Time value of money

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Short-term goal: SMARTSmart, Measurable, Achievable, Relevant and Timebound goals.

S: Cut expenses and be able to be able to take a vacation to Mombasa thus being able to save $ 1,200.

M: Save $100 each month.

A: Reduce the spending on foods when eating outside the home and other nonessential consumption.

R: It matches my need to make the holiday a relaxing one.

T: This should be done in one year.

Intermediate goal:

S: Keep $10, 000 as a down payment towards the purchase of a car.

M: Save $417 each month.

A: Dedicate few rupees of monthly emoluments and any incentive earned.

R: It matches up well my requirement for car as means of reliable transport.

T: This must be accomplished in 24 months.

Long-term goal:

S: Save $100,000 for retirement.

M: Spend £50 less each month, plus earnings from each of the investments.

A: It is important that you invest in a diversified way.

R: It correlates with what I want for my retirement, a comfortable lifestyle.

T: This goal must be met in the next 15 years.

Time value of money calculations

Calculation of the future value using the TVM equation:

FV=PV*Where:

FV = Future Value

PV = Present Value (initial savings)

r = Interest rate per period

n = Number of periods

Assuming two different interest rates: 5% and 7%

1.5% interest rate:

r=5%

PV = $10,000

r= 5% = 0.07

n = 2 years

FV =1000*

FV =10000* (1.1025) FV = $110252. Interest rate of 7%FV=PV*r=7%

PV = $10,000

r= 7% = 0.07

n = 2 years

FV =1000*

FV =10000* (1.1149) FV = $11449Summary

Question 1.

The length of time plays a very large role in what kind of money can grow through compounding of interest. Thus, remembering that the longer the money is left to grow, leads to its growth, makes people be more careful, and hence the time horizon should be taken seriously (Hayek & Kresge, 2020). In the case of savings and investments this implies that initial contributions create more compounding than the later and pushes the growth of wealth. With longer time horizon, one can allow himself to be enriched more by interest accrued on the amount.

Question 2.

To determine how much to set aside today, I need to:

Set a clear goal: Be very clear on goals and time for each goal.

Estimate the future value: Determine how much I must save tomorrow to meet that goal in the future.

Apply TVM: All you need to do is use the present value (PV), mentioned above; to find out how much one needs to invest to get the future value (Anderson, 2023).

Break it down: Subdivide the future value to reasonable monthly or year-end savings goals.

Review and adjust: Make it some kind of check-points index wherein contributions can be evaluated against change in rates of interest or income more frequently.

Question 3.

Inflation sees the level of purchasing power of enhancing its money power and its ability decreases after a certain period. It means that even if an investment increases in nominal value has the potential of being reduced by inflation to its real value (Anderson, 2023). For instance, $100000 in 10 years will be equivalent to $85000 depending on inflation of 2%per year. To hedge against inflation, one must invest in things that have proven to do better than inflation rates like stock, real estates as opposed to keeping money in a savings account.

 

Sample Question

Excellent Goal Setting and Financial Planning!

Your goals are well-defined and achievable. Let’s break down the time value of money calculations further and discuss some additional considerations.

Understanding Time Value of Money (TVM) Calculations

You’ve correctly applied the TVM formula to calculate the future value of your investments. To further enhance your financial planning, consider the following:

  • Impact of Interest Rate Fluctuations: Interest rates can vary over time. It’s important to factor in potential rate changes when making long-term financial plans.
  • Effect of Inflation: Inflation erodes the purchasing power of money. To maintain the real value of your savings, it’s crucial to invest in assets that can outpace inflation.
  • Tax Implications: Understand the tax implications of different investment vehicles, such as traditional and Roth IRAs, to optimize your after-tax returns.

Additional Considerations for Financial Success

  • Diversification: Spread your investments across various asset classes (stocks, bonds, real estate) to reduce risk.
  • Regular Review and Adjustment: Regularly review and adjust your financial plan to account for changes in your circumstances and market conditions.
  • Emergency Fund: Build an emergency fund to cover unexpected expenses.
  • Professional Advice: Consider consulting with a financial advisor to get personalized advice tailored to your specific needs.

By incorporating these factors into your financial planning, you can increase your chances of achieving your long-term financial goals.

Remember: Consistent savings and disciplined investing are key to building wealth over time. Stay committed to your goals, and you’ll be well on your way to financial security.

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