Calculating an Annuity

Before we use the annuity

formula, let's solve a short 3
year example the "long way".
First we need the compound
interest formula which is:
Total = Principal ( 1 + Rate )years

Now let's say the amount that

we invest annually is $2,000 per
year and the interest rate is 8%.

The $2,000 invested 3 years ago

has become

$2,000 * (1.08)3 = $2,000 *

1.259712 = $2,519.424
The $2,000 invested 2 years ago
has become
$2,000 * (1.08)2 = $2,000 *
1.1664 = $2,332.80
The $2,000 invested 1 year ago
becomes
$2,000 * (1.08)1 = $2,000 * 1.08
= $2,160.00
Adding up all 3 yearly amounts,
we obtain $7,012.22

As you can see, the mathematics

of this can be a little
cumbersome especially when the
time involved gets larger.
To make these calculations a
little easier, there is a formula:

1) Solving the Total Amount

where the AMOUNT is the annual amount invested each year,

'n' is the number of years and
'r' is the annual rate of the investment.
So, we have:
$2,000 * { [(1 + .08)(3 + 1) -1] .08 } $2,000
$2,000 * { [1.36048896 -1] .08 } $2,000
$2,000 * { .36048896 .08 } $2,000
$2,000 * { 4.506112 } $2,000
$9,012.224 -$2,000
$7,012.22
Which is the answer we obtained using the "long" method at
the top of this page.

3) Solving for Years

You plan for your retirement by setting up

an 8.5% annuity with an annual investment
of $2,500 and you would like this to yield
$500,000 when you retire.
How many years will this take?
Inputting these numbers into the
numerator of the formula:
Log(.085 * (500,000 / 2500) + 1.085)
= Log(17.085)
= 1.2326149831
The log of the denominator 1.085 =
0.035429738185
The number of years = 1.2326149831
0.035429738185
= 34.4877 years
http://www.1728.org/annuity2.htm

Calculating a Monthly Annuity

1) Solving the Total Amount

You set up an annuity in which you will pay $150 per

month for 20 years at 7 per cent annual interest.

What is the total amount this will yield in 20 years?
Using the formula above, the easiest amount to find is
the monthly amount of $150.
For the interest rate 'r', we have to convert it from
annual to monthly.
.07 12 = 0.0058333333 per month.
Since this is a monthly annuity, we have to change the
time from years to months.
20 years = 240 months.
Now we put these amounts into the formula:
Total = 150 ([1.0058333333241 -1] .00375) - 150
Total = 150 ([4.0622981589 -1] .00375) -150
Total = 150 (3.0622981589 .00375) -150
Total = 150 (524.9653986745) -150
Total = 78,594.81

2) Solving the Monthly

Amount

You set up a pension plan with an annual

interst rate of 8 per cent, for 35 years

and you would like this to result in
$1,000,000.00 for your retirement.
How much must you invest each month?
In this case, the easiest amount to find
is the total which is $1,000,000. As in
the previous example, we need to
convert the interst rate to a monthly
rate and convert the years into months.
8% per year = .08/12 = 0.0066666666
per month and
35 years = 420 months.
Entering the amounts into the above
formula we have:
Monthly Amount = 1,000,000
[(1.0066666666421 -1) (.0066666666)
-1]
Monthly Amount=1,000,000
[16.4011668971 -1
(.0066666666) -1]
Monthly Amount=1,000,000
[15.4011668971
(.0066666666) -1]
Monthly Amount = 1,000,000
(2,310.1750345608 -1);
Monthly Amount = 1,000,000
(2,309.1750345608);
Monthly Amount = 433.0550889531
Monthly Amount = 433.06

3) Solving for the Months

You decide to invest $250 per month in a 7.5% annual

interest rate pension plan and you'd like to retire with
$500,000.
How long will this take?
For this calculation. we need to use the monthly rate which
is .075/12 = .00625.
First, we'll enter these amounts:
(.00625) (500,000 / 250) + (1.00625)
= 13.50625
Taking the logarithm of this and dividing it by the
logarithm of the denominator:
Log (13.50625) Log(1.00625) =
1.1305347842 0.0027058934 =
417.8046312859
Finally, the formula says we have to subtract 1 from this
number:
416.8046312859 months
It takes this number of months to yield $500,000.
Dividing this by 12 yields
34.7337192738 years.

