Question

Explain the concept of time value of money in the context of simple interest. How would you use this in retirement planning?

Please do not copy and paste, thank you.

Answer 1

Solution :

Simple interest is the method of calculation of interest where interest is calculated on the principal amount itself. Eg. 10 percent interest on $100 will give $10 interest each year.

Time value of money is a concept that incorporates time and value of the money. It says that one dollar is worth more today than in future. A dollar is worth more today because we can invest it and earn interest on this.

We can use discounting method to find the present value of future value

Present value = future value / ( 1+ discount rate ) ^ time

Time value of money in retirement planning:

When we retire in the future then for same standard of living we will require more dollars as compared to the dollars require today. This is due to the fact that prices of all things will increase due to time value of money. Hence we have to invest in the assets that will give return in such a manner that even after discounting our present value is more than required.