Question

You have just inherited $100,000 tax free. You have three options. Invest in a savings account at your local bank at 1% annual return. Invest the the S&P 500 with an anticipated return of 12% annual return, though there is always some risk as the past is not always an indication of the future.. Invest in your business with an anticipated return of 24%, but with moderate risk due to the changing business environment. Which option would you pursue and why? Assuming these numbers for annual return are correct, how often will each of these investments double in the next 72 years?

Answer 1

If someone wants to take higher risk, investing in business will be the best option. The return will be highest.

For investors with low risk preference , investing in S&P 500 will be the best option because the return will be high with moderate risk.

As per rule of 72,

Number of years required to double an investment =72/(Interest rate in percentage)

Local bank at 1% annual return the investment will double in (72/1)=72 years

Hence investment will double only once in 72 years

S&P 500 with an anticipated return of 12% annual return

the investment will double in (72/12)=6 years

Hence investment will double (72/6)=12 times in 72 years

Invest in business with an anticipated return of 24%:

the investment will double in (72/24)=3 years

Hence investment will double (72/3)=24 times in 72 years

Calculations will show approximately same result

Future Value(FV)=Present Valu(PV)*(1+i)^N

i=interest rate, N=Number of years

For investment doubling

FV=2 times PV

(1+i)^N=2

NLog (1+i)=Log2

N=Log2/Log(1+i)

For 1% interest i=0.01

N=Log2/Log1.01=69.66072

For 12% interest i=0.12

N=Log2/Log1.12=6.116255

For 24% interest i=0.24

N=Log2/Log1.24=3.222271