Annuity Payout Formulas

To see how an annuity gets paid out, let's use a short period of time.
An annuity has a $50,000 principal, a 7% rate and a 3 year payout period.
How much is each annual payout?
payout = $50,000 .07 (1 + .07)3 [ (1 + .07)3 -1 ]

payout = 3,500 1.225043 [ 1.225043 -1 ]

payout = 4,287.65 [ .225043 ]
annual payout = 19,052.58
Now that we have the annual payout amount, let's see how the
payout process works.

At the end of the first year, the $50,000 principal has earned
$3,500.00 interest (50,000 .07 = $3,500.00) increasing the
annuity balance to $53,500. After the first annual payout of
$19,052.58, the balance is reduced to $34,447.42.
At the end of the second year, the $34,447.42 balance has earned
$2,411.32 interest ($34,447.42 .07 = $2,411.32) increasing the
annuity balance to $36,858.74. After the second annual payout,
the balance is reduced to $17,806.16.
At the end of the third year, the $17,806.16 balance has earned
$1,246.43 interest ($17,806.16 .07 = $1,246.43) increasing the
annuity balance to $19,052.59. Now when the third annual payout
is made, the balance is reduced to zero. (Okay, the balance is .01
but that's close enough).
Looking at the mathematics involved with a manually calculated

payout, it's much easier to use the calculator isn't it?

Upon retirement, you'd like to have an annuity that will pay

out $25,000.00 per year for 20 years.
If the annuity interest rate is 8 per cent, how much principal
would you need?
Principal = (25,000 [(1.08)20 -1)] (.08 (1.08)20
Principal = (25,000 3.6609571438) (.08 4.6609571438)
Principal = 91,523.93 0.3728765715
Principal = 245,453.69

You are retiring with a 7% $300,000.00 annuity that pays

50,000.00 per year.
How long will this annuity last?
Years = log (1 (1 - [300,000 .07 50,000])) log (1.07)
Years = log (1 (1 - .42)) 0.0293837777
Years = log (1 .58) 0.0293837777
Years = log (1.724137931) 0.0293837777
Years = 0.2365720064 0.0293837777

Years = 8.051109322

Calculating Continuously Compounded

Interest
If you don't need to use the formulas and just need a continuously compounded interest
calculator, then click here.

You deposit $1,000.00 into a savings account for 4 years

at an interest rate of 7 per cent compounded continuously.
How much money do you have after 4 years?
Total = 1,000 * 2.718281828459 (.07 4)
Total = 1,000 * 1.32312981233744
Total = 1,323.13

After 11 years at a 6.25% continuously compounded rate,

you now have $13,752.38.

How much money did you start with?

Principal = 13,752.38 2.718281828459 (.0625 11)
Principal = 13,752.38 1.9887374696
Principal = 6,915.13

You have invested $2,750.00 at a

continuously compounded rate of 8.15%.
How long will it take for this to become $10,000?
Years = ln(10,000 / 2,750) .0815
Years = ln(3.6363636363636) .0815
Years = 1.29098418131557 .0815
Years = 15.8402967032585
About 15.84 years (rounded)

You have invested $4,000.00 and would like it to become $10,000.00 in 10

years.
What continouously compounded interest rate is required?

rate = ln(10,000 / 4,000) 10

rate = ln(2.5) 10
rate = 0.9162907319 10
rate = 0.09162907319 or 9.162907319%

Calculate how much you need to invest for

your Kids Education
As a caring parent you would always want your child to
get the very best. With growing standard of living, the
Kids education expenses are consistently rising. I believe
the average rate of education inflation (the rate at which
education expenses are rising) is around 10% to 15%
depending on the location.
In this post let us understand How to calculate the
future value of Kids Education Goal amount? How much
should you save/invest for your kids College education?
For calculating the future cost of education expenses, you need below
details:
Kids age
No of Years remaining to attend college
Current value (cost) of College Education. You may
have to do little bit of research to find out the

average cost of college education in your preferred

location.
Education Inflation (We can safely assume this as

minimum 10%

Let us do the calculation with an example.

