Chapter 11 Saving and Investing Options

Slide 2 What Are Low-Risk Savings Options? 11-1 Low-Risk Choices Liquid savings include cash or investments that can be changed into cash quickly. Savings and checking accounts are liquid. Illiquid investments cannot be converted to cash quickly or without a penalty.

Slide 3 What Are Low-Risk Savings Options? 11-1 Low-Risk Choices Savings accounts Usually at a bank, credit union, or other insured financial institution. Good for meeting short term need because money can be drawn at any time without penalty. Money market accounts o Two types: deposit account or fund o A deposit account is similar to a savings account, but it offers a higher rate of interest in exchange for larger than normal deposits o A minimum balance, such as 1,000 or 5,000, is often required to maintain a money market account.

Slide 4 What Are Low-Risk Savings Options? 11-1 Low-Risk Choices Money market accounts A money market fund is a type of mutual fund the invests in low risk securities (such as US Treasury bills). On average, money market funds pay a higher rate than deposit accounts Why invest in a checking or savings account when money market accounts pay higher interest? Money market accounts are usually limited in the number of withdrawals each month. They also required higher balances

Slide 5 What Are Low-Risk Savings Options? 11-1 Low-Risk Choices Certificates of deposit Money set aside for specific length of time at a fixed interest rate Pays higher interest than a money market or savings account. Not a liquid investment, Why? You must pay a heavy penalty if you withdraw the money before the stated time. They are safe because they are insured by the FDIC The biggest risk is inflation risk. Inflation may be higher than the return thus causing you money to lose value.

Slide 6 What Are Low-Risk Savings Options? 11-1 Low-Risk Choices Certificates of deposit Early withdrawal penalty: fee imposed to discourage depositors from withdrawing the money before the stated time period. The penalty may be 6 months interest or more. CD’s pay higher interest when money is set aside for a long period of time

Slide Low-Risk Choices Early Withdrawal Penalty Certificate of Deposit Amount deposited: $5,000 Interest rate: 5% yearly Term: 5 years Penalty for Early Withdrawal If the money is withdrawn before 5 years, the penalty imposed will equal 365 days’ interest, whether earned or not. Sample Scenario The money is withdrawn after 180 days. $5,000 x 0.05 x 180/365 = $ interest earned $5,000 x 0.05 x 365/365 = $ penalty $5, amount deposited interest earned $5, early withdrawal penalty $4, amount received at early withdrawal

Slide 8 What Are Low-Risk Savings Options? 11-1 Low-Risk Choices Life insurance savings plans o Borrow against the policy’s cash value o If this benefit is not repaid, the life insurance death benefit is reduced by the amount of the loan. o These are illiquid Brokerage accounts o An account at an investment company

Slide 9 What Are Low-Risk Savings Options? 11-1 Low-Risk Choices Brokerage accounts o An account at an investment company o This account may pay interest like a savings account or it may be a clearing account. o A clearing account is used to buy and sell investments. o Money is taken from the account to buy them and put back in the account when they are sold o These account earn low interest rates. o Brokerage accounts are not insured however they are considered low risk when placed with a reputable investment company.

Slide 10 What Are Low-Risk Investing Options? 11-1 Low-Risk Choices Bonds A bond is a loan that a buyer makes to a bond issuer. Government and corporations issue bonds. The face value is the amount the bondholder will be repaid on the maturity date. The maturity date is the date the borrowed money must be repaid. Bonds can be purchased at a discount or premium.

Slide 11 What Are Low-Risk Investing Options? 11-1 Low-Risk Choices Bonds A discount bond is one that is sold for less than its face value –For example, a bond that is 5,000 and you pay 4,900, the discount is $100. Bonds are sold at a discount to increase the overall profit of the bond and attract more investors. A premium bond is one that is sold for more than its face value –Bonds are very attractive to investors because they are safer than other choice and pay a good interest rate. –These may sell at a premium.

Slide Low-Risk Choices Return on a Corporate Bond Corporate Bond Face value: $5,000 Discount rate: 4% Coupon rate: 4% yearly (paid semiannually) Term: 2 years Purchase price: $5,000 × 0.04 = $200 discount amount $5,000  $200 = $4,800 discounted purchase price Semiannual interest: $5,000 × 0.04 = $200 interest per year ($100 semiannual payment) $200 × 2 years = $400 total interest received Return on investment: At the end of the second year, the bond is redeemed for $5,000 (face value). $ 5,400 total amount received ($5,000 face value + $400 interest)  4,800 amount invested $ 600 total profit in dollars $600 ÷ $4,800 = = 12.5% total return on investment

Slide 13 What Are Low-Risk Investing Options? 11-1 Low-Risk Choices Bonds You must pay taxes on interest and gains you make from bonds. A bond may be callable A callable bond has a clause that allows the issuer to repay the bond early (before the maturity date) at a set amount –The amount is typically higher than the face value –If interest rates are dropping, corporations may choose to call the bonds because they can re-issue them at a lower interest rate.

