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Investing small amounts regularly

Discussion in 'Finance & Banking' started by BuffettTheDog, 10th Dec, 2011.

  1. BuffettTheDog

    BuffettTheDog Active Member

    Joined:
    22nd May, 2011
    Posts:
    35
    Location:
    Melbourne, VIC
    I was taking a money management quiz from the MoneySmart government website.

    This was one of the questions:

    Question 4. If Laura deposited $20 a week in a high interest savings account with an interest rate of 6% for her newborn son, how much money would he have when he turns 21?

    I did a calculation on Excel assuming no tax and it gave the correct answer (about $43,000). However, in reality, wouldn't regular taxes severely reduce the final amount to well below $43,000?
     
  2. Johny_come_lately

    Johny_come_lately Well-Known Member

    Joined:
    1st Jul, 2009
    Posts:
    703
    Location:
    SE Queensland
    The reality is, you can't extrapolate without including tax And inflation.

    If you saved, and once a year invested your saving for 21 years.
    The formula is:

    lump sum in todays buying power= X$yearly*(1+((interest rate-inflation)*tax))^(no of years)

    X$yearly=$20*52= $1040
    Tax(assume a simple 15%)= 0.85
    Interest rate= 0.06
    Inflation( assume a flat rate 3.5%)= 0.035
    No of years= 21

    Lump sum= 1040*(1+((.06-.035)*.85))^21
    = 1040*(1+(.025*.85))^21
    = 1040*(1.02125)^21
    = 1040*1.55515421
    = $1617 in Year 1's buying power after 21 years.

    In other words Tax and Inflation count! They must be included in your calculations. Your buying power isn't even doubled in 21 years. Clearly not a good outcome. Tax and inflation are killers.



    Johny. :p
     
  3. BuffettTheDog

    BuffettTheDog Active Member

    Joined:
    22nd May, 2011
    Posts:
    35
    Location:
    Melbourne, VIC
    Thanks! Yeah, that's what I thought after doing the question. :) Although I guess that makes the question too complicated for a simple quiz. Nevertheless, they probably should have given an asterisk note about tax and inflation.