how to make an investment plan 1

The investor who gives up $100 today expects to consume $104 of goods and services in the future. This assumes that the general price level in the economy stays the same. This price stability has rarely been the case during the past several decades when inflation rates have varied from 1.1 percent in 1986 to 13.3 percent in 1979,with an average of about 5.4 percent a year from 1970 to 2001. If investors expect a change in prices, they will require a higher rate of return to compensate for it. For example, if an investor expects a rise in prices (that is, he or she expects inflation) at the rate of 2 percent during the period of investment, he or she will increase the required interest rate by 2 percent. In our example, the investor would require $106 in the future to defer the $100 of consumption during an inflationary period (a 6 percent nominal, risk-free interest rate will be required instead of 4 percent).Further, if the future payment from the investment is not certain, the investor will demand an interest rate that exceeds the pure time value of money plus the inflation rate. The uncertainty of the payments from an investment is the investment risk.  The additional return added to the nominal, risk-free interest rate is called a risk premium. In our previous example, the investor would require more than $106 one year from today to compensate for the uncertainty. As an example, if the required amount were $110,$4,or 4 percent, would be considered a risk premium.