simple interest -- Interest earned on the principal investment (not compounded)
Principal -- The original amount of money invested or saved
Amount invested x annual interest rate x number of years = interest earned (notice that you receive less in interest compared to the previous compounding example)
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

5. Three Factors Affecting the Time Value Calculations
Amount invested
Interest rate

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

7. A Little Goes a Long Way
At age 23, 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

8. 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

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

10. The Costs Add Up Investing at age 18 at 8% interest until age 65. Item
Average Yearly Expense
Future Value
Daily cup of coffee or hot chocolate at $2.50
$912.50
$446,333.10
Eating lunch out 5 days per week at a cost of $5-$10 each time
$1, $2,600.00
$635,871.81
$1,271,743.63
Daily can of soda or chips at $1.00 each or both a can of pop and chips $2.00
$365.00
$730.00
$178,533.24
$357,066.48

11. 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%
$1,040.00
$1,221.00
$1,490.83 6%
$1,060.00
$1,348.85
$1,819.40

12. Risk A higher interest rate generally has a greater risk
Risk -- The uncertainty of the outcome of an investment
Example: Investing money in the stock market generally provides a high return, but it is riskier—you may lose more money than you gain

13. 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

14. 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
Example: If an individual has money invested at 4% interest and the inflation rate is 4%, the individual’s wealth will stay the same

15. 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.

16. Time Value of Money Calculations (cont.)
Present value
PV=(FV)(1+i)-N
Future value
FV=(PV)(1+i)N
FV=(PV)(1+i)(Yx)N
eg. 20,000 x 1.05(Yx)5
Future Value of an Annuity
FV(A)=(A x (1+i)N -1) / i
Financial calculators may be used to complete these calculations.

17. 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)

18. Review Compounding interest earns interest on interest
Increased time=more interest earned
Higher principal=more interest earned
Higher interest rate=more interest earned