Slide 14 What Are Low-Risk Investing Options? 11-1 Low-Risk Choices Bonds A convertible bond is one that may be exchanged for shares of common stock at the option of the bondholder. –If you see the company is doing well and/or is willing to take more risk. You can exchange you bond for an equivalent number of shares of stock. A zero coupon bond is a discount corporate bond that does not provide the typical semiannual interest payments. –The bond is sold at a deep discount and grows in value over time.

Slide 15 What Are Low-Risk Investing Options? 11-1 Low-Risk Choices Bonds Bond rating services study the financial health of bond issuers They risk ratings based to judge the risk of buying the bond –Investment grade bonds have high ratings (AAA,AA,A and BBB) –Speculative grade bonds have low ratings (BB and lower) These are sometimes called junk bonds These are medium to high risk but pay higher interest rates

Slide 16 What Are Low-Risk Investing Options? 11-1 Low-Risk Choices Government Bonds and Securities Issued by the US Treasury and US government agencies. The interest earned from these investments is subject to federal taxes but not state and local taxes. These bonds are considered tax shelters –A tax shelter is an investment that allows you to legally avoid or reduce income taxes

Slide 17 What Are Low-Risk Investing Options? 11-1 Low-Risk Choices Government Bonds and Securities Treasury Bills (T-Bills): these securities are sold in terms ranging from two to ten years –Sold at a discount from face value Treasury Notes: Sold in terms of two to ten years at a fixed rate of interest, which is paid every six months until maturity Treasury Bonds: These bonds are available for a minimum purchase of $100 and have a 30-year term. They pay interest every six months until they mature. Other types –EE Savings Bond –I Savings Bond –Treasury Inflation Protected Securities

Slide 18 What Are Low-Risk Investing Options? 11-1 Low-Risk Choices State and Local Securities Municipal Bonds –Issued by states, counties, cities, and towns. –Used to pay for projects, such as roads or public buildings –You do not have to pay federal, state, or local taxes on the income from municipal bonds. –These bonds are considered a tax shelter.

Slide 19 What Are Low-Risk Investing Options? 11-1 Low-Risk Choices Annuities Annuity –A contact purchased from an insurance company that guarantees a series of regular monthly payments for a set time. –To buy an annuity you would pay a monthly payment into the account for a set number of years (such as 20). –You could also invest a lump sum –Then at the end of the set number of years, the annuity would start pay you monthly payments. –These are commonly used as retirement income

Slide 20 What Are Good Financial Market Investments? A mutual fund is a professionally managed group of investments. It is bought using a pool of money from many investors Medium-Risk Choices

Slide 21 What Are Good Financial Market Investments? 11-2 Medium-Risk Choices Mutual funds consist of stocks, bonds, and other investments Because mutual funds have a variety of investments, they are diversified which lowers their risk Buying a mutual fund is a form of indirect investing. Indirect investing: buying shares of a mutual fund instead of buying individual shares of stock in various companies. Asset Allocation: choosing a combination of funds within a single mutual fund company

Slide 22 Mutual Funds Balanced Funds: Diversified portfolio that includes some low- risk, some medium-risk, and some high-risk stocks Bond Funds: Invests primarily in bonds Global Funds: Invests in international companies, new industries in foreign countries, and companies in the world marketplace Growth Funds: Invest in companies that are expected to grow in the long run Income Funds: Invest in bonds and stocks that produce steady and reliable dividend and interest payments Index Funds: Invest in securities to match a market index with the goal of having returns similar to those of that index Money Market Funds: Invest in short term securities that go up or down with current interest rates and the economy Medium-Risk Choices

Slide 23 Mutual Funds New Venture Funds: Invest in new and emerging businesses and industries. High risk Precious Metal funds: Invest in companies that are associated with precious metals, such as gold, silver, and platinum Stock Funds: Invest primarily in stocks Medium-Risk Choices

Slide 24 Asset Allocation in a Mutual Fund 11-2 Medium-Risk Choices ASSET ALLOCATION Percent of HoldingsType of FundReason for Choice 20%Bond fundFor stability and to offset risk of other funds 20%Growth fundTo invest in high-risk choices that could grow greatly over time 20%Global fundTo benefit from world economic growth 20%Money market fund To provide liquidity and short-term gains 15%Income fundTo receive income in the form of dividends 5%New venture fundTo invest in emerging, young businesses that could become highly profitable and provide a high return

Slide 25 What Are Individual Retirement Account Options? 11-2 Medium-Risk Choices An IRA allows you to deposit money into an account during your working years and withdraw it upon retirement. –You can begin withdrawing money from an IRA at age 59 ½ or later. –If money is withdrawn earlier than 59 ½ you are subject to a 10% early withdrawal fee and still taxed at regular rates. Traditional IRA: an individual retirement account that allows individuals to contribute pretax income to an account that grows tax-deferred. –Withdrawals from a traditional IRA must begin by age 70 ½ Roth IRA: an account in which contributions are taxed but earnings are not. –You cannot deduct the amount you contribute from your gross income. –Do not have to begin withdrawals by 70 ½

