Presenter: Rob Massimi
The students will see how compounding returns make investing at a young age pay off.
Allocating resources between consumption today and investment for tomorrow is one of the critical choices all citizens are faced with. As retirement funding in the United States becomes more focused on individual savings rather than corporate pensions and government programs, it becomes more important for all students to understand this tradeoff. This lesson is designed to give the students a better understanding of compounding returns on an investment. The lesson also can be a powerful tool to use in determining the opportunity costs of consumption versus investment decisions.
Questions for Thought:
Let's look at a couple of hypothetical investors and see how the choice of when to invest affects the amount of money available at retirement.
Our investors are two 23-year-old women who have just graduated from college and started their careers. For the first two years after college neither woman saves any money toward retirement; both focus instead on establishing their careers and purchasing household items. At age 25, Mia Saver starts to save money for retirement by investing $200 per month into an account paying 7% annual interest compounded annually. Ima Spender continues to spend all of her money. From ages 25 to 35, Ima drives a nicer car than Mia and takes a more elaborate vacation each year.
When the women reach age 35, Mia Saver chooses to work only part time, so she does not invest any more money into her retirement fund. However, she leaves it invested in the account paying 7% annually. At age 35, Ima Spender begins investing $200 per month toward retirement. Ima's account also pays a 7% rate of return compounded annually. Ima invests $200 per month for 30 years, until age 65.
[Note: Click on the Compounding Interest Graphing Tool: it will give the students a visual representation of how quickly compound interest can build.]
Have the students use the https://www.dinkytown.net/java/compound-savings-calculator.html website to complete the Worksheet showing the value of the accounts every 10 years. You may need to do the first couple of calculations as a class to make sure the students understand the calculator.
After everyone has completed the top half of the spreadsheet, compare the answers. [At a 7% rate of return, Mia Saver, who only invested $24,000, but invested it early, has $261,893 for retirement. Ima Spender, who invested $72,000 over 30 years has less: $235,215.]
The students should repeat the exercise using another rate of return
on the lower half of the worksheet to confirm the results. Another option is to let the students choose their own rates of return, within a reasonable range, and compare their results with those of other classmates.
Attached is a Key with the worksheet completed, using a 7% rate of return on the top half and an 8% rate on the lower half.
Due to the power of compounding returns, a small investment made early in life can lead to a larger account balance than a larger investment made later in life.
Have the students turn in their completed spreadsheet and a short paragraph summarizing the power of compound interest.
Presenter: Rob Massimi