Principles of Finance: Unit 5, Compounding

Compounding is the practice of iterating the value of a given investment or rate of return at a given % value for a period of time.

CoursesFinance Concepts
Principles of Finance
FinanceFinancial Responsibility
Personal Finance
Finance and EconomicsPrinciples of Finance
LanguageEnglish Language
Life SkillsPersonal Finance
SubjectsFinance and Economics

Transcript

00:25

practice of iterating the value of a given investment or

00:28

rate of return at a given percentage value of reach

00:30

period of i measured bottom line to get the most

00:33

out of com pounding invested and don't touch it Okay

00:36

so your prototypical investment sits there in compounds at ten

00:40

percent a year right around the average stock market's performance

00:43

over the last one hundred fifty years yourself So if

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you have one hundred grand after one year it's the

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one hundred ten thousand after two years it's one hundred

00:50

twenty one thousand that extra grand is going to be

00:54

the you know star of the show so pay attention

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Here we come pound at one hundred ten grand to

01:00

get there not one hundred grand and after three years

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it's one hundred thirty three thousand one hundred dollars and

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so on And you can kind of look at this

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chart here and you think about it and yes we

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rounded numbers of it here But you get the gist

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After ninety six years and change of compounding your hundred

01:15

grand you saved your way to being Ah billionaire And

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also yes it's Too bad you're now too old to

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really enjoy it Sorry but power of compound ing is

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pretty impressive huh You've made ten thousand times your money

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in a hundred years Key idea discipline Fifty shades of

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saving that is you didn't take out even up penny

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from your original investment The whole thing compounded year after

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year after year you took no bling budget nor no

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car cash nor no toy tax A rich uncle larry

01:46

has died Crocodile tears gives a break He's left you

01:50

fifty grand You in Vast like you're a little old

01:53

lady from peoria with blue hair driving a old cadillac

01:57

at two percent in a bank savings aqui count How

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long till you can afford the hundred grand maserati You've

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been ogling Well you'd need to double your money Well

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remember that rule of seventy two thing It's the calculator

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you use to figure out how many years it takes

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for a compound investment to double given a continuous interest

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rates That is if you invested ten percent annual return

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It takes you seven point two years to double your

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money invested twelve percent and it takes only six years

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But in this case your little bank account at two

02:27

percent takes you seventy two divided by two or thirty

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six years to double your money You'll likely be a

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tad old to really enjoy it And it's likely that

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by then that same hundred thousand dollar maserati you wanted

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will cost three hundred grand So yeah i don't do

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that All right Another helpful tool The compound ing formula

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Here's How it looks in plain english Wealthy eventual value

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equals the initial amount invested times the quantity one plus

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the interest rate at which the investment is compounding through

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the power of years All right how about some numbers

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here That was silly Ma's money fifty grand times quantity

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one plus point two two thirty six That help Alright

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notice that it's point zero two here point to would

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be twenty percent compound raid and get you that car

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really quickly Three and a half years Way better And

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in more normal speak Nomenclature The fifty k Is the

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present value i eat the value today of the dough

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uncle larry left you the future value is the ma's

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money and to be more finance e you'll see are

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a lot here That's the rate of return of your

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investment i either two percent of the twenty percent or

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the whatever you'll also see in a lot that's the

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number of periods in which you are come pounding that

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can get confusing So listen up We could have given

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you a curveball and said that an internet company was

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growing trafficked and per cent a month Who And then

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we ask you how much traffic it'll have in three

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years At that rate if it has started out with

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ten thousand page visits a day today what does that

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mean Well it means the internet company will do grade

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for about six puns than flattened growth and then decline

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and that you can't trust the numbers any internet company

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gives you with growth projections like that that's just said

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from the dark cynical side cigar chewing part of shmoop

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so you can kind of move on now All right

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well you actually answer the problem like this Well if

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i back out the numbers to be an annual compound

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ng raid in extrapolating the ten percent a month and

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said that it grows at one hundred twenty percent a

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year then that would be ten thousand times one plus

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the quantity one point two to the third power which

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equals ten point six five So in three years my

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ten thousand page visits a day will be ten point

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six five times ten thousand or one hundred six thousand

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four hundred eighty Page visits a day but that's not

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really with questions implying it's are about the voice there

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It gives a monthly compound period You can't just back

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out an annual period willy nilly The right way to

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answer this question to a formulas more like ten thousand

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times quantity one plus point one to the thirty sixth

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power that's thirty six ends or thirty six periods of

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calm pounding to get three hundred nine thousand one hundred

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twenty six and huge difference from that much smaller one

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hundred six thousand change paid view number Right Well the

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period here is one month and we compound everything each

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month Not each year So it pulls our basis against

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which were compounding much closer and ends up generating a

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much bigger number At the end the annual rate on

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any given month is the same in both cases It's

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One hundred twenty percent But the fact that we compounded

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monthly in the second case gave us three times the

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number of changes the sell ads against at the end

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of the year Three rainbow and let's Just hope that 00:05:35.834 --> [endTime] pot of gold comes with compound interest No