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Investment Decisions

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You have inherited $500,000 at age 20. The money is in a trust fund that is paying 8% interest per year. You can either take the interest each year or reinvest it in the trust fund. The principal cannot be withdrawn from the trust fund until you are 40. 1) Divide it into two groups. One group to be the "Spenders." They will spend money as they receive it (on cars, vacations, new homes, etc.). The other group will be "Savers." They want to retire at age 45 and lead a comfortable life before and after they retire. 2) Next, determine the value of the trust fund at age 40. Which of the groups will be most likely to achieve its primary financial goal and why? You have inherited $500,000 at age 20. The money is in a trust fund that is paying 8% interest per year. You can either take the interest each year or reinvest it in the trust fund. The principal cannot be withdrawn from the trust fund until you are 40. 1) Divide it into two groups. One group to be the "Spenders." They will spend money as they receive it (on cars, vacations, new homes, etc.). The other group will be "Savers." They want to retire at age 45 and lead a comfortable life before and after they retire. 2) Next, determine the value of the trust fund at age 40. Which of the groups will be most likely to achieve its primary financial goal and why?

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Solution Preview

The spenders will receive and spend $40,000 in interest per year.

The savers will continue to pour interest back into the trust fund each year. The interest will accrue for 20 years. Using the compound interest formula FV=PV(1+I)/t we get:
FV=PV(1+I)/t
FV=$500,000(1+0.08)/19 ...

Solution Summary

The solution shows the financial difference between living on interest earnings of an investment versus letting the interest compound for future withdrawal.

$2.19