time value of money & when to start investing
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Time Value of Money & When to Start Investing
An Investor Education & Awareness Initiative By Franklin Templeton Mutual Fund
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Savings
The dream home...which was worth Rs 50 lac
few years ago…costs Rs 1 crore today.
Why?
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Time Value of Money
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Inflation
Value of all Goods and Services
Purchasing Power of Money
Impact Today your Rs 500 note is worth less than what it was a few years ago
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What will you choose?
Suppose you have won prize money in a contest and you have the option to receive
Rs 1 lac today or after 1 year
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You will be at an advantage by taking Rs 1 lac today
Why?
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If you choose to take it after 1 year, you may be losing out on the interest that you may earn over the next 1 year…
Rs 1 lac invested today = 1.08 lac after 1 year[100,000 X 8% = 108,000]
Rate of interest of 8% is used for illustrative purpose only.
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How to calculate Time Value of Money?(Some basic concepts)
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Simple Interest
Simple interest is the interest you earn only on your principal amount
Simple Interest: Principal X Rate X Number of Years
100
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So total interest you earn in 2 years’ time is Rs 2,000
What will be the simple interest on a 2 year deposit of Rs 10,000 offering interest @ 10% p.a.?
Simple Interest: 10,000 X 10% = Rs 1,000 p.a.
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Compound Interest
Compound interest is the interest you earn on both principal and interest
Amount = Principal X (1+ Rate/100) N
Compounded Interest = Amount – Principal
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What will be the compound interest ona 2 year deposit of Rs 10,000 @ 10% p.a.?
Amount: 10,000 (1 + 10%)2 = Rs 12,100
Compound Interest: Rs 12,100 – Rs 10,000 = Rs 2,100
1st Year: 10,000 X 10% = Rs 1,0002nd Year: 11,000 X 10% = Rs 1,100
So total interest you earn in 2 years’ time is Rs 2,100
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Future Value
Inflation increases the cost of goods, year on year basisSo you may need to pay more in future
Future Value = Present Value (1 + Inflation)N
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Future Value: 50 (1 + 10%) 1 = Rs 55
Say a packet of milk costs Rs 50 today and the inflation rate is 10%. So in this case, what will be the
cost of the packet of milk after 1 year?
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Present Value
Real value of money in hand goes on decreasing because of inflation
So in future, your money needs to maintain pace with inflation
Present Value =Future Value
(1 + Inflation)N
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Say, you have Rs 100 in your pocket today, but will the value of Rs 100 be the same 1 year hence
assuming inflation rate of 10%?
Present Value =100
(1 + 10%) 1= Rs 90.91
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Real Rate Of Return
The Real Rate of Return you earn on your investment reduces due to inflation
Real Rate of Return = Rate of Return on Investment – Inflation
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Real Rate of Return = 15% - 10% = 5%
If the Rate of Return on your investment is 15% and inflation is 10%, then what will be your real
rate of return?
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• If you are already saving, then you are just one step away from starting your investment
• It is never early to start investing, but you can be late
• You should not wait for the right time to start investing
• Instead you may gradually start investing
• Starting early has its benefits!
When To Start Investing?
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“Compound interest is the eighth wonder of the world. He who understands it, earns it ...
he who doesn't ... pays it.”
– Albert Einstein
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Power Of Compounding
Earning interest on interest refers to Power of Compounding
Longer your time horizon Higher the effect of Power of Compounding
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Longer Your Time Horizon – Higher The Effect Of Power Of Compounding
Disclaimer: The figures are fictitious and used for example purpose only. Also, the interest rate mentioned above is for illustration purpose only.
Rs 1,000 p.m. @ 10% p.a. Starting Age
Total Amount Saved(Rs)
Value at the Age of 60(Rs)
25 Rs.4.20 lacs Rs.38.28 lacs
30 Rs.3.60 lacs Rs.22.79 lacs
35 Rs.3.00 lacs Rs.13.38 lacs
40 Rs.2.40 lacs Rs.7.66 lacs
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Impact Of Delay
Disclaimer: The names and figures are fictitious and used for example purpose only.
Particulars Ram Shyam
Starts investing at the age of 25 45
Monthly Savings (Rs) 5000 15000
Returns p.a. (Assumed) 12.00% 12.00%
Investment till the age of 55 55
Total Investment (Rs) Rs.18 lacs Rs.18 lacs
Accumulated amount at Age 55 (Rs) Rs.1.76 crore Rs.34.85 lacs
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Cost Of Delay
Disclaimer: The names and figures are fictitious and used for example purpose only.
To catch up with Ram, Shyam has two choices:
Earn on his investment 36.23%
OR Save per month 75,965
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Points To Remember
Inflation decreases the value of money over time
Prices of goods and services keep on increasing due to inflation
Money received today is worth more than the same amount of money received after a few years
In real terms, inflation also reduces the actual return you earn on your investment
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Points To Remember
Compound interest yields more return than simple interest
Longer your time horizonHigher will be the effect of Power of Compounding
You should not wait for the right time to start investing
It is never early to start investing, but you can be late
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Thank You For Participating!
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Mutual Fund Investments Are Subject To Market Risks, Read All Scheme
Related Documents Carefully.
© 2014 Franklin Templeton Investments. All rights reserved.
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