Unit 3 - Investing: Making Money Work for You

What do you think? Adam started saving $50 per month when he turned 18, while Beth started saving $100 per month when she turned 24. They both earn 6% on their money. Beth will have more money by the time they both turn 30. A dollar today is worth less than a dollar in the future The higher the interest rate, the less time it takes to reach a savings goal The smaller the down payment someone makes on a car, the less interest the owner pays for a car loan.

What do you think? - Answers False - Adam started saving $50 per month when he turned 18, while Beth started saving $100 per month when she turned 24. They both earn 6% on their money. Beth will have more money by the time they both turn 30. (Compound interest worked longer for Adam) False - A dollar today is worth less (more) than a dollar in the future (Inflation) True - The higher the interest rate, the less time it takes to reach a savings goal (Faster Money Grows) False - The smaller the down payment someone makes on a car, the less interest the owner pays for a car loan. (Principal amount accruing interest is smaller)

Discussion Which strategies do you use now to save or invest your money? Which do you think is better use of your money – saving or investing? Why?

Risk / Reward When It comes to Investing Risk and Reward go together. The more risk to take the higher the potential reward – When it comes to investing, the risk is that you loose your money Its all about your tolerance for risk vs. your desire for the highest return (reward). As an investor you are either Conservative – Very Risk Averse willing to take very little risk Average – willing to take some risk for some reward Aggressive – willing to take high risks for potential high rewards

Saving = Investing Saving is what people do to meet short-term goals. Safe (FDIC Insured) in a savings account earning a small amount of interest Investing means you are setting your money aside for long-term goals There is no guarantee that the money you invest will grow, over time investment rise and fall in value RISK / REWARD

Exercise 3A – Ways to save and invest ________________ ________________

Time Value of Money Refers to the relationship among time, money and rate of interest Inflation – rise in cost of goods and services over time

Time value of Money Earned Interest – payment you receive for allowing a financial institution or corporation to use your money The more money you have to save or invest the more money you will earn The higher the rate of interest you earn, the more money you are likely to have The sooner you invest your money the more time it has to make new money

Interest = Principal x Interest Rate x Time $3 = $100 x .03 x 1 year

Answers to Exercise 3B ? ? ? ? ? ? 4% $10.40 $10.82 $11.70 $12.66 8% Interest Rate 1 Year 2 Years 4 Years 6 Years 4% $10.40 $10.82 $11.70 $12.66 ? ? 8% $10.80 $11.66 $13.60 $15.87 ? ? ? ?

A = P(1+i)n Show me the money! Compound Interest – idea of earning interest on interest already earned A = P(1+i)n *Assignment 3-1*

The Price of Procrastination The more time you have to invest the more money you are likely to end up having By waiting to invest you’re paying an opportunity cost Saving for your goals involves delayed gratification

Rule of 72 Doubling your money Interest Rate = Years Needed to Double Investment 72 Interest Rate Required = Years Needed to Double Investment 3-H

The Rule of 72 Doubling your money Compounding – concept that your money is making more money while you sleep Divide 72 by rate of interest or # of years 72 / 6% interest = 12 years to double the investment 72 / 4 years = 18% interest to double the investment

Exercise 3C What interest rate would be necessary to double a $100 investment in 24 years? How many years would it take to double $100 if it earned interest at a rate of 8% per year? What interest rate would be necessary to double a $100 investment in 11 years? How many years would it take to double $100 if it earned 7.75% interest per year?

