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Value of Money Discussion

I need help with the scenario below, please.

Work out how many years (10) to go before you retire, now look back the same number of years, and see how much the dollar has fallen in value from then to now. The US Government has the statistics.

1. Why take a risk with your money?

2. Find the interest paid on risk-free US Government 5 year bonds and pretend you want to invest $10,000.

3. Find the current rate of inflation.

4. Your tax bracket is 40% at the end of one year how much will you have made or lost?

Solution Preview

There are a couple of ways to interpret how much value the dollar has lost in 10 years. You can compare it to an asset like gold and you'd find that it has lost around 75% of its value. I suppose your professor wants you to use the "official" inflation numbers though. Here's a cool little tool that can do that for you:

Putting in 2003 to 2013 an item that cost $1 ten years ago would be $1.27 today. So its lost 27%. Note that this calculator uses the US Gov data (CPI) that your professor is referring to.

1. You want to take a risk with your money because its just about a certainty that it will lose its purchasing power over the long term. You much realize the difference between the nominal value of money and its purchasing power. If you save $10,000 a year for 10 years you'd have $100,000 plus whatever tiny interest it accumulates (assuming you are putting it in a savings account and not just stuffing it under your mattress). However; in ten years $100K will not buy as much oil, gold, clothing, ...

Solution Summary

Risk vs. reward when investing for retirement. Impact of inflation on savings and investments. Real vs. Nominal interests rates and impact of taxes on investment returns.