SAVINGS AND CASH INVESTMENTS Personal Finance Modified March 2012

Activity Financial Fitness For Life – Theme 3: Tomorrow’s Money: Getting to the End of the Rainbow T3_L8_ Student Letter 2

Savings and Investments UniqueSavingsFeaturesUniqueInvestmentFeatures CommonFeatures Short term needs Easy to get to money Safe Longer term needs No Guarantee $ will grow Grows NEFE High School Financial Planning Program Chapter 3: Investing: Making Your Money Work for You 3

Investing - Objectives Identify factors that affect your investment choices Explain the steps to developing your own personal investment plan. Explain how money grows through compounding interest Use the Rule of 72 to determine the length of time an investment will double Distinguish between and calculate future value (FV) and monthly payments (PMT) using a spreadsheet. Explain the benefits of interest compounding and calculate the future value of a lump sum investment 4

Financial Planning Pyramid Penny Stock Commo- dities Collectibles Speculative Stock / Bonds / Mutual Funds Real Estate Blue-Chip Common Stock Growth Mutual Funds High-Grade Convertible Bonds High-Grade Preferred Stock Balanced Mutual Funds High-Grade Corporate Bonds or Mutual Funds High-Grade Municipal Bonds or Mutual Funds Money Market Accounts or Mutual Funds Certificates of Deposit U.S. Savings Bonds Insured Savings / Checking Accounts Treasury Issues Highest Risk Highest Earnings Lower Risk Lower Earnings 3-J NEFE High School Financial Planning Program Chapter 3: Investing: Making Your Money Work for You 5

6

Investing Basics Saving Builds a foundation… 4 Basic Steps: 1.Create a "rainy day" reserve 2.Pay off your debts 3.Get insured 4.Max out any tax-deferred retirement plans, such as 401(k)s and IRAs 7

Investing Basics Inflation reduces the purchasing power of your dollars over time The sooner you start saving or investing, the more time and potential your investments have for growth. Compounding helps you provide for your financial future by doing some of the work for you. 8

6 Step Process 1. Setting investment goals 2. Understanding your investment personality 3. Designing an investment portfolio 4. Selecting specific investments 5. Managing and monitoring the portfolio 6. Rebalancing or redesigning the portfolio, if needed Investment Planning 9

Activity NEFE Worksheet: 3-2 Are You a Risk Taker? NEFE book p – What Do You Think p28 – Exercise 3B p

Types of Interest  Simple Interest – Interest paid (earned) on only the original amount, or principal borrowed (lent).  Compound Interest Interest paid (earned) on any previous interest earned, as well as on the principal borrowed (lent). © 2001 Prentice-Hall, Inc. Fundamentals of Financial Management, 11/e Created by: Gregory A. Kuhlemeyer, Ph.D. Carroll College, Waukesha, WI 11

Types of Interest  Simple Interest – Interest paid (earned) on only the original amount, or principal borrowed (lent).  Compound Interest Interest paid (earned) on any previous interest earned, as well as on the principal borrowed (lent). © 2001 Prentice-Hall, Inc. Fundamentals of Financial Management, 11/e Created by: Gregory A. Kuhlemeyer, Ph.D. Carroll College, Waukesha, WI 12

TIME INTEREST TIME allows you the opportunity to postpone consumption and earn INTEREST. Why TIME? TIME Why is TIME such an important element in your decision? © 2001 Prentice-Hall, Inc. Fundamentals of Financial Management, 11/e Created by: Gregory A. Kuhlemeyer, Ph.D. Carroll College, Waukesha, WI 13

$10,000 today Obviously, $10,000 today. TIME VALUE TO MONEY You already recognize that there is TIME VALUE TO MONEY!! The Interest Rate $10,000 today $10,000 in 5 years Which would you prefer -- $10,000 today or $10,000 in 5 years? © 2001 Prentice-Hall, Inc. Fundamentals of Financial Management, 11/e Created by: Gregory A. Kuhlemeyer, Ph.D. Carroll College, Waukesha, WI 14

$140 SI = P 0 (i)(n) = $1,000(.07)(2) = $140 Simple Interest Example Assume that you deposit $1,000 in an account earning 7% simple interest for 2 years. What is the accumulated interest at the end of the 2nd year? 15

Answers to Exercise 3B NEFE p. 30 8% 4%$10.40$10.82 Interest Rate1 Year2 Years4 Years6 Years ???? ?? $10.80$15.87$13.60$11.66 $12.65$11.70 NEFE High School Financial Planning Program Chapter 3: Investing: Making Your Money Work for You P * r * t = I Principal * interest rate * time (yrs.) = $Amount of Interest to pay 16

Activity NEFE - Dollar and Sense Worksheet and Savings Plan Worksheet – Use Excel and PMT function and FV function to help answer 17

Compounding Interest Let's say you invest $5,000 a year for 30 years. After 30 years you will have invested a total of $150,000. Assuming your funds grow at exactly 6% each year, after 30 years you will have over $395,000, because of compounding. 18

FV 1 P 0 $1,000 $1,070 FV 1 = P 0 (1+i) 1 = $1,000 (1.07) = $1,070 Compound Interest You earned $70 interest on your $1,000 deposit over the first year. This is the same amount of interest you would earn under simple interest. Future Value Single Deposit (Formula) © 2001 Prentice-Hall, Inc. Fundamentals of Financial Management, 11/e Created by: Gregory A. Kuhlemeyer, Ph.D. Carroll College, Waukesha, WI 19