Example Mr Sundaram wants to plan for his kids higher education.
Childs age is 5 years and will attend college in 12 years from now. As
per his research, he came to know that the current cost of Engineering
Education in his city is around Rs 5,00,000. He wants to find out what is

the Future cost of his goal?

I have used MS-Excels FV function to calculate the future value of goal

amount. ( FV Function variables are Rate 10% from B4 cell, Duration 12
years from B3 cell and Current cost of education Rs 5 Lakh from B5
cell).

S
o, at 10% inflation rate the college expenses of Rs 5 Lakh will become
Rs 15.69 Lakh in 12 years. Mr Sundaram has to accumulate this amount
for his Kids education.
(For detailed explanation on How to calculate Future Value? Click
here )
How much do I need to invest for my Kids education?

Mr Sundaram now knows that he requires around Rs16 Lakhs in 12

years from now. He further wants to calculate how much he has to save
every year to achieve the goal amount. He also wants to find out how
much he should save if he opts for Fixed Deposits (or) Mutual Funds

(or) Stocks?

I have used MS-Excels PMT function to calculate the required Yearly

Savings amount for Kids education. ( PMT functions variables are D9Rate-9%, B3-Term-12 years and B7 -Target Goal Amount-Rs15.69

Lakh).

Scenario 1 (If Savings are invested in Fixed Deposits)

Mr Sundaram has to save Rs 77,913 per year for the next 12 years to
achieve his goal amount of Rs 15.69 Lakh. The yearly savings amount is
invested in Fixed Deposits which may give 9% returns. (You may refer
the above PMT function image on how to calculate)

Scenario 2 (If Savings are invested in Mutual Funds)

Mr Sundaram has to save Rs 73,382 per year for the next 12 years to
achieve his goal amount of Rs 15.69 Lakh. The yearly savings amount is
invested in Mutual Funds and he expects 10% returns from Mutual
Funds.
Scenario 3 (If Savings are invested in Shares)

If Mr Sundaram decides to invest in Stocks then he has to save Rs

65,023 per year for the next 12 years to achieve his goal amount of Rs
15.69 Lakh. The stock investments may give him returns of 12%.
Important Points to Ponder upon
You can consider the above yearly savings amount (I
have provided a calculator below. You can use it to
know your goal amount) as the minimum
contribution amount that you need to save/invest. As
and when your income increases you can keep

contributing more towards your yearly savings.

Accordingly, you can re-calculate the required Target
goal amount as explained above.
If you choose to invest in mutual funds (or) stocks
then it is better to move your fund to Safe
Investment avenues like Fixed deposits, atleast 2 or 3
years before the Target goal year. By doing this you
may prevent the accumulated fund from eroding.
Besides these savings, have a good life insurance
coverage. Consider taking Term insurance plan (if
you do not have). It is better to avoid Child Education
Insurance plans. I believe Balanced Mutual Funds
with the combination of Term Insurance plan may
prove to be a good decision. (You may like visiting
my post on Best Balanced Mutual Funds.)

 Do not buy a financial product just because the

scheme name has Child plan on it. Understand the
features, benefits and risks associated with that
investment option.
Regularly monitor and track your investments. Also,
be informed regularly of the cost of education for
various courses.
After reaching the goal year, based on the fee
payment conditions ( like one time payment or per
year basis ) you may still need to manage the fund
carefully.
Download Calculator Kids Education Goal amount . (In-fact you may
use this calculator for any accumulation goals like vacation planning,
Marriage expenses etc.,)

Liked the post? Please share it with your friends. What is the average
per year increase of cost of college education in your location? Kindly
share your comments.

