Question

How would you use present value to decide how much to save for your retirement? What discount rate would you use in your calculations? Why? ( point format Please)

Answer 1

Answer-

1) The present value that should be invested now to get an amount that will give an fixed amount post retirement for the remaining part of life.

2) For illustration an individual retiring at the age of 65 and would plan at the age of 40 to deposit an amount till 65 for 25 years so that he can avail the retirement benefits till the age of 100 ie. from 65 till 100.

[ This is an anticipation that the individual will live for 100 years. ]

3) The amount of $ P should be invested every month that will lead to total payments of ( 25 x 12 ) ie. 300 payments. These payments should lead to the total amount contributed which will be $ (300 x P).

4) This monthly amount will be compounded at the interest rate or discount rate which will approximately 6- 7 % ( risk free rate of 3-4 % plus an inflation rate of 2 %)

5) The rational behind the discount rate or interest rate is that the investor is riisk averse and investing for retirement life and would stay away from investing in equities anf high risk products in anticipation of the outbreaks like COVID-19 or any event that will cause the ecconomic slowdown which will erode all the investments.