Intro to Investing

Risk v. Return High risk investments pay higher rates of return than low risk investments. Type depends on goals of investor. Investors should avoid complex investments they do not understand.

Types of Investments Certificates of Deposit (CDs) are issued by financial institutions and are the most common form of investments available. Bonds are long-term investments in which the borrower pays a stated rate of return (interest) on the amount of money borrowed (principal). Example: Treasury Bonds , Corporate Bonds, Municipal Bonds

Types of Investments…Bonds Corporate bonds are issued by corporations and are usually used for long-term investment because they can be liquidated quickly. Municipal bonds are bonds issued by state and local governments and are regarded as a safe, tax-exempt investment. Savings bonds are low-denomination, nontransferable bonds issued by the federal government and are very attractive because they have a virtually no risk of default.

Types of Investments (cont.) Stocks - certificates of ownership in a corporation. Stocks can produce high returns, but have a greater risk than bonds or CDs. Stocks are less risky over time, especially if the investment in stock is diversified (spread over several different companies).

Types of Investments (cont.) A 401(k) plan is a tax-deferred investment plan that acts as a personal pension fund for employees. Mutual Funds – an investment where a financial company diversifies and makes investment decisions on behalf of investors.

Intro to Investing

Basic Investment Considerations High risk investments pay higher rates of return than low risk investments. The type of investment chosen depends on the goals of the investor. Consistent investing can yield large returns. Investors should avoid complex investments they do not understand. A 401(k) plan is a tax-deferred investment plan that acts as a personal pension fund for employees.

Financial Assets and Their Characteristics Certificates of deposit are issued by financial institutions and are the most common form of investments available. Corporate bonds are issued by corporations and are usually used for long-term investment because they can be liquidated quickly.

Financial Assets and Their Characteristics (cont.) Municipal bonds are bonds issued by state and local governments and are regarded as a safe, tax-exempt investment. Savings bonds are low-denomination, nontransferable bonds issued by the federal government and are very attractive because they have a virtually no risk of default.

Financial Assets and Their Characteristics (cont.) Treasury notes and bonds are large long-term obligations issued by the federal government and are seen as the safest of all financial assets. Treasury bills are large short-term obligations issued by the federal government. Individual Retirement Accounts (IRAs) are long-term, tax-sheltered time deposits intended for retirement.

Interest

Intro to Interest Interest is what you earn when you let people borrow your money.  Interest is also the cost you have to pay when you borrow someone else's money. Some call it the price of borrowing money.

Example If I borrow $100 from you at 10% interest for one year, then at the end of the year I have to pay you back the $100 plus an additional $10 in interest. If you leave $1,000 in the bank for one year and they are paying 2% interest, then the bank will add $20 to your account at the end of the year.

How Banks Make Money Banks and Financial Institutions make money by charging a higher interest rate on loans than they do on deposits. Example: If you deposit $1,000 in a savings account the bank will pay you 2% interest ($20) per year. If someone borrows $1,000 from the same bank they will be charged 7% interest ($70) per year. Thus the bank will make a profit of $50 ($70-$20) per year on the $1,000 deposit.

Simple v. Compound Interest Simple interest is interest on the principal amount Compound interest is interest on the principal + any earned interest. You will want to remember this simple rule: simple interest grows slowly, compounding speeds up the process. 

Example Suppose you have $100 to invest. You decide to invest it at the Hogg National Bank. It is a small bank located in the heart of Hazzard County. You walk in and speak with the Boss. He says he will pay 10% simple interest on your $100.  Ten percent of $100 is $10 so at the end of 1 year you will have the original principal of $100 + $10 of interest. Still excited you calculate it for the next year. $100 + $10 +10% of the principal which is still 100. So in year 2 you have $120. Mmm…this is not as good as you thought. But you keep going, third year you get another $10. Moreover, if you were to repeat this calculation you would have $10 of interest each year. The reason is that the interest you earn does not get added to the principal amount so you do not earn interest on the interest.

Example Suppose for the time being that there were another bank in Hazzard County that paid 10% compound interest. That is they paid interest on both your principal as well as the interest you have already earned. The first year you would be no better off: you would still only have 100(1+interest rate)= 100(1.1)= $110. The difference starts in the second year. Now your interest also earns interest. So you would end up with ($100 + $10)(1.1)=$121. The one-dollar difference does not sound like much, this difference gets very large over time. Indeed the difference can get very large if there is enough time.

Example After  Simple Interest Compound 1 year 110 2 years 120 121 3 years 130 133 4 years 140 146 5 years 150 161 10 years 200 259 20 years 300 672 30 years 400 1,744 40 years 500 4,526 50 years 600 11,739 You begin off with $100. In each case the money is invested at 10% annual interest. In the two columns your total dollar balance is given.

A = amount to be repaid P = Principal r = interest rate n = number of compounding periods in a year (annually=1), (quarterly=4), (monthly=12) t = number of years in the loan

Credit

Intro to Credit You are granted credit when an organization or individual makes a sum of money available for you to borrow.

Types of Credit There are two main types of credit: Home loans (mortgages) and personal or store loans are linked to a specific item or items – for example: a new car or a house. Revolving credit on credit cards can give you access to a fixed amount of money that you can spend as you wish, in a wide range of stores and locations.

