Let’s Do the Math! Maximizing your Return Savings Let’s Do the Math! Maximizing your Return

Opportunity Cost The value of the next alternative when making a decision If I did (bought) A instead of B, what would the cost be? Can have monetary or non monetary value

Savings Setting aside money for future use Discretionary income (aka disposable income): the amount of money left over after all obligations have been met Gross Pay Taxes and Deductions Net Pay - = Net Pay Discretionary Income Bills - =

Interest Interest is money paid for the use of someone’s money Simple Interest Interest is computed on amount borrowed or saved only Accumulated interest doesn’t earn interest

Simple Interest Calculations I = P x R x T I – interest P- principal (amount borrowed or outstanding) R- rate, usually expressed as an annual percentage (APR) T – length of time (usually in years) Note: R and T must be in the same units

Simple Interest Example How much interest would you pay on a three year loan of $10,000 at 5% APR? I = P x R xT I = 10,000 x .05 x 3 $1,500

Manipulating the Formula What is the APR on a six-month 1,000 loan that costs $50 in interest? I = P x R X T R = I/(P x T) R= 50/(1000 X .5) R=10%

Compound Interest Interest is computed on the original principal AND the accumulated interest. For example if you save $100 at 6% and it is compounded annually: Year Principal($) Interest ($) Total ($) 1 100 6 106 2 6.36 112.36 3 6.74 119.10

Calculating Compound Interest A=P(1+(r/n))nt (Future Value Formula) A= Accumulated principal + Interest R = APR T = time N = number of compounding periods For example $100 @ 6% for 2 years, compounded quarterly = A = 100(1+(.o6/4))4*2 = $119.56 Earn $19.56 in interest

Making Comparisons @ 3 Years Simple Interest : I=100*.06*3=18.00 Interest Compounded Annually: $19.10 Interest Compounded Quarterly: $19.56 Quarter Principal ($) Interest ($) Total ($) 1 100 1.5 101.5 2 1.52 103.02 3 1.55 104.57 4 1.57 106.14 5 1.59 107.73 6 1.62 109.34 7 1.64 110.98 8 1.66 112.65 9 1.69 114.34 10 1.72 116.05 11 1.74 117.79 12 1.77 119.56

Annual Percentage Yield APY (rate of return) percent increase in savings due to interest APY = APR with simple interest APY > APR with compound interest APY will increase as the number of compounding periods increases APY = Interest/(Principal * Time)*100

Calculating APY What is the APY on $100 savings for 3 years @ 6% under simple interest, compounded annually or quarterly Simple interest: APY=APR=6% Compounded Annually: APY = Interest/(Principal * Time)*100 APY = 19.10/(100*3)*100 = 6.36% Compounded Quarterly APY = 19.56/(100*3)*100 = 6.52%

Savings Products Savings products are purchased at a bank or similar financial institution There is a trade off between liquidity and rate of return Liquidity is the ease of conversion to cash The less liquid the higher the return Investment – use of savings to earn a financial return Investments usually contain an element of risk

Savings Account Highly liquid Demand account Low, usually fixed rate of interest Can be linked to checking account and accessed via an ATM FDIC insured (if purchased through a bank)

Certificate of Deposit (CD) Time deposit Earns a fixed rate of interest for a specific term (3 months to 2 years) Maturity date – date on which interest comes due for payment Redeem for cash or renew Automatic renewal option Check for change in interest rate Steep penalty for early withdrawal FDIC insured

Money Market Account Liquid investment account Deposits are invested in safe, liquid securities Variable rate of return Generally low Minimum balance requirements Account limitations may include: Min. $ per check, max # of checks Not FDIC insured

Establish a Savings Plan Determine a specific dollar amount or percentage of income to invest each pay period Automatic payments take the pain out of saving You don’t miss what you don’t see Direct Deposit Payroll Deduction