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

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.

Average Yearly Expense The costs add up The future value problems are calculated for an 18 year old person investing at 8% until age 65. Item Average Yearly Expense Future Value Eating lunch out 5 days per week at a cost of $5-$10 each time $1,300.00-$2,600.00 $55,140.60 - $110,281.21 Daily candy bar $365.00 $15,481.78 Monthly gym membership at $38.00 $456.00 $19,341.63 Monthly hair cut at $25.00 per month $300.00 $12,724.75

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 principal=more interest earned Higher interest rate=more interest earned

$100.00 Invested at an 8% interest rate What would you do? 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 $4,593.63. $100.00 Invested at an 8% interest rate Age Amount Earned 17 $100.00 25 $189.25 35 $420.06 45 $932.38 55 $2,069.54 65 $4,593.63

$100.00 Invested at an 8% interest rate What would you do? What if the participant chooses to invest $30.00? $100.00 Invested at an 8% interest rate Age Amount Earned 17 $30.00 25 $56.77 35 $126.02 45 $279.71 55 $620.86 65 $1,378.09