Exercise 3C Answers What interest rate would be necessary to double a $100 investment in 24 years? 72 / 24 = 3% How many years would it take to double $100 if it earned interest at a rate of 8% per year? 72 / 8 = 9 years What interest rate would be necessary to double a $100 investment in 11 years? 72 / 11 = 6.55% 4. How many years would it take to double $100 if it earned 7.75% interest per year? 72 / 7.75 = 9.29 years

Risky Business When people hear investment they think of the stock market (the place where stocks are bought and sold) plus they think about loosing all of their money All investment have some degree of risk Risk/reward trade off is the principle that an investment must offer higher potential returns to compensate for the increased potential risk

Financial Planning Pyramid Penny Stock Commo- dities Collectibles Speculative Stock / Bonds / Mutual Funds Real Estate Blue-Chip Common Growth Mutual Funds High-Grade Convertible Bonds Preferred Balanced Corporate Bonds or Mutual Funds Municipal Bonds Money Market Accounts Certificates of Deposit U.S. Savings Insured Savings / Checking Accounts Treasury Issues Financial Planning Pyramid Highest Risk Highest Earnings Lower Risk Lower Earnings 3-J

Risky Business Vocabulary Dividend – Share of the profits you receive as a stockholder Capital gain – difference between purchase and sale price when the sale price is greater than the purchase price Capital loss - difference between purchase and sale price when the sale price is less than the purchase price Rate of return – annual percentage return on investment – tell you how fast your money is growing

Income Investments Savings account U.S. Savings Bond Often the first banking product people use Earn a small amount of interest Federal Government guarantees safety of money up to $250,000 Liquid asset Federal government pays interest to investors for loaning it money Bond – formal agreement where the borrower can use your money for a set period of time and the lender will get paid interest Can be held for up to 30 years - Penalty for cashing in early

Income Investments Bank/Credit Unions version of a savings bond Certificates of Deposit (CDS) Money market deposit accounts Bank/Credit Unions version of a savings bond Set period of time The longer the term the higher the interest Penalty for cashing in early Offered by bank & credit unions Work like a checking account May have a limited number of checks you can write per month Pay a higher rate of interest than savings accounts due to higher minimum balances Insured by the Federal Government

Income Investments Money Market Mutual Funds Corporate and Government Bonds Investment company takes your money and invests it into a diversified group of securities Stable way to save your money but No guarantee Not insured by Federal Government Earn higher rate of interest than Money market deposit accounts Pay the highest interest rates A bond’s potential return is referred to as a yield US bonds (treasury bonds) safer since backed by Government But Corporate bonds offer higher interest rates Range from 2-30 years, longer the time the larger the interest rate

Growth Investments Stocks Real Estate You own a part of the company Investors who buy stock are called shareholders Riskier investment because you can loose more money Generally liquid asset Investors buy property – land or buildings hoping to generate a profit Many forms of investment – malls, apartment complex, farmland, undeveloped land etc. Not a liquid asset because it is difficult to sell

Growth Investments Collectibles Mutual Funds Items relatively rare in number Paintings, sculptures, other works of art, baseball cards, antiques etc Don’t make a profit/loss until item is sold High risk due to small market for collectibles Take money from many investors and uses it to make growth or income investments based on a investment objective Offer investors an affordable way to own shares of many stocks Professionally managed

Many baskets of eggs Diversification – reducing investment risk by putting money in several types of investments By spreading your money around you are reducing the impact that a drop in any one investment’s value can have on your overall investment portfolio

Smart, Steady Eddie PYF even if it a small amount at first cause the little money can build up quickly Dollar cost averaging – practice of investing a fixed amount in the same investment at regular intervals, regardless of what the market is doing

Dollar-Cost Averaging One-Time Investment Dollar-Cost Averaging Amount Invested Share Price ($) Shares Purchased Amount Invested Share Price ($) Shares Purchased $1,000.00 $20.00 50.00 $100.00 $20.00 5.00 $100.00 $19.50 5.13 $100.00 $19.25 5.19 $100.00 $19.75 5.06 $100.00 $19.20 5.21 $100.00 $18.90 5.29 100/19.78 = 5.06 shares, not 5.08 (second to last row on the right) Total shares purchased then becomes 51.66, not 51.68 $100.00 $18.00 5.56 $100.00 $18.60 5.38 $100.00 $19.78 5.06 $100.00 $20.90 4.78 $1,000.00 $20.00 50.00 $1,000.00 $19.39* 51.66 * Average Share Price