Question
Part 1 Time Value of Money 1. Jamie wants to retire in 20 years. She thinks she will need to have $1,000,000 for her retirement
Part 1 Time Value of Money
1. Jamie wants to retire in 20 years. She thinks she will need to have $1,000,000 for her retirement in order to live on while she is no longer working. Were going to solve how much she should save each year if she thinks she can earn a 10% annual return on her investments.
The following is a step by step example and then Id like for you to use the same format to create your own retirement or savings goal.
The idea is we want to have a million dollars 20 years from now so that gives us our future value of $1,000,000 and the number of periods as 20.
Lets assume we dont have any money to start out with so our present value is 0.
FV = $1,000,000
N = 20
PV = 0
We have an opportunity to invest in a stock or project that will earn us 10% each year. Now, we just want to know how much we should put into the investment each year.
R = 10%
PMT = ?
We can use the online Time Value of Money calculator (or financial calculator or excel) and enter each of these values. Then click on payment and the answer will be revealed to be $17,459.62 that we need to save each year to be a millionaire and retire in 20 years.
http://www.zenwealth.com/businessfinanceonline/TVM/TVMCalculator.html
Notice the -$17,459.62 is negative because it is a cash flow that you are paying out each year.
If you save $17,459.62 each year without earning any interest on those funds, how much will you have in your retirement account after 20 years?
$17,459.62 x 20 = $349,192.40
Thats a lot less than a million dollars!!!! And thus, this is the power of compounding interest, and saving early and often.
Your Turn!
Now, try this with your own savings goal. You can choose for your savings to be $50,000 10 years from now to purchase a house. Or use the same retirement example, and change the interest rate (maybe you will invest in safe securities that only provide 2 or 3% interest). You can change any of the variables, fill them in below and solve for PMT which is the annual amount youll need to save to reach your personalized goal.
PV =
Pmt =
Rate =
N =
FV =
2. Terrell decided to attend Grad School to earn a PhD in finance and took out a student loan in the amount of $5,000 during his first year of school at an annual interest rate of 6%. He receives a scholarship in his second year and doesnt take out any other loans. He doesnt have to start paying back the loan until 6 months after he graduates, but the loan is not subsidized meaning the interest will accrue, or build up, while he is in school. How much will the loan balance be after his 4 years of school are complete?
Hint:
PV = $5k
Pmt = 0
Rate = 6
N = 4.5 (4 years of school, and start paying back 6 months after graduation)
FV = ?
You can also use the simple formula:
FV = 5000(1.06)^4.5 = ?
Note that the answer is not as follows because this solution does not take into account compounding interest:
$5,000 x 6% = $300 in interest
$300 x 4.5 years = $1,350
After 4 and a half years, Terrell will *not* owe $6,350.00 (your answer should be higher because his debt will increase each year, and interest gets charged on each previous years balance)
Part 2 - Investments
1. Describe the key difference between a stock and a bond.
2. Youve decided you want to sock away some savings for a rainy day, so you pick up a parttime job delivering pizzas on the weekends. After a month youve saved $1,000. Instead of it sitting in your checking account, youd like to invest it so you can put your money to work and start earning interest! Youre new to the stock market, so you do a little research on the best online brokerage firm to use.
Use online search tools to research 3 online brokers and compare them based on the following criteria. Examples of brokerage firms include Charles Schwab, TD Ameritrade, E*Trade, Robinhood, etc.
Name of Company:
Minimum balance to open an account:
Cost to buy or sell a security:
Other features:
Name of Company:
Minimum balance to open an account:
Cost to buy or sell a security:
Other features:
Name of Company:
Minimum balance to open an account:
Cost to buy or sell a security:
Other features:
Which brokerage will you invest your $1,000 with and why?
3. After a year of delivering pizza on the weekends, youve saved up $10,000! Think about how you will invest your funds and consider the following questions in your decision-making process:
Will you keep some of the funds in cash? Will you buy equities in the stock market? Government or corporate bonds? Real estate? How will you achieve diversity in your investments?
List your investments in the table below and a couple sentences below it describing your reasoning and what factors you considered in your decisions.
Investment (Name of specific security or ETF, mutual fund, commercial/residential rental property, etc) | Type (Equity, Bond, Real Property, etc) | Amount | % of Total |
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If you need to access some of these funds for an emergency or other opportunities such as higher education or professional certification, which of these assets is most and least liquid?
If you have funds invested with one of the stock brokers you researched above, and have an emergency come up where you need to access these funds, how many days will it take to get the funds from the brokerage firm back into your bank account?
Resource: http://finance.zacks.com/long-funds-clear-after-selling-stocks-6540.html
Would you consider this a liquid or illiquid investment?
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