MoneyCounts: A Financial Literacy Series Time Value of Money 11-A Grange Building University Park, PA 16802 financialliteracy.psu.edu finlit@psu.edu 814-863-0214

Description Time value of money (TVM): Money that is available at the present time is worth more than the same amount in the future, due to its potential earning capacity TVM includes that provided money can earn interest, and any amount of money is worth more than the sooner it is received Money has a time value attached to it A dollar was worth more yesterday than today A dollar today is worth more than a dollar tomorrow

Learning Outcome Understand interest rates, types and terminology about TVM Understand APR (annual percentage rate) Learn to read an amortization schedule Understand TVM impact on debts Understand TVM impact on investments

The number of period (N) What is TVM? Present Value (PV) Future Value (FV) The number of period (N) TIME MONEY Interest rate (I)

TVM simplified Q If you invest one dollar (PV) for one year (N) at 6% (I), how much will you receive? A $1.06 (FV) Q What is the present value of $1.06 you expect to receive in one year? A $1.00 (PV)

Types of interest rates Simple Interest Rate Compound Interest Rate Fixed Interest Rate Variable Interest Rate Mixed Interest Rate

Q A Simple Interest Rate $1,000 invested for ten (10) years at 5% yearly simple interest will yield by the end of ten years? A 1000 + (1,000 x 0.05 x10) = $1,500.00

Q A Compound Interest Rate $1,000  invested for ten (10) years at 5% interest compounded quarterly (4 times a year) will yield by the end of ten years? Q A 1000 + ((1,000 x(1.0125)40) = $1,643.62

Fixed Interest Rate Fixed interest rate is a straight forward rate that remains constant during the life of the loan or investment. A 30 year mortgage at 4.25% A 5 year car loan at 6.8%

Variable Interest Rate Variable interest rate changes during the life of the loan and is usually tied to the prime rate. It can go up or down depending on the prime rate set forth by the Federal Reserve. Credit card interest rates

Mixed Interest Rate Mixed interest rate changes from fixed to variable or from variable to fixed. It has some merits depending on your situation, but it is not a rate you would want to choose for a long-term investment or debt. A 30 year mortgage with low interest for the first 5 years, but you plan to sell and move before the increase in the rate!

APR What is APR? APR = Annual Percentage Rate Interest Rate Points Mortgage Broker Fee Other Charges Points Compare APR credit cards to find the best rate

APR 365 days DPR What is DPR? DPR = Daily Percentage Rate Interest charged daily accumulate faster than interest charged monthly or yearly (compounding)

What is Amortization? An amortized loan is a loan with scheduled, periodic payments that consist of both principal and interest. An amortized loan payment pays the relevant interest expense for the period before any principal is paid and reduced.

Amortization More principal, less interest in next months Same amount of payment each month P: Principal I: Interest More principal, less interest in next months Amortization

Amortization Schedule Pmt # Payment Principal Interest Balance 1 1,656.61 331.61 1,325.00 299,668.39 2 333.07 1,323.54 299,335.32 3 334.55 1,322.06 299,000.77 4 336.02 1,320.59 298,664.75 5 337.51 1,319.10 298,327.24 6 339.00 1,317.61 297,988.24 7 340.50 1,316.11 297,647.74 8 342.00 1,314.61 297,305.74 9 343.51 1,313.10 296,962.23 10 345.03 1,311.58 296,617.20 11 346.55 1,310.06 296,270.65 12 348.08 1,308.53 295,922.57 Year 1 4,077.43 15,801.89 Principal: $300,000.00 Interest Rate: 5.25% Payment Interval: Monthly # of Payments: 360 Payment: $1656.61

Impact of TVM on Debt Debts grows bigger with time! Debt TVM

Opportunity Cost You can’t have your cake and eat it too!!! Is the item worth the extra payments (plus interest) I will have to make to pay it off? Is the opportunity cost of giving up the potential earning of interest acceptable for my financial goals? Is acquiring the desired item on credit is more meaningful to my financial freedom and security than saving and investing?

Impact of TVM on Investment Investments grow bigger with time! $$ Invest now Get more in future TVM

Planning for retirement Planning for retirement is an example for calculating various scenarios How much money should I invest now to reach a certain annuity in the future? How much money should I expect to receive if I invest a predetermined amount now?

Invest Early! The longer you wait to start investing, the more money you need to invest to reach your goal for a final retirement value

Final Retirement Value Starting Age 25 35 Total Investment $55,000 $130,000 Final Retirement Value $615,580 $431,754 *Annual Return: 8%

MoneyCounts: A Financial Literacy Series Comments and questions 11A Grange Building University Park, PA 16802 financialliteracy.psu.edu finlit@psu.edu 814-863-0214