1. Time Value of Money Family Economics & Financial Education

2. 14.5.G1 © Family Economics & Financial Education – Revised November 2004 – Saving Unit – Time Value of Money Funded by a grant from Take Charge America, Inc. to the Department of Health and Human Development at Montana State University – Bozeman 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

3. 14.5.G1 © Family Economics & Financial Education – Revised November 2004 – Saving Unit – Time Value of Money Funded by a grant from Take Charge America, Inc. to the Department of Health and Human Development at Montana State University – Bozeman 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

4. 14.5.G1 © Family Economics & Financial Education – Revised November 2004 – Saving Unit – Time Value of Money Funded by a grant from Take Charge America, Inc. to the Department of Health and Human Development at Montana State University – Bozeman 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$1,200.00 $1,000 Invested at 10% Simple Interest Rate 1 Year2 Years $1,100.00$1,200.00

5. 14.5.G1 © Family Economics & Financial Education – Revised November 2004 – Saving Unit – Time Value of Money Funded by a grant from Take Charge America, Inc. to the Department of Health and Human Development at Montana State University – Bozeman Three Factors Affecting the Time Value Calculations  Time  Amount invested  Interest rate

6. 14.5.G1 © Family Economics & Financial Education – Revised November 2004 – Saving Unit – Time Value of Money Funded by a grant from Take Charge America, Inc. to the Department of Health and Human Development at Montana State University – Bozeman Time  The earlier an individual invests, the more time their investment has to compound interest and increase in value

7. 14.5.G1 © Family Economics & Financial Education – Revised November 2004 – Saving Unit – Time Value of Money Funded by a grant from Take Charge America, Inc. to the Department of Health and Human Development at Montana State University – Bozeman 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

8. 14.5.G1 © Family Economics & Financial Education – Revised November 2004 – Saving Unit – Time Value of Money Funded by a grant from Take Charge America, Inc. to the Department of Health and Human Development at Montana State University – Bozeman 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

9. 14.5.G1 © Family Economics & Financial Education – Revised November 2004 – Saving Unit – Time Value of Money Funded by a grant from Take Charge America, Inc. to the Department of Health and Human Development at Montana State University – Bozeman 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

10. 14.5.G1 © Family Economics & Financial Education – Revised November 2004 – Saving Unit – Time Value of Money Funded by a grant from Take Charge America, Inc. to the Department of Health and Human Development at Montana State University – Bozeman The Costs Add Up ItemAverage Yearly ExpenseFuture 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$365.00$15,481.78 Investing at age 18 at 8% interest until age 65.

11. 14.5.G1 © Family Economics & Financial Education – Revised November 2004 – Saving Unit – Time Value of Money Funded by a grant from Take Charge America, Inc. to the Department of Health and Human Development at Montana State University – Bozeman 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$1,490.83 6%$1,061.68$1,348.85$1,819.40

12. 14.5.G1 © Family Economics & Financial Education – Revised November 2004 – Saving Unit – Time Value of Money Funded by a grant from Take Charge America, Inc. to the Department of Health and Human Development at Montana State University – Bozeman Risk  A higher interest rate generally has a greater risk Risk -- The uncertainty of the outcome of an investment

13. 14.5.G1 © Family Economics & Financial Education – Revised November 2004 – Saving Unit – Time Value of Money Funded by a grant from Take Charge America, Inc. to the Department of Health and Human Development at Montana State University – Bozeman 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. 14.5.G1 © Family Economics & Financial Education – Revised November 2004 – Saving Unit – Time Value of Money Funded by a grant from Take Charge America, Inc. to the Department of Health and Human Development at Montana State University – Bozeman 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

15. 14.5.G1 © Family Economics & Financial Education – Revised November 2004 – Saving Unit – Time Value of Money Funded by a grant from Take Charge America, Inc. to the Department of Health and Human Development at Montana State University – Bozeman 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. 14.5.G1 © Family Economics & Financial Education – Revised November 2004 – Saving Unit – Time Value of Money Funded by a grant from Take Charge America, Inc. to the Department of Health and Human Development at Montana State University – Bozeman 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)

17. 14.5.G1 © Family Economics & Financial Education – Revised November 2004 – Saving Unit – Time Value of Money Funded by a grant from Take Charge America, Inc. to the Department of Health and Human Development at Montana State University – Bozeman Review  Compounding interest earns interest on interest  Increased time=more interest earned  Higher principle=more interest earned  Higher interest rate=more interest earned