ECONnections: Lesson 2 Activity 3: Timing is Everything

Lessons:

Trade in Colonial America / NAFTA

Timing is Everything

Developing a Financial Investment Portfolio

Widgets: Producing More, Using Less

How E-Commerce Influences Consumer Choice

The Great Depression Mystery

Lowell Workers and Producers Respond to Incentives

LESSON 2: TIMING IS EVERYTHING

Activity 3

You learned in Activity 2 the power of compound interest. Interest is the price paid for the use of someone else's savings. Compound interest is interest earned on saving that includes previously earned interest.

How does compound interest work?

Suzy Saver and Tommy Savalot each have accumulated $2000. Suzy and Tommy are putting their $2000 in an account that pays 5% interest per year where their interest will be compounded at a rate of 5% a year. Suzy leaves her interest in the account where it will be compounded at a rate of 5% per year. Tommy withdraws his interest each year and uses it to buy himself something special.

After one year what will be the total savings?

For Suzy
For Tommy

In year 2, Suzy and Tommy each deposit another $2000 to their accounts. At the end of year 2, how much interest do they receive?

For Suzy
For Tommy

Suzy keeps her interest in her account. Remember, Tommy does not leave any of the interest in his account. At the end of two years, what are the total savings?

For Suzy
For Tommy

Now consider how much Suzy and Tommy will have in their accounts after 20 years. If Suzy and Tommy continue to save for 20 years, what will be their total savings?

For Suzy
For Tommy

In both Suzy's and Tommy's saving program, the rate of interest was the same-5%. However, Suzy's total savings at the end of 20 years was $69,438.42 and Tommy's was $40,000. Suzy earned more money because her interest was compounded.

Listen to an interview with Harvey Greenberg on the importance of saving often and early in life.

Challenge Question
What if Tommy had his money in a bank where he earned 3% and leaves the money in the account to accumulate interest for 20 years just like Suzy?

Calculate the total amount of savings Tommy will have earned after 20 years when he allows the 3% interest to compound over 20 years.

Now that Tommy earned compounded interest on his money, he still has a total savings of less than that of Suzy's after 20 years. This is because his money was earning interest at a rate of 3% as opposed to Suzy's 5%.

Saving for College >>