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Spending, Saving, & Investment UNIT 8: PERSONAL FINANCE (1)
Making Rational Decisions Making rational decisions often involves delaying a small benefit now for a greater benefit later. Most Americans have enough money to provide themselves with the things they need. However, people have unlimited wants. Our market economy provides us with an enormous amount of choices in terms of goods and services.
Making Rational Decisions When you weigh the opportunity cost of spending your money NOW, you may decide that your decision could deprive you of the chance to afford something better later. Making rational decisions involves deciding how much money to spend now and how much to set aside as savings. Money can be set aside as savings to reach short- term goals or as investment to achieve long-term goals.
Saving & Investing Savings Money deposits placed securely in banks Short-term goals Usually placed in banks or credit unions Tend to earn smaller amounts of interest Investments Money paid into a business with the expectation of future rewards. Long-term goals Risky investments can pay big returns in the long run. Stocks and bonds
Financial Institutions for Savings 1. Banks 2. Savings and Loans 3. Credit Unions
Banks A corporation that stores deposits and makes loans in order to earn a profit. Banks use the money their customers deposit to make loans to people who want to buy a house, a car, or any other expensive item. In exchange for using the money in your savings account, the bank pays you a small amount of interest per year. If your savings account pays 3% interest, for example, and you deposit $100, you will have $103 at the end of one year. One way to earn more interest from a bank is to buy a certificate of deposit (CD). This is a deposit you promise to leave in the bank for a specific period of time. People who borrow from a bank, on the other hand, must pay interest. The interest a bank charges for a loan is always more than the interest it pays for savings accounts. This is how the bank earns a profit.
Savings and Loan Similar to a bank. Gets most of its deposits from consumers rather than businesses. Lends most of its money to home buyers. Not very common today.
Credit Union A not-for-profit financial institution that is both owned and controlled by its members. Credit union deposits earn interest and depositors are eligible to borrow money. Sometimes interest rates for loans are lower at credit unions than commercial banks. Membership at credit unions can be limited to a specific company or occupation.
FDIC All three types of financial institutions are protected by the FDIC- Federal Deposit Insurance Corporation. -Accounts are insured for amounts up to $250,000. -If your bank goes bankrupt, your money is safe.
Investments: Higher Returns For Higher Risks Investing your money can bring higher rates of return but not without a higher risk. Investments in the stock market are not FDIC insured. Typically, the greater the risk you are willing to take, the higher the potential rewards you can earn. Three important kinds of investments are bonds, stocks, and mutual funds.
Bonds When you buy a bond, you are simply lending your money now for a specified amount of interest to be earned over a period of time. The borrower pays pack the cost of the bond plus interest. All bonds have a “maturity” date. Bonds can be purchased from corporations, the federal government, or state/local governments. Bonds earn higher rates of interest than regular savings accounts or certificates of deposits. They are considered a safe investment because the issuers of the bonds are evaluated in advance to determine their credit worthiness. Evaluators are Standard & Poors as well as Moodys
How do bonds work?
United States Savings Bonds
Stocks Stocks are the riskiest investments but also have the highest potential rewards. When you buy stocks, you buy shares in the ownership of the corporation. In return for your investment, you earn dividends, your share of the company’s profits. You may also sell your stock at any time and keep the profit you earn if the value of your shares has increased. These profits are called capital gains. If the company fails to earn a profit, however, you can lose money. If the company goes bankrupt, you can lose your entire investment. This is why most investors today choose mutual funds.
Mutual Funds A mutual fund pools money from many investors and uses it to buy a variety of stocks and bonds called a portfolio. Mutual funds offer a compromise by including low-risk, low- return stocks with some high risk, high return stocks. Most mutual funds also include certain amounts of bonds as well in order to reduce risk. The mix of stocks and bonds depends entirely on the investor and his/her risk tolerance. Mutual funds are managed by financial experts who make the decisions- for a fee.
Reasons People Save and Invest Most people save and invest because there is something they want in the future that is more important to them than anything they might purchase with the same money today: To buy a house To buy a car Take a vacation Purchase a luxury item Children’s college education Retirement When do you want to retire? How long do you want to work?
Risk & Return
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