UNIT FOUR Savings and Investments: Your Money at Work

Questions to be answered: How can you develop the habit of saving? What is the difference between saving and investing? What does time value of money mean, and why is it such a neat thing for one to know now? What is a quick way to find out how long it will take your money to double? What is the difference between a stock and a bond? How do mutual funds work?

Saving vs. Investing Talked about how to earn money. Will focus on how you can make your money work for you. Where does the money come from? Two significant ways: savings and investments. Are they the same?????????????????

Savings: Money set aside for a short-term goals. May save money in order to have money to invest later. Usually very safe and probably earns a small amount of interest. Can usually get your money out of the account whenever you want – is called liquidity.

Investing Money set aside for future income, benefit, or profits to meet LONG-TERM goals Is no guarantee your money will grow or increase. Earnings or loses usually more than from savings accounts. Investor recognizes it usually takes a LONG TIME to earn big bucks – in it for the LONG HAUL.

Time Value of Money Is the relationship between time, money and rate of return (interest), and their effect on earnings of growth. Earned Interest – the payment you receive for allowing a financial institution or corporation to USE your money.

Time, Money and Rate of Interest The more TIME you have to save, the more money you will have at the end of the time period. The more MONEY you have to save, the more money you will have at the end of the time period. The higher the RATE OF INTEREST you can earn, the more money you have at the end of the time period.

The really cool thing is that people of your age have the dynamics of time and compound interest on your side because you have more time to save and invest.

Compounding Compounding, or compound interest – is the idea of earning interest on interest. One of the greatest aspects of personal finance. “Compounding is the 8th wonder of the world.” –attributed to Albert Einstein. Savings that earn interest can grow into an investment fund. Individual who learn to P.Y.F generally have money when they need it.

First year - $100 x 10% =10 + 100 = $110 Second year - $110 x 10% = 11 + 110 = $121 Third year - $121 x 10% = 12.10 + 121 = $133.10 Fourth year - $133.10 x 10% = 13.31 + 133.10 = $146.41 Earning - INTEREST on INTEREST

Rule of 72 Simple rule based on the concept of compounding: It tells you how long it takes for your money to double in value. 72 / interest rate = number of years for your money to double. 72/6% = 12 years If you have a time period in mind, you can figure out what interest you need to double your money. 72/8 years = 9% interest.

Time We discussed the time value of money – fact is, the more time you have to reach your savings goals, the more money you will have at the end of that time. Example: page 49 in Student Guide

Risk and Return Investments in the stock market do have risks – one can certainly lose money on stocks – or any other investments. The risk-to-return relationship is a key investment principle. The more risk you take, the greater the potential return you can receive. The reverse is also true – less risk, less return on your money. Page 50 – Figure 4.2 Student Guide.

Rate of Return Is a critical factor in the saving and investment world, that is how fast your money grows. Interest rate and rate of return are synonymous. Earlier you read that the more time you have, the less money you need to reach your goal. In a similar way, the higher your rate of return, the less money you need to reach a goal. Page 51 – Assignment 4.2 - Figure 4.3 Student Guide.

Diversification People have different ideas about how much risk to take with their money. Some are conservative and want to be safe – like savings accounts. Others are more aggressive and are willing to take a risk – like the stock market. Regardless of your investment style –wise investors know that diversification a critical element in any investment plan. Diversification is the reduction of investment risk by spreading your invested dollars among several different investments.

Inflation and Taxes Inflation occurs when the price of goods and services rise. Has been around for decades – ranging from barely .5% to 18% What does that mean and why should you care: It means you are going to be paying more in the future for the same items. A dollar in the future won’t buy as much as a dollar today. Depending on your type of investments, inflation can go up faster than your earnings. Inflation can work against your money, so you need to protect yourself against that risk. Learn to invest wisely, follow the rate of inflation, and make sure your investment rates are higher than those of inflation.

Taxes are the another drain on your savings and investments. When you have a job, state and federal governments take their share from your income. When you have income from your savings and investments, the state and federal governments tax those earnings as well. If you buy and sell investments, like stocks, the governments taxes you on any gains or profits you make. There are types of savings and investments that can overcome inflation and minimize the impact of taxes.

In general terms, people put their money to work for two reasons: Income or Growth. Income means they get paid – in cash – for holding certain types of investments. Growth means they hold an investment with the hope that it will increase in value over time. In terms of months or a few years, income investments tend to provide more reliable returns with less risk and lower returns than growth investments.

“Owner or Lender” If you are a lender, you lend your money to a business or the government and receive interest. If you are an owner, you actually buy a piece of a business and hope the business goes up in value. Lenders typically take less risk than owners, so owners tend to get paid more – but there’s no guarantee.

Income Investments (Lenders) Savings Accounts: payments are called interest. U.S. Savings Bonds: formal agreement between you (lender), the U.S. government (borrower) covering a set time period. Borrower agrees to pay you cash – interest. It will cost you a penalty of lost interest if you cash in the bonds within five years of purchase. Bonds typically pay higher rates of interest than savings accounts.

Not to be out done by the government, banks and credit unions have their own versions of bonds, called certificates of deposit (CD). Set up for a period of time and pay interest. Usually pay slightly higher interest than savings accounts, although do have penalties if cashed in early. Money Market Accounts: Work like checking accounts and pay a higher rate of interest than savings accounts. You can take money out whenever you want and usually with no penalty. Corporate and Government Bonds: Government bonds tend to be safer than company bonds, so corporate bonds usually pay higher rates of interest. Time periods can be 2 to 30 years. In general, the longer the time period, the higher the interest rate.

Growth Investments (Owners) Stocks: Investments that represent ownership in a company. When a company first issues stock, it does so to raise money for itself. The company then puts that money to work to produce its product or service. The stock itself sells for a price. A stock buyer wants the price of the stock to increase over time. Eventually, the buyer will sell the stock. “Buy low – sell high.” The difference between the purchase price and selling price is the investor’s earnings, which is called capital gain.

Real Estate. Investors buy pieces of property, such as land or a building, in hopes of generating a profit. Collectibles. Are usually unique items that are relatively rare in number. Examples include paintings, sculptures, baseball cards, etc. Just like stocks or real estate, collectors buy items they hope will go up in value over time. They are very high risk, because popularity and demand can change from one year to another.

Mutual Funds. Investors always have choice when making investment decisions. Although some people like to hire a professional to make their management choices for them. Investors who want professional management turn to mutual funds. A mutual fund pools money from several investors and uses the money to buy a particular type of investment, such as stock. A fund manager, who is an investment expert, makes all the buy and sell decisions for the investments in the fund. Because mutual funds own a variety of investments, investors enjoy the benefits of diversification, and are a great choice of investing. Mutual funds invest in almost any area of the business world. If you can imagine it, there is probably a fund in existence that specializes in a particular type of business or product.