Presentation on theme: "5.1 Savings and Investing 5.2 The Rule of 72 Getting Started."— Presentation transcript:
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 = $110.25 3: $110.25 x.05 = $5.51$110.25 + 5.51 = $115.76
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
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%
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.