FV 1 P 0 $1,000 $1,070 FV 1 = P 0 (1+i) 1 = $1,000 (1.07) = $1,070 FV 2 P 0 $1,000 P 0 $1,000 $1, FV 2 = FV 1 (1+i) 1 = P 0 (1+i)(1+i) = $1,000(1.07)(1.07)= P 0 (1+i) 2 = $1,000(1.07) 2 = $1, $4.90 You earned an EXTRA $4.90 in Year 2 with compound over simple interest. Future Value Single Deposit (Formula) Future Value Single Deposit (Formula) © 2001 Prentice-Hall, Inc. Fundamentals of Financial Management, 11/e Created by: Gregory A. Kuhlemeyer, Ph.D. Carroll College, Waukesha, WI 20

Compounding Interest = earning interest on interest A=P(1+i) n A= amount in account P= principal (original investment) N=number of years i= interest rate Compounding Interest 21

Why Compound Interest? © 2001 Prentice-Hall, Inc. Fundamentals of Financial Management, 11/e Created by: Gregory A. Kuhlemeyer, Ph.D. Carroll College, Waukesha, WI 22

FV $1,140 FV = P 0 + SI = $1,000 + $140 = $1,140 Future ValueFuture Value is the value at some future time of a present amount of money, or a series of payments, evaluated at a given interest rate. Simple Interest (FV) Future Value FVWhat is the Future Value (FV) of the deposit? © 2001 Prentice-Hall, Inc. Fundamentals of Financial Management, 11/e Created by: Gregory A. Kuhlemeyer, Ph.D. Carroll College, Waukesha, WI 23

11% 10% 9% 8% 7% 6% 5% 12% InterestRate 5 Years 20 Years 15 Years 10 Years $5,526 $6,353 $6,228 $6,105 $5,985 $5,867 $5,751 $5,637 $12,578 $17,549 $16,722 $15,937 $15,193 $14,487 $13,816 $13,181 $21,579 $37,280 $34,405 $31,772 $29,361 $27,152 $25,129 $23,276 $33,066 $72,052 $64,203 $57,275 $51,160 $45,762 $40,995 $36,786 Investing $1,000 Annually NEFE High School Financial Planning Program Chapter 3: Investing: Making Your Money Work for You 24

Activities FFFL - Theme 3: Tomorrow’s Money: Getting to the End of the Rainbow Lessons: T3_L8_8.2 25

Rule of Interest Rate = Years Needed to Double Investment 72 Interest Rate Required = Years Needed to Double Investment NEFE High School Financial Planning Program Chapter 3: Investing: Making Your Money Work for You 26

Activity Ex. 3C – P. 32 NEFE – 4 problems to solve 8.3 Save Early and Often (Rule of 72) Rule of 72 27

The Impact of Higher Returns on Savings and Investments Rule of 72: The approximate frequency with which $100 doubles at specific interest rates Interest Rate 3% 24 Yrs. $800 4% 6% 8% 12% 6 Yrs. 9 Yrs. 12 Yrs. 18 Yrs. $400 $400 $400 $200 $200 $200 $200 $200 NEFE High School Financial Planning Program Chapter 3: Investing: Making Your Money Work for You 28

SAVINGS OBJECTIVES: Discuss the Truth in Savings Act Define annual percentage yield (APY) Explain characteristics of several different types of investments such as CD’s, Money Market Accounts, and IRA’s, Explain PYF Describe the relationship between risk and reward 29

Cash Investments Advantages Predictable earnings Highly liquid Little risk to principal Tradeoffs Relatively low returns May not outpace inflation Examples: Savings Accounts Money market deposit accounts Money market funds Certificates of deposit Guaranteed investment contracts (GICs) Government savings bonds U.S. Treasury bills Certificates of deposit Commercial paper 30

SAVINGS AND THE ECONOMY Money borrowed from financial institution could include your invested money – Help individuals, businesses, & governments Buy houses, cars, college Operate or expand services Build highways, schools, public services – Demand for goods and services created – More jobs = stable economy 31

TRUTH IN SAVINGS ACT Requires financial institutions to “present the interest rate on savings accounts in terms of annual percentage yield (APY)” Yearly rate of return Easier to compare 32

Regular Savings Accounts Savings plan with a low or zero minimum balance High liquidity Signature card Withdrawal Slip – Written request to take money out of account Deposit Slip 33

Certificates of Deposit Minimum deposit Certain period of time (not liquid) – 6 months, 12 months, 24 months, 36 months Penalty for early withdrawal Higher interest rates (than Reg. Sav. Acc.) – Longer the period the higher the interest rate 34

Money Market Account Savings Account Minimum Balance ($1,000) Variable rate of return (monthly) 35

Comparing Cash Investments 36

Individual Retirement Account (IRA) –Tax-sheltered plan allows people to invest up to $2,000 annually –Tax-deductible Roth IRA –No taxes on future investment gains –Grow tax-free indefinitely, no mandatory withdrawal requirements Penalties if w/d early (before 59 ½) Saving for Retirement 37

Activity FFFL – Theme 3 Worksheet: T3_L9_1 Risks (6 questions), T3_L9_2 Pyramid (8 scenarios) 38