Question

Scenario

Imagine you inherited $50,000 and you want to invest it to meet two financial goals: (a) to save for your wedding, which you plan to have in two years, and (b) to save for your retirement a few decades from now.

How would you invest the money for each of these goals? Explain your answers.

Answer 1

a. First, determine the amount that you need in two years for your wedding. Suppose you need $ 10,000. Find out what is the interest that can be earned on fixed income securities, which are not at all linked to the equity markets. Equity markets are going to be very choppy due to the Covid-19 situation, and you could end up with capital erosion.

Suppose that the interest earned per year on the fixed income securities is 7%, compounded annually. The amount you need to set aside now to meet your $ 10,000 goal ( future value ) is $ 10,000 / ( 1.07 )² = $ 8,734 ( present value ).

b. After investing the amount to meet your wedding needs, you are left with $ 50,000 - $ 8,734 = $ 41,266.

Let's say that you would retire in 35 years from today. Because of the pandemic, you are likely to get stocks of blue chip companies like Microsoft, Google, Facebook, Apple, Coca Cola etc rather cheap. Allocate $ 20,000 to buy stocks of these companies, as these are priceless stocks. If you are not too confident about the stocks to choose, delegate the same to a reputed wealth management company. In the short term you might not get a great return, but in 35 years, these stocks are going to be priceless. With an average return of 12 % per year, this investment should grow to 20,000 * ( 1.12) ³⁵ = $ 1,055,992 Plus, these companies will also give you handsome dividends almost every year, which can be reinvested.

The remaining $ 21,266 should be allocated to debt market securities. With a conservative average return of 7 % per annum, this investment should grow to 21,266 * ( 1.07 ) ³⁵ = $ 227,049

So at retirement you will have $ 1,055,992 + $ 227,049 = $ 1,283,041