# Investing Unit 2: Time Value of Money

## The Time Value of Money

Now that you understand the concepts of risk and return, let’s turn to an element that is at the heart and soul of building wealth and financial security…TIME.

Here is how time can work for you:

1. The longer you invest, the more money you will accumulate.
2. The more money you invest, the more it will accumulate because of the magic of compound interest.

Compounding works like this . . .

The interest earned on your investments is reinvested or left on deposit. At the next calculation, interest is earned on the original principal PLUS the reinvested interest. Earning interest on accumulated interest over time generates more and more money.

Compounding also applies to dividends and capital gains on investments when they are reinvested. The following illustration and questions give you a first-hand opportunity to calculate the impact of time on the value of your investment accumulation. Please complete the exercise below before moving ahead to the next section.

## How Time Affects The Value Of Money

Investor A invests \$2,000 a year for 10 years, beginning at age 25. Investor B waits 10 years, then invests \$2,000 a year for 31 years. Compare the total contributions and the total value at retirement of the two investments. This example assumes a 9 percent fixed rate of return, compounded monthly. All interest is left in the account to allow interest to be earned on interest.

Age Years Investor A Investor B
Contributions Year End Value Contributions Year End Value
25 1 \$2,000 \$2,188 \$0 \$0
26 2 2,000 4,580 0 0
27 3 2,000 7,198 0 0
28 4 2,000 10,061 0 0
29 5 2,000 13,192 0 0
30 6 2,000 16,617 0 0
31 7 2,000 20,363 0 0
32 8 2,000 24,461 0 0
33 9 2,000 28,944 0 0
34 10 2,000 33,846 0 0
35 11 0 37,021 2,000 2,188
36 12 0 40,494 2,000 4,580
37 13 0 44,293 2,000 7,198
38 14 0 48,448 2,000 10,061
39 15 0 52,992 2,000 13,192
40 16 0 57,963 2,000 16,617
41 17 0 63,401 2,000 20,363
42 18 0 69,348 2,000 24,461
43 19 0 75,854 2,000 28,944
44 20 0 82,969 2,000 33,846
45 21 0 90,752 2,000 39,209
46 22 0 99,265 2,000 45,075
47 23 0 108,577 2,000 51,490
48 24 0 118,763 2,000 58,508
49 25 0 129,903 2,000 66,184
50 26 0 142,089 2,000 74,580
51 27 0 155,418 2,000 83,764
52 28 0 169,997 2,000 93,809
53 29 0 185,944 2,000 104,797
54 30 0 203,387 2,000 116,815
55 31 0 222,466 2,000 129,961
56 32 0 243,335 2,000 144,340
57 33 0 266,162 2,000 160,068
58 34 0 291,129 2,000 177,271
59 35 0 318,439 2,000 196,088
60 36 0 348,311 2,000 216,670
61 37 0 380,985 2,000 239,182
62 38 0 416,724 2,000 263,807
63 39 0 455,816 2,000 290,741
64 40 0 498,574 2,000 320,202
65 41 0 545,344 2,000 352,427
Value at Retirement \$545,344 \$352,427
Less Total Contributions (\$20,000) (\$62,000)
Net Earnings \$525,344 \$290,427

Figure 3. How time effects the value of money, Source: National Institute for Consumer Education, 1998

Using the data for Investors A & B, answer the following questions.

1. At \$2,000 a year, how much did Investor A invest in the ten years between the ages of 25 and 35?
2. What is the value of Investor A’s investment when the Investor is 35?
3. At \$2,000 a year, how much did Investor B invest over the 31 years, from age 35 through 65?
4. What is the value at retirement of Investor A’s investment?
5. What is the value at retirement of Investor B’s investment?
6. What are Investor A’s net earnings?
7. What are Investor B’s net earnings?
8. What advice would you give to your children about investing for their retirement?

The answers to questions 1 – 7 can be found at the end of this unit.

Note that Investor A, who invested much less than Investor B, has a much higher nest egg at retirement age, because of a 10-year head start. As you can see from this example, compound interest is especially magical when money is steadily invested and left to grow over a long period.