The World of Investments and Money

Monday, June 4, 2007

Financial goal - calculate the rate required

The author of the book described in my previous post gave a very simple method to calculate the interest rate required to achieve a financial goal in the long term. As an investor knows very well, one should always have a financial goal in mind when he starts investing. Otherwise, his approach won't be a systematic one and the returns not as good. Most investors have a retirement goal.

To start, you must compute a variable called Investment Capital. This is an estimate of the amount of money you have invested and will contribute in the future. The equation to compute this Investment Capital is:

Investment Capital = Value of Current Investments + (1/2 * Annual Contributions*Years to Retirement)

From this equation, compute the Capital Fraction as:

Capital Fraction = Investment Capital ÷ Financial Goal

For example, if I have a goal of 20,000,000 that I want my investments to grow to in 25 years. If my current investments are of worth 400,000 and I contribute 100,000 every year to my investment.
Then,

Investment Captial = 400,000 + (1/2 * 100,000 *25 ) = 1,650,000

The Capital Fraction variable would then be computed as 1650000/20000000 = 0.0825

Now, there is a chart with years and Fraction variable matching the compound interest rate required. It is given in the chart below.


From the above chart it is clear that if I want my investment to be worth 20000000 in 25 years, I have to match 0.0825 in the column '25' i.e. my investments have to grow at about 11.0 to 11.5% every year to achieve that. I find this calculation to be very useful. Just create a long term financial goal, calculate the rate your investment has to grow every year and work towards achieving it.

2 comments:

invest mutual funds said...

Really great post for investors. Hoping you will be there with more blog on Finance.

amit said...

Thanks for great information you write it very clean. I am very lucky to get this tips from you





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