Savings BA250 - Personal Finance Week 3.

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Presentation transcript:

Savings BA250 - Personal Finance Week 3

Establishing A Savings Program Create emergency fund Set aside funds for financial goals Utilize direct deposits and automatic transfers Make suitable choices based on goals and time horizon PAY YOURSELF FIRST On payday - deposit money into savings account, using check or debit card

Earning Interest on Your Money Simple Interest interest paid only on initial deposit Compound Interest interest paid at set intervals and added back to principal

Earning Interest on Your Money Nominal rate - named or stated interest rate Effective rate - annual rate of return actually earned If interest is compounded more frequently than once a year, the effective rate will be greater than the nominal rate of interest

How Is Interest Calculated? If simple interest is used, there is no compounding Interest = Principal x rate x time = $1000 x .05 x 1 = $50

How Is Interest Calculated? If compound interest is used and the compounding occurs semiannually then 1st 6 months' interest: $1000 x .05 x 6/12 = $25.00 2nd 6 months' interest: + $1025 x .05 x 6/12 = $25.63 Total annual interest = $50.63

How Is Interest Calculated? Nominal rate = 5% …but…. Effective rate = 5.063% Effective Rate = $50.63  $1000 = 0.05063 = 5.063%

How Much Interest Will You Earn? Amount of interest earned depends on Frequency of compounding Balance on which interest is paid Interest rate applied Time value of money concepts are used in compounding to find interest earned

A Variety of Ways to Save U.S. Treasury Bills Debt securities issued by U.S. Treasury Sold at a discount; $1000 minimum Mature in 1 year or less Certificates of Deposit (CDs) Funds remain on account for a given time period Early withdrawals incur an interest penalty

A Variety of Ways to Save Series EE Bonds Purchased at a discount Accrual-type security with Interest paid when cashed in Exempt from state, local taxes New bonds must be held at least 1 year Income taxes may be avoided if redeemed for educational purposes

References Gitman, L. J., Joehnk, M. D., & Billingsley, R. S. (2011). PFIN. Mason, OH: South-Western Cengage Learning.