Our goal as investors is to get money to work for us rather than the other way around. When we have money work for us, the principles of investing are able to turn a seemingly small amount of money into a huge amount of money with sometimes little effort on our part. In this Challenge, we will see how the principle of compounding interest works and how it can make money multiply at almost unbelievable rates, in particular to a child's savings account.
Here, Ellie recently was born and her parents decide it is time for her to have a retirement account (you can never start too early, right?) Anyway, they decide to put $10,000 into her account and invest it at 15% (I know that many of you think that number is impossible, that number is very possible, but it takes study. Click here for a real life example of a return well over 12%). Furthermore, let’s assume that no more money is added during this time and that Ellie can't touch the money until the age of 50. How large will the initial investment grow to be in 50 years?
ANSWER (Enter the following numbers into you HP10bii financial calculator)
N (number of months) = 600 (it will be 50 years, which is the equivalent of 600 months)
I/YR (interest rate per year) = 15 (this is the interest rate in which the money is invested)
PV (present value) = -$10,000 (this is the amount of the money that is invested today. This has to be entered in as a negative because Ellie and her parents will not have access to it while it is compounding)
PMT (payments) = 0 (there will be no payments put into the investment or taken out for the next 50 years)
FV (future value) = ?? (this is the amount that we are solving, we want to know how big the nest egg will be in 50 years)
After entering the numbers above into your financial calculator, the answer comes out to $17,259,139.22!!! It is amazing the a relatively small amount of money today can turn into such a huge amount of money down the road thanks to the principle of compounding interest.
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