Investing Unit 2: Time Value of Money

Introduction Unit 1: Basic Building Blocks of Successful Financial Management Unit 2: Investing Basics Saving and Investing Risk Diversification Dollar-Cost Averaging Time-Value of Money Asset Allocation Investment Preferences Summary Action Steps About the Author Unit 3: Finding Money to Invest Unit 4: Ownership Investments Unit 5: Fixed-Income Investing Unit 6: Mutual Fund Investing Unit 7: Tax-Deferred Investments Unit 8: Investing with $mall Dollar Amount$ Unit 9: Getting Help: Investing Resources Unit 10: Selecting Your Team of Financial Professionals Unit 11: Investment Fraud Study Guide Action Steps Monthly Investment Messages Glossary

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 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.