Scenario: A client comes to you for investment advice on his $500,000 winnings from the lottery. He has been offered the following options by three different financial institutions and requests assistance to help understand which option would be the best for his investment.
Option 1: 6% compounded interest quarterly for 5 years.
Option 2: 8% compounded interest annually for 5 years.
Option 3: 14.5% simple interest for 10 years.
Option 1 is worth
= $500,000*(1+0.06/4)^(5*4)
= $500,000*(1.015)^20
=$673,427.50
Option 2 is worth
= $500,000 * (1.08)^5
= $734,664.04
Option 3
= 500,000 * (1 + (.145*10))
= $1,225,000
Even for 5 years, you get
= 500,000 * (1 + (.145*5))
= $862,5000
The best option is Option 3
To determine which option would be the best for the client's investment, we need to calculate the future value of each option and compare the results. Let's break down the calculations for each option:
Option 1: 6% compounded interest quarterly for 5 years.
To calculate the future value, we can use the formula:
Future Value = Principal * (1 + (interest rate / number of periods))^(number of periods * number of years)
In this case, the principal is $500,000, the interest rate is 6%, the number of periods is 4 (quarterly compounded), and the number of years is 5.
Plugging in the values, the calculation would be:
Future Value = $500,000 * (1 + (0.06 / 4))^(4 * 5)
Option 2: 8% compounded interest annually for 5 years.
Using the same formula as before, with the principal of $500,000, the interest rate of 8%, the number of periods is 1 (annually compounded), and the number of years is 5.
The calculation would be:
Future Value = $500,000 * (1 + (0.08 / 1))^(1 * 5)
Option 3: 14.5% simple interest for 10 years.
For simple interest, the formula to calculate the future value is:
Future Value = Principal * (1 + interest rate * number of years)
Applying this formula to our scenario:
Future Value = $500,000 * (1 + 0.145 * 10)
After calculating the future values for each option, we can compare them to determine which option yields the highest return. The option with the highest future value would generally be considered the best choice for investment.
It's important to note that these calculations assume no additional contributions or withdrawals from the investment during the specified period. Additionally, when comparing different investment options, it's crucial to consider other factors such as risk, liquidity, and the individual's specific financial goals and circumstances. Consulting with a financial advisor is recommended to make an informed investment decision.