Advantages Purchase Power and Ease of Purchase - Credit can make it easier to buy things. If you don't like to carry large amounts of cash with you or if a company doesn't accept cash purchases (for example most airlines, hotels, and car rental agencies), putting purchases on a credit card can make buying things easier. Building a Credit Line - Having a good credit history is often important, not only when applying for credit cards, but also when applying for things such as loans, rental applications, or even some jobs. Emergencies - Credit cards can also be useful in times of emergency. Sometimes emergencies (such as your car breaking down or flood or fire) may lead to a large purchase (like the need for a rental car or a motel room for several nights.)

Disadvantages Blowing Your Budget -- The biggest disadvantage of credit is that they encourage people to spend money that they don't have. Most credit cards do not require you to pay off your balance each month, so even if you only have $100, you may be able to spend up to $500 or $1,000 on your credit card. While this may seem like 'free money' at the time, you will have to pay it off -- and the longer you wait, the more money you will owe since credit card companies charge you interest each month on the money you have borrowed. High Interest Rates and Increased Debt -- Credit card companies charge you an enormous amount of interest on each balance that you don't pay off at the end of each month. This is how they make their money and this is how most people in the United States get into debt (and even bankruptcy.)

Credit Worthiness How reliable a lender thinks a borrower will be in repaying the debt owed. Things that impact credit worthiness: Job / Income Current Debt Bills paid on time? (Credit History) Assets (Home, Car, etc..) Stability (location/job) *Determines interest and loan amount.

Credit Score Bad – 0 to 650 Good – 650 – 750 Great – 750 - 850

Credit Choice

Rational Decision Making Rational Choice is simply a choice that is made where benefits outweigh the costs. Rational Decision Making requires us to weigh possible options and determine which will be best.

Rational Decision Making Model Define the Problem/Decision to be made. Identify Important Criteria (Quality, Price, Service) Consider All Possible Options Calculate Consequences/Cost Choose Best Option

Choosing Credit Things to know when choosing credit: Interest Rate Extra Fees Length of Loan Amount of Monthly Payment Credit Limit (If applicable)

Review How can you apply the Rational Decision Making Model to the process of choosing which credit card to use or which bank to borrow money from?

Insurance

What is Insurance? Insurance is a form of risk management primarily used to protect against the risk of a financial loss. Insurance is defined as the transfer of risk of a loss, from one entity to another, in exchange for a premium.

Risk Management Strategies transfer the risk to another party avoiding the risk reducing the negative effect of the risk

Types of Insurance Auto Health Homeowner’s Life Disability

Auto Insurance Do I need… Liability? Comprehensive Coverage? Provides financial protection from losses due to an auto accident or other damage to a car. Do I need… Liability? Comprehensive Coverage?

Health Insurance Provides payments for certain health-care costs. Do I need… Basic Health? (Doctor visits/routine care) Major Medical? (Major illness/injury) Dental and Vision?

Homeowner’s Insurance Protects against financial loss of personal possessions on mortgaged property. Do I need… Physical Damage? (Fire, Water, Etc…) Loss or Theft? Liability? (If someone gets hurt) Renter’s Insurance is similar for renters.

Life Insurance Provides financial protection to dependents of policy owner when policy owner dies. How much do I need? Enough for funeral costs? Enough to pay off debt? Enough to provide for dependents?

Types of Life Insurance Whole Life Policy lasts until the policy holder dies Has a cash value that can be used as collateral Deemed an investment by some Premiums (payments) tend to be higher Term Life Policy lasts for a certain time period When term ends, policy ends No payout, cannot get money back Premiums tend to be lower

Disability Insurance Provides income over a specified period when a person is ill or unable to work. Think AFLAC!

Taxation

What are Taxes? A tax is a financial charge imposed on an individual or business by the government. Tax money is used by the government to provide public goods and service to its citizens.

Economic Impact of Taxes Taxes affect the economy by encouraging or discouraging certain activities. A sin tax is a high-percentage tax that raises revenue while reducing consumption of a socially undesirable product. Taxes affect productivity and economic growth by changing the incentives to save, invest, and work.

Types of Taxes A proportional tax is one that imposes the same percentage on everyone, regardless of income. Flat Tax, Fair Tax A progressive tax is one that imposes a higher percentage of tax on persons with higher incomes. Income Tax A regressive tax is one that imposes a higher percentage on low incomes than on high incomes. Sales Tax

Sales Tax A sales tax is a tax on goods at the point of purchase. Most counties in Georgia charge a 7¢ tax on every $1.00 of a purchase. Therefore, a $10.00 purchase will actually cost $10.70.

Question Explain how an increase in sales tax affects different income groups.

Answer A sales tax is a REGRESSIVE Tax. This is true because 7¢ is a larger percentage of a poor person’s income than a rich person’s. Example: Cody makes $5.85 an hour. He has to buy $100 a week in groceries to feed his family. If sales tax is a 7%, then Bobby will have to work more than an hour just to pay for the tax on the food.

Tax Brackets 2012. Single. Married Filing Jointly 10% Bracket Tax Brackets 2012      Single                         Married Filing Jointly               10% Bracket               $0 – $8,700                  $0 – $17,400                              15% Bracket               $8,700 – $35,350          $17,400 – $70,700                      25% Bracket               $35,350 – $85,650        $70,700 – $142,700                    28% Bracket               $85,650 – $178,650      $142,700 – $217,450                   33% Bracket               $178,650 – $388,350    $217,450 – $388,350                   35% Bracket               $388,350+                   $388,350+                                 

Questions?