Slide 26 What Are Individual Retirement Account Options? 11-2 Medium-Risk Choices Spousal IRA: Individual retirement account set up to benefit a spouse that has no income. –Working spouse contributes money –Can be traditional or Roth –Must file a joint tax return SEP (simplified employee pension) plan is a tax deferred retirement plan for small business owners and their employees. –Employer can make a contribution of 25% of the employees salary Keogh Account is a tax deferred retirement plan for self- employed professionals. –Used more by higher income business owners because it can have higher contribution limits

Slide 27 What Retirement Plans Are Available through Employers? 11-2 Medium-Risk Choices Defined-contribution plans o 401(k) plans: tax-deferred plans for employees of profit-seeking businesses o There is a limit to the amount a employee can contribute o Not taxed until money is withdrawn o Early withdrawal penalties o 403 (b) plans: tax-deferred plans for government and nonprofit organization employees o Operates the same as a 401k except employers cannot contribute to this account

Slide 28 What Retirement Plans Are Available through Employers? 11-2 Medium-Risk Choices Defined-benefit plans o An employer sponsored retirement plan in which retire workers receive a set monthly or lump sum payment base on their wages earned and number of years of service. o Must work for a certain number of years or become vested in the plan. Retirement accounts may be portable, meaning you can take the account with you when you leave a job. –Rollover: the process of moving a retirement account balance to another qualified account without incurring a tax penalty.

Slide 29 Success Skills 11-2 Medium-Risk Choices Set up a spreadsheet to show purchase price and change in value of investments. Track investments over time. Use it to compare investments. Use it to help decide when to change your investment strategy. Use Excel ® to get updated stock quotes. Tracking Investments Using a Spreadsheet

Slide 30 How Can You Invest Directly in Financial Markets? Direct investing is buying stocks and other investments directly from companies and holding them. If you buy the stock of only one company, the risk is high because your money is invested in only one place High-Risk Choices

Slide 31 How Can You Invest Directly in Financial Markets? 11-3 High-Risk Choices Buying stocks o You become a stockholder and own shares in a company. o Make money in two ways o Receiving dividends o Selling stock at a higher price than bought o Purchased through a stockbroker

Slide 32 How Can You Invest Directly in Financial Markets? 11-3 High-Risk Choices Types of stocks –Common Stock: pays variable dividends and gives owners voting rights. Can vote on company issues No guarantee on if stock with increase or decrease No guaranteed dividends –Preferred Stock: guarantees fixed dividend but does not provide voting rights Generally costs more than common stock because there is less risk If a company goes bankrupt, preferred stockholders would be paid first.

Slide 33 How Can You Invest Directly in Financial Markets? 11-3 High-Risk Choices Futures contracts and commodities o Futures Contract: You agree to buy or sell a commodity at a set price and date in the future. o Commodity: an item that has the same value across the market with little or not difference in quality among producers o Meat, soybeans, cattle, coffee, etc. o Buying and selling futures does not transfer ownership o Used as a way to hedge or reduce the likelihood of losing money in the future o Ex: suppose a company has agreed to buy some fuel in the future at a set price. The company might also want to buy some fuel futures contracts. If the price of fuel rises, then the company may make enough money on the futures contracts to pay for the increased price of fuel itself.

Slide 34 How Can You Invest Directly in Financial Markets? 11-3 High-Risk Choices Investment clubs o You pool your money with other people and invest together. o Examples: o May buy a timeshare o Pool money to buy stocks

Slide 35 How Do You Invest in Business Ownership? 11-3 High-Risk Choices A proprietorship is owned by one person. A partnership is formed by two or more persons. IPO (initial public offering): taking a business public and making the owners shareholders

Slide 36 How Do You Invest in Business Ownership? 11-3 High-Risk Choices A franchise is a contract that gives you the right to sell a company’s products and services. A business venture is a business that is backed by investors.

Slide 37 What Are Other High-Risk Investment Choices? 11-3 High-Risk Choices Real estate o Land or vacant lots o Real estate investment trusts (REIT): a corporation that pools money of many individuals to invest in real estate. o Rental property

Slide 38 What Are Other High-Risk Investment Choices? 11-3 High-Risk Choices Collectibles: rare, valuable objects, such as fine art, coins, baseball cards, super duper neato sneakers, etc. Precious metals: gold, silver, platinum Gems: natural precious stones –Diamonds, rubies, etc.

Slide 39 Focus On... Day Traders Attempt to make money by buying and selling stocks and bonds over short periods of time Sell stock when prices rise for a quick profit Must be aware of general market conditions Must be familiar with companies, products, and industries Can make high profits over time 11-3 High-Risk Choices