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GETTING RICH IS CHILD'S PLAY- THE NEWS
ABOUT COMPOUND INTEREST
Activity 1
The When and What of Compounding,
But Mostly the When
You can use compounding to make your money work for you in
the stock market. Economist Bill Dickneider explains this type of
compounding to The Stock Market Game participants in his In The News
publications. "Besides putting money in banks, people use their
savings to buy financial assets like stocks, bonds, mutual funds, an
insurance. These different ways of saving offer a wide range of risk
and return. For example, common stocks provided an average yearly
return of about 10 percent from 1925 to 1992. Corporate bonds had an
average annual return of a little over 5 percent over that time. And
short-term government securities, called Treasury bills, had an average
yearly return of under 4 percent. Of course, there is no guarantee
that these types of saving will have similar returns in the future.
Still, these past averages show some of the different returns (and risks)
available to savers who want a chance to compound their money."
The following are two case studies of people who saved and
invested. We will assume that each invested in common stocks earning
an average of 10% a year. (Remember, in the real world, this amount
will vary, and there are no guarantees unless the amount is placed in a
guaranteed interest account like a Treasury Bill.) Your
mathematical mission is to find out which one was the wiser investor.
To do so, you may use the calculator constant operation or create a
spreadsheet. Your mathematical skills will come in handy here, but you
also need to look for another factor that has a great deal to do with the
financial accumulation totals.
INVESTOR A started investing when she was 22,
right out of college. Saving involves an opportunity cost- the best
alternative given up. IT wasn't easy to invest $2,000 a year
then, what with her student loan to pay off and other new financial
responsibilities such as finding a decent place to live and a car to get to
her new job. But she was determined to save because her grandmother
always said that it wasn't what you make, but what you save, that determines
your wealth. So, reluctantly, she gave up buying that new car and
renting a really nice apartment, and she invested $2,000 a year. After
12 years, she got tired of the sacrifice, yearning for a brand new red
sports car and other luxuries. She didn't touch the money she had
already invested, because she wanted to be sure she would have money for
retirement when she reached age 65. But she quit investing an hit the
malls.
INVESTOR B didn't start investing until he was 34.
He also graduated from college at 22, but he had done without many things in
college and now that he had an income, he wanted them. He bought a new
car, and a very nice wardrobe, and took some wonderful trips. But
spending his current income involved an opportunity cost. By the time
he was 34, he was married, had many responsibilities, and decided he'd
better start saving and planning for his financial future. He had also
heard that it isn't what you have earned, but what you have saved that
determines your wealth. He figured he had 25 to 30 productive years
left in his career, so, with new determination, he saved $2000 a year for
the next 32 years, until he retired at age 65.
Was A or B the wiser investor? Complete the following
spreadsheet to find out.
Answer the following questions...
1. How much money did each person invest?
2. What was the total wealth accumulation of each?
3. How much longer would it take for A to become a
millionaire?
4. At age 45, investor A and B had invested the same
amount of money, $24,000. What was the end-of-year accumulation for A
and B?
5. What did it "cost" Investor A to invest?
6. What did it "cost" Investor B to invest?
7. What is as important as the amount invested and
amount of time invested? Why?
8. What are the incentives for early investment?
9. What might be an opportunity cost for early
investment?
10. What conclusions can you draw from this exercise?
11. So, is getting rich child's play? Explain.
DO I HAVE A DEAL FOR YOU!
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