Page 1 | PPT-INFN-01-001-1009-01Effective Date: 01OCT2009

Getting Rich via Compounded Interest

Introduction

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Objectives

Risk / Reward

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Do

You want to be a

Millionaire?

What would you do with all that

Money?

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How am I going to

become a Millionaire?

How do I choose

which idea to pursue?

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Risk / Reward Model

Risk:

Reward:

What’s the RISK for pursuing …..

vs

What’s the REWARD for pursuing …..

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Model for Evaluating Investment Ideas

Reward

Low High

Risk

Low

High Don’t do this! Why?

Fill in the cells with the investment ideas from

class discussion.

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Model for Evaluating Investment Ideas

Reward

Low High

Risk

Low • Savings with Compound Interest

• Permanent Life Insurance

• Variable Annuity

• Options

High Don’t do this! Why?• Play the Lottery

• Start a Business• Invest in Stock M

arket

• What else could be added to this model to make it better?– Tax implications– Likelihood of success

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Objective

Using a compound interest model,

If you deposit your money in a bank ….

that pays compound interest …..% / Time

how long until

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Compound Interest – What is it?

• Interest - is a fee paid on borrowed assets.1. It is the price paid for the use of

borrowed money (auto loan, house mortgage)

OR2. Money earned by deposited

funds.

Compound Interest?

Deposited funds X interest in % / time = Money Earned

Xinterest in units of

%/time = /time

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Compound Interest: Continued

• The units of interest: [Interest] = % / Time– 6% / year for example

• For calculations, remember to convert %’s to decimals

• Interest – money earned on funds depositedCompound

Interest?

Deposited Funds X Interest Money Earned

Percent (%) Decimal

Given 6% 6% = 6/100 = 0.06

0.06 x 100 = 6% Given 0.06

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An Example

• Deposited Funds = $10000• Interest = 6% / Year

What is the interest earned in 1 Year?Interest Earned = Deposited Funds x Interest

Interest Earned = $10000 x 6/100Interest Earned = $60

What is the future value of your deposit after 1 Year?

Future Value = Deposited Funds + Interest EarnedFuture Value = $10000 + $60Future Value = $10060

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Compound Interest: Continued

$1000 Today x 6% Interest / year $60 earned in one

year

Compound interest is interest earned on interest!

OK, but what is Compound Interest?

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Compound Interest: Continued

Year # Present Value

Interest Earned in One Year

Future Value of Deposit

0 - Today $1000 $60 $1060

If I leave $1000 deposited for 2 Years, how much will I have at the end of 2 Years at 6% interest / year?

1 $1060 $63.6 $1123.60

2 $1123.60

And So On . . . !

I got paid 6% interest on the $60 in interest I earned!!

End of year 1

End of year 2

$1060 X 0.06 = ($1000 + $60) X 0.06OR

($1000 + $60) X 0.06 = ($1000 X 0.06) + ($60 X 0.06)

Interest on Interest!

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Compound Interest: Continued

• Compound Interest - arises when interest is added to the initially deposited funds or principal, so that from that moment on, the interest that has been added also itself earns interest.

• Compound interest has a compounding period– Compounding period is the interval of time until earned

interest is added to the principal

Example: 12% interest / year, compounded monthly

12% / Year12 Months / Year

= 1% / Month

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Compound Interest: Activity

• In groups of 2,– Describe and demonstrate the concept of compound interest using

anything BUT formulas and / or numbers

You may use wordsOR

You may use drawingsOR

You may use manipulativesOR

You may use ?• You have 10 minutes to create your solution. Pick a

representative from your group and share your solution with the class.

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Compound Interest: Example

You have recently graduated from Acme University with a Masters in Mathematics. Luckily for you, the economy was chugging along nicely when you graduated. Jobs were plentiful. You had several interviews and accepted a position at better than expected pay and benefits doing something that sounded good during the interview. Unfortunately, it sounded better than it is. After six years in college you have become acclimated to the college life and making the transition to the 40+ hours per week for 50 weeks a year has been tough. In fact, you hate it, and have vowed to find a way to retire young.

To retire you must have money to live on. Looking back at your spending habits during college, you have deduced that a million dollars in savings would be enough for you to retire with. Hence, you have decided to put your math skills to work to figure out how long it will take to save a million dollars.

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Compound Interest: Example Continued

Mom and Dad have given you a good start. Mom and Dad were so proud of your academic accomplishments that they gave you $10,000 at graduation. You don’t want to take a lot of risk with your $10,000 nest egg so you have decided to invest this money in government bonds since your research has shown that you can get, on average, a 6% yearly return compounded monthly. Further, your frugal nature has kept your living expenses low and you estimate that you can save 10% of your $5000 monthly salary if need be. With a partner;

1. (10 minutes) Develop a table to track your savings growth, on a monthly basis, for the first six months using the following table format. Make sure you show all your calculations.

Month # Present

ValueYearly

InterestMonthly Interest

Future Value of Deposit

0

1

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Compound Interest: Example Continued

2. (10 min) Transfer your formula’s to Excel and make a graph showing growth to at least your Million dollar goal.

3. In a paragraph, summarize the characteristics of your graph and your findings.

Month #Present Value

Yearly Interest

Monthly Interest

Future Value

0 $ 10,000 6% 0.5% $ 10,050 1 $ 10,050 6% 0.5% $ 10,100 2 $ 10,100 6% 0.5% $ 10,151 3 $ 10,151 6% 0.5% $ 10,202 4 $ 10,202 6% 0.5% $ 10,253 5 $ 10,253 6% 0.5% $ 10,304 6 $ 10,304 6% 0.5% $ 10,355 7 $ 10,355 6% 0.5% $ 10,407 8 $ 10,407 6% 0.5% $ 10,459 $9,950

$10,000 $10,050 $10,100 $10,150 $10,200 $10,250 $10,300 $10,350 $10,400 $10,450

0 2 4 6 8 10

Futu

re V

alue

($)

Month #

Future Value

Excel Tutorial: If you need it!

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Review

• What is Compound Interest ?

• If you deposit your money in a bank that pays compound interest,1. What RISK are you taking?

2. What REWARD do you expect?

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Home Work

Compare the example we did in class with the following

4. Suppose you waited 10 years before investing the initial $10000 at the same interest rate. What is the difference in value at 20 years, 30 years, 40 years?

5. Suppose you save an additional $500 dollars a month from you salary that also earns the same interest rate. Make a model to track your savings growth.

6. In a paragraph or two, compare the performance of the three scenarios. Which approach would you recommend to reach your savings goal, why? How might you get to your goal quicker?

7. What other forms of investment pay “interest”? Catalogue at least 5 of them showing average yearly interest. Is there a relationship between RISK and interest paid? Explain your answer.

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Investing in Stock Market

• StockInvesting_101• Resources

– TheStreet.com– JubakPicks.com– MotelyFool.com

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Reference