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5.0 FINANCIAL PLANNING
My concept of financial planning is to determine the rate of return (or average annual interest rate)
required to reach an amount of money desired or needed within a period of time by compound interest,
annuity or a combination of the two.
With the background and knowledge on annuity and compound interest from the previous section 4.0,
we can make a hypothetical plan for a 30 year old person who has a savings of $10,000 and would
like to stop working for a living by age 60 or in 30 years. If the person has $1 Million, it is conceivable
that he/she can retire and live on 10% of $1 million or $100,000/year.
5.1 RATE OF RETURN
By using the compound interest calculation with the following 3 parameters:
Initial principal, Po, of $10,000,
Number of years, n, for compounding of 30
Total amount after 30 years, P, of $1,000,000
the result is an average annual compound interest rate, r, of 16.59%
That means if we put $10,000 in an investment that has an annual yield (or interest rate) of
around 17% for 30 years, we would have $1 million, after 30 years..
Should a person want to achieve $1,000,000 in 30 years by saving a fixed amount each year in
an investment with a 17% rate of return, using the annuity calculator, the result is $1,320/year.
So saving $1,320/year for 30 years at a 17% rate of return investment, a person would have $1M.
5.2 AMOUNT OF RISK
Based on the above hypothetical financial plan, there is no reason for a person to make an investment
at a higher rate of return to reach his/her goal. Higher rate of return investments usually are riskier.
