Assume that your aunt recently gifted you $12,000. You are both excited and worried about what to do with the money. You evaluated your options and came up with five possible uses:
Which option would you choose? Go through each option and explain how the time value of money concept affects each option. How does the time value of money concept play a part in your final decision about the use of the $12,000 gift? Explain.
Time value of money means that the identical sum of money Available today(present point of time) is worth more than the identical sum of money Available tomorrow (Future point of time).
The factors taken into consideration by the time value of money
are
1. The opportunity cost.
The sacrifice Of current consumption.
2. The Inflation premium.
The general rise in prices, loss of purchasing power.
3. Risk Premium:
Extra return or compensation required for bearing risk.
a. pay off credit card debt.
The person can pay credit card debt on the last day because it will
save him opportunity cost. So $12000 should only be used to pay
credit card debt, if the person is actually unable to pay from his
own pockets.
b. set aside money for a major investment, such as a car or house.
Car is a depreciating asset so it is not advisable to invest in
a car. Until unless you are travelling cost is more than Car
EMI.
If money is set aside for a major investment. The money will grow
with time and at least the beat inflation.
c. invest the money in a retirement account.
The should be used for a retirement account because of the magic of
time value of money.
Due to the compounding effect and long term investment the money
will multiply many folds and give handsome returns at the time of
retirement.
d. use the money for career training/education.
If you are good at education or academics, you need to invest in
yourself. Because investment in self pays the highest
returns.
You will be losing the opportunity cost of investing $12,000 in
some other asset like Stock Index.
e. donate funds to a charitable organization that serves the
needy within the community.
You may donate up to 10% of money & not more than that. Because
it's not wise to donate at the gift money at once & it is not
it's intended purpose.
You will be losing huge due to it & unable to take benefit of
the time value of money.
I would invest:
1. Retirement savings: as it had the highest time value of money
benefit.
2. use the money for career training/education.
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