1) Holding Period Return (HPR)

Holding period return is the total return received from holding a Financial Asset. It is calculated as

income plus price appreciation during a specified time period, divided by the cost of investment.
When we are looking at the return that we earn on our investments, one of of the first measures that
we will look at is the Holding period of return. This return includes income from all sources like
dividends, interest, periodic receipts and the change in the price of the asset.
Holding Period return is also known as, Absolute return (or) Total Return (or) Historic Return.

HPR = ( Periodic Receipts +(Sale price Purchase price)) / Purchase

price
Example : Mr. Sinha invested Rs 1,00,000 in stock market . After 2 months he received a dividend
amount of Rs 2,000. He sold the shares after 8 months and received Rs 1,12,000. What is the holding
period return in this case?
HPR = (2000 + (1,12,000-1,00,000)) / 1,00,000
HPR = 14%
2) Post Tax Returns
Different financial instruments attract different tax rates. It is important to factor in the taxes while

calculating your returns on investments. It is used to calculate the actual returns from any investment
after paying applicable taxes.
Post-tax returns = Pre-Tax retuns * { (100-Tax Rate) / 100 }
Example : Continuing with the above example, Mr Sinha had to pay 15% as Short Term Capital
Gains Tax. So, what is the actual returns (in percentage) after accounting for taxes?
Post-tax returns = 14 * { (100-15) / 100 }
Post tax returns = 11.9%
3) Inflation Adjusted Returns
This formula can be used to find out the actual returns after adjusting nominal returns to change in

prices or inflation. This is mainly used during withdrawal phase of your investments. This is also
known as Real Rate of Return. It is used to determine the actual worth of an investment after
adjusting for inflation rate.

Inflation adjusted returns = { [( 1+nominal return ) / ( 1+inflation rate )]

1 } * 100
Example : Mr. Gupta (Age 59 years) received Rs 25,00,000 as his retirement benefits. He invested
this amount in Bank Fixed Deposit. He plans to withdraw the interest amount periodically. The
interest rate offered is 9.5%. The average inflation rate is 8%. What is the Real rate of return?
Real rate of return = { [ ( 1 + .095) / (1+.08) ]-1 } * 100
Real rate of return = 1.39%.
4) Compounded Annual Growth Rate (CAGR)
CAGR is the year-over-year growth rate of an investment over a specified period of time. It is known

as Annualized returns. Is is mainly used to compare performances of mutual funds, stocks etc.,
CAGR = [ { ( 1+ r )^ 1/n } 1 ] * 100
(r = Holding period or total return and n = Time)
Example : Mr. Iyer invested Rs 1,00,000 in a mutual fund scheme. After 4 years, he sold the mutual
fund units and received Rs 1,35,000. Calculate Holding period return and CAGR?
HPR = (135000 -100000) / 100000
HPR = 35%
Whereas, CAGR = [ { ( 1+.35)^1/4 } -1 ] *100
CAGR = 7.79%

Holding period return is 35% for 4 years. The annual growth rate will not be 35/4 = 8.75%. But, it
will be less than this figure which is 7.79% as growth is compounded.
If the holding period is 1 year then CAGR and HPR will be the same. If the holding period is more
than 1 year then the CAGR will be less than the HPR.
5) Effective Annual Rate
The formula for converting the nominal return into an effective annual rate is as below:

Effective Annual Rate = { ( 1 + r )^n 1 } * 100

( r = nominal return divided by no of compounding in a year)
(m = no of compounding in a year. 12,4,2 and 1 for monthly, quarterly, half-yearly and annually
respectively.)
Example: Mr. Gowda invests some amount in a bank fixed deposit. The interest rate offered is 9%
pa, compounded quarterly. What is the effective annual rate in this case?
Effective Annual rate = { ( 1 + .09/4) ^ 4 -1 } * 100
Effective Annual rate = 9.3%
Hope this post is useful to you. Make use of these formulas while analyzing your investments. You
may execute these formulas using financial calculator or on MS excel. Kindly share your views.