5.1 Savings and Investing 5.2 The Rule of 72 Getting Started

Saving Why Save? Have a Goal A future goal  Car  College tuition  New computer  Purchase a home  Retirement  Vacation  How much do you need?  When do you need it by?  Do you have to borrow?

How To Save  Make choices about how to use money  Set money aside to buy later  Pay off CREDIT CARDS  Pay yourself FIRST (10% away)  Put it in a safe place (bank)  Rule of thumb: Money for 6 months of bills  Emergency cash Saving/Investing is important for people of ALL income levels

Liquidity  How easy it is to turn an item into cash without losing any money Ex. Money in savings = VERY liquid because it’s readily available Ex. House = not very liquid because you may have to wait to find a buyer Ex. Government bonds = not very liquid because you have to hold them for a specific period of time  (You could purchase a $25 savings bond and receive $50 in 10 years when it “matures”)

CD – Certificate of Deposit  CDs are a good place to put extra money for relatively short amounts of time.  Typically offered in terms of 3 months, 6 months, 1 year, 2 years, 3 years, 5 years or greater  CDs are considered a safe investment, but their low interest rates mean your money grows slowly.  You must pay penalties if you withdraw your money before the CD has fully matured. Would a 2 year CD be liquid?

Investing  Process of putting money some place with the intention of making a financial gain  Has higher financial gain  No guarantee you’ll get more money  More risk than savings  RISK: chance of losing some or all of the money you invested  Default risk: potential you may not get your money back once it’s invested

Earning Interest  WHY? – loaning the bank your money while it’s deposited in your account  IN RETURN – bank guarantees your money is available when needed  Interest = compensation  TWO ways interest can be computed: simple and compound  Principal: original amount deposited for investing

SIMPLE INTEREST Calculated on ONLY the money you invest or loan Example: simple interest = 5% amount = $100 time = 3 years Year 1: $100 x.05 = $5 Year 2: $100 x.05 = $5 Year 3: $100 x.05 = $5 Total earned: $5 + $5 + $5 = $15

Example: simple interest = 2% amount = $200 time = 2 years Year 1: $200 x.02 = $4 Year 2: $200 x.02 = $4 Total earned: $4 + $4 = $8

COMPOUND INTEREST Calculated on the money that you invest/loan PLUS any interest they have already paid you Example: compound interest = 5% amount = $100 time = 3 years 1: $100 x.05 = $5 $100 + $5 = $105 2: $105 x.05 = $5.25$105 + $5.25 = $ : $ x.05 = $5.51$ = $115.76

Example: compound interest = 10% amount = $300 time = 2 years 1: $300 x.10 = $30$300 + $30 = $330 2: $330 x.10 = $33$330 + $33 = $363 Compound Total Earned = $ = 63 Simple Total Earned = $ = $60

Rule of 72  Length of time (years) it takes an amount of money saved to double when it receives compound interest Rule of 72: Years to double = 72 / Interest Rate  At 6% interest, your money takes 72/6 = 12 years to double.  At 9% interest, your money takes 72/9 = 8 years to double

Module 5.3 Saving and Investing Tools

Saving and Investing  Many options available  Decision based upon how you plan to use the money and when you’ll need it  Savings – short and medium term goals or 7 years or less  Investing – long-term goals

Differences in Saving and Investing  Saving is less risk than investing  Investing has higher rates of return which means higher risk  Saving products guarantee a specific rate of return  There is no guarantee in investing

Saving Strategy - Saving Accounts  Interest bearing accounts  Banks and credit unions  Low interest rates  Deposit small amounts of money  Meet short-term goals  Emergency fund

Saving Strategy - Certificate of Deposit (CDs)  Banks and credit unions  Federal insurance (protect $ if bank/credit union closes)  CDs “mature” – days or years  Longer terms = higher interest  Less liquid than savings account

Saving Strategy - Government Savings Bond  Little or no risk (back by government)  Held for a minimum number of years before you can cash them in to get money and interest  Higher rate or return than savings and CDs

Saving Strategy - Money Market Mutual Funds  Provide higher rates of return than savings  Banks and credit unions  Covered by insurance with banks and credit unions  Good for long term goals because it’s diversified  Provide higher rates of return than savings accounts as the money is invested in very short-term investments with a low risk.

Saving Strategy - Checking Accounts  Purpose is NOT to save money  Convenience  BUT some earn a very small % of interest

Investing Strategy - Mutual Funds  Investors pool money to buy shares of a fund that invests in many different financial products (stocks, bonds, and securities)  Great starting point for people with limited knowledge about investing  Accounts have professional money manager who monitors

Investing Strategy - Stocks  Buying stocks = owning part of a company  Stocks do not provide more risk than a mutual fund  If a company fails, your investment is gone  Buy a variety of stocks and diversify (investing your money in various ways in order to spread risk)

Investing Strategy - Corporate bonds  Making a loan to that company  They use your money and pay you back with interest  Lower risk option  Lower return than stocks

Rates of Return  The amount of money you can earn when saving or investing  The higher the average return, the more risk you are taking as an investor  Shows past performance and how it’ll do in the future (T-bill: short-term securities that mature in one year or less from their issue date) Asset ClassRate of Return (Average) Common stocks10% - 13% Stocks of smaller companies14% - 16% Long term corporate bonds6.5% - 8% Long term US gov bonds5% - 7.5% Short term US Treasury bills3.5% - 5%

Module 5.4 Time is Money

Asset Class  Defined as specific kind of investment  Different classes have different risk levels Match the amount of time you need to financially meet your goal with the asset class.

Fixed Income Items LEAST RISKY  Bank accounts – immediate access to $  Certificate of Deposits – varies based on contract  Government Bonds - $ loaned to US government  Municipal Bonds - $ loaned to a city  Corporate Bonds - $ loaned to a business corporation

Equity Items  Large Cap Stocks – ownership in large companies  Small Cap Stocks – ownership in small companies  International stocks – ownership of foreign companies  Commodities - ownership of gold, oil, etc.  Microcap stocks – ownership in small companies with high risk of failure MOST RISKY

More Terms  Risk tolerance: relates to how much potential loss you can handle with your investment  Risk takers may want to invest in the stock market  People with low risk tolerance should use fixed income or saving products  Diversification: investing your money in various ways in order to spread risk (stocks, bonds, money market accounts, etc.)

More Terms  Inflation: increase in the average price of goods and services from one year to the next  Ex. With 3% inflation, $100 this year = $97 next year Keeping money in a checking account that does NOT earn interest means you’re actually losing money. Average inflation rate in the US is about 3% a year.