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  • 1. Time is Money: Personal Finance Applications of the Time Value of Money Barbara O’Neill, Ph.D, CFP
  • 2. Time : A Financial Management Tool
    • “A penny saved is a penny earned”
    • “Time is money”
    • “I’m on the clock”
    • “I’m buying myself some time”
    • “Timing is everything”
    • Albert Einstein: quote about compound interest
    Too many young people don’t appreciate the awesome power of the time value of money!!!
  • 3. Time Reduces Investment Volatility Source : Ibbotson Associates
  • 4. So What Exactly Is The Time Value of Money? (Review)
    • Key message of remainder of class:
    • Compound interest can be...
    • Your worst enemy (credit card debt)
    • Your best friend (5+ decades of compound interest)
    The choice is up to you!
  • 5. Ways to Calculate TV of Money
    • Mathematically
    • Financial calculator (e.g. TI-BA35)
    • Computer spreadsheets with formulas
      • (e.g., Microsoft Excel)
    • TV of money interest factor tables
  • 6. Let’s Review
    • Future value of a lump sum
      • Example: Value of $10,000 gift today in 20 years
      • 8% i, N =20, FVF =4.6610 ($46,610)
    • Present value of a lump sum
      • Example: Value of a $10,000 gift in 20 years today
      • 8%i, N =20, PVF =.2145 ($2,145)
  • 7. More Review: What Is An Annuity?
    • Two types of annuities (according to timing of receipt or payment of $)
    • Ordinary Annuity: payment at end of period
      • Examples: bank account interest, stock dividends, car note, mortgage
    • Annuity Due: payment at start of period
      • Examples: insurance premiums, leases
  • 8. Which Type of Annuity is Better If You’re an Investor?
  • 9. Annuity Due
    • The sooner a dollar is received, the sooner the compounding process begins
    • FV and PV of an annuity due are always greater than FV and PV of ordinary annuity
      • Common Example: Funding an IRA on Jan. 1 versus April 15 of the following year
    • Compound interest magnifies the difference in returns over time
  • 10. Key Variables in TV of Money Problems
    • N- Number of compounding periods
    • % i- Interest rate (for compounding FV or discounting PV)
    • PV
    • FV
    • For annuity calculations, periodic payment
    • or receipt amount
      • Enter 3 known variables; solve for the 4th (unknown) variable
  • 11. Problem #1
    • Your first “real” job pays $32,000 a year to start. How much will you need to be earning in 20 years to maintain the same purchasing power if inflation averages
    • 3%?
    • 4%?
    • 5%?
  • 12. Problem #2
    • Your grandparents (age 60 and 62) are about to retire next month with a monthly income of $2,000. Assuming an annual inflation rate of 4%, how much will they need in 10 years to equal the purchasing power of $2,000 today?
    • 20 years?
    • 30 years?
  • 13. What can your grandparents do to prevent inflation from eroding their purchasing power?
  • 14. Problem #3
    • Your rich uncle has promised to give you $25,000. The only “catch” is that you must graduate from college and get a “real job” before he gives it to you. Let’s assume that’s in 4 years. What is the value of his gift today if his money is earning
    • 5%?
    • 7%
    • 10%
  • 15. Problem #4
    • Kevin is 19 and wants to have $10,000 saved by the time he’s 25. Thanks to a generous gift from his grandparents, he currently has $6,500 invested in a bond paying 5%. If he makes no further deposits, will he reach his goal?
  • 16. How could Kevin reach (or exceed) his goal?
  • 17. Problem #5
    • Heather starts a Roth IRA at age 22. She plans to contribute $3,000 at the end of each year year for 45 years until age 67. How much will she have if her IRA investments earn 4% ?
    • 7% ?
    • 9% ?
  • 18. $3,000 a Year is About $60 a Week of Savings
    • How can Heather “find” $60 a week to invest in her Roth IRA?
  • 19. Problem #6
    • Wendy and Sal just got married and want to save $15,000 for a down payment and closing costs on their first house. They intend to save $500 per month in CDs averaging a 4% annual return. How long will it take them to reach their goal?
    Hints: Use a financial calculator…The answer is less than 5 years!
  • 20. Problem #7
    • You quit smoking a pack a day of cigarettes and save $2,550 a year (savings of $7 per pack per day). You are 20. How much would you have if you invested the money in a stock index fund averaging a 10% return and don’t touch it until age 55?
  • 21. Problem #8
    • Lucky you…you won the NJ lottery. You have a choice between receiving $1,000,000 as an annuity of $50,000 a year over 20 years or taking $500,000 as a lump sum payment today. Ignoring taxes for the moment and, assuming a discount rate of 6%, which option is the best deal?
  • 22. Problem #9
    • You want a $1 million dollars when you retire and will average a 10% return. How much do you need to save per year if you have…
    • 40 years to save?
    • 30 years to save?
    • 20 years to save?
    • 10 years to save?
    What do these results tell you?
  • 23. Problem #10
    • Your grandparents, both age 62, have a retirement fund of $100,000 saved to supplement their pension and Social Security. Assuming an average annual interest rate of 7%, how long will the fund last if they withdraw $750 per month? What would you advise them to do?
  • 24. Two Take-Home Messages: 1. For every decade that you delay saving, the required investment triples (approx.) 2. Compound interest is NOT retroactive!!!
  • 25. The Millionaire Game: A Perfect Metaphor For Compound Interest
  • 26. A: Answer A C: Answer C B: Answer B D: Answer D 50:50 15 14 13 12 11 10 9 8 7 6 5 4 3 2 1 $1 Million $500,000 $250,000 $125,000 $64,000 $32,000 $16,000 $8,000 $4,000 $2,000 $1,000 $500 $300 $200 $100
  • 27. YOU WIN $1 MILLION DOLLARS!