Copyright 2007 Thomson South-Western Unit Two Savings & Budgeting

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Chapter 1: Savings Accounts Key Terms Budget Fixed vs. variable expenses Variance Savings Investing Deposit Withdrawal Interest Interest rate Depository institution Credit unions vs. banks Federal Reserve system Monetary policy Account balance Compounding of interest Money market Certificates of Deposit Savings account Individual retirement accounts (IRA’s) Future value Present value Discount factor Rule of 72 & FDIC

Slide 5 What Is the Purpose of Budgeting? A budget is a spending and saving plan. It is based on estimated income and expenses. 4-2 Basics of Budgeting

Slide 6 Four Steps to Building a Budget Estimate income Plan savings Estimate expenses –Variable expenses –Fixed expenses 4-2 Budgeting Eating at a fancy restaurant is entertainment, a variable expense. Balance the budget

Slide 7 Purpose of Budgeting Budget –Allows you to compare financial resources with financial needs –Use spreadsheet software to prepare a budget 4-2 Budgeting A budget can be created using a spreadsheet.

Slide 8 Budget Analysis Income, savings, and expenses will not be exactly as budgeted Differences between planned and actual amounts are called variances –Favorable variances –Unfavorable variances Looking at variances can help you budget better in the future 4-2 Budgeting

Slide 9 Budget Variances Report 4-2 Budgeting Why are these variances favorable/ unfavorable?

Slide 10 The Purpose of Savings Saving means accumulating money to use for future needs A savings account –Is a time deposit in a bank or other financial institution –Is a safe way to set aside money –Typically pays interest –May have some restrictions on how quickly or easily the money can be withdrawn 5-2 Savings Accounts

Purpose of Savings Accounts Definition Goal The process of setting money aside for a future date instead of spending it Provide funds for emergencies Short-term goals Investments Pay yourself first 10%

Investing The process of setting money aside to increase wealth over time and accumulate funds for long-term financial goals such as retirement

Savings Accounts Secure place to store your cash while earning interest. Interest Money paid to you by the bank for being able to use your money (+) Deposit Put money into your savings account (+)(+) Withdrawal Take money from your savings account (-) Accounts at banks are insured by the Federal Deposit Insurance Corporation (FDIC). This insurance is for up to $250,000 per depositor per bank.

Interest Payments Interest rate is the percentage you are paid for your money and can vary from month to month Account balance is the total amount of money that is in the account at a given point in time.

Savings Options Certificates of deposit Money market accounts Individual retirement arrangements (IRAs) Interest bearing checking U.S. savings bonds 5-2 Savings Accounts The TreasuryDirect Web site provides information on savings bonds. Source: TreasuryDirect, (accessed April 27, 2006).

Compare and Contrast THREE savings accounts 1.Name of bank? 2.Is there a student savings account? 3.Is there a minimum balance required? 4.Is a debit card included? 5.What is the minimum age to start an account? 6.What is the address of the closest branch to your house? 7.Would you use this bank? Why?

Types of Savings accounts passbook account Depositor receives a booklet in which deposits, withdrawals, and interest are recorded. Average interest rate is lower at banks and savings and loans than at credit unions. Funds are easily accessible. statement account Basically the same as a passbook account, except depositor receives monthly statements instead of a passbook. Accounts are usually accessible through 24-hour automated teller machines (ATMs). Interest rates are the same as passbook account. Funds are easily accessible. interest-earning checking account Combines benefits of checking and savings. Depositor earns interest on any unused money in his/her account.

Types of Certificates of Deposit 1. Rising-rate CDs with higher rates at various intervals, such as every six months. 2. Stock-indexed CDs with earnings based on the stock market. 3. Callable CDs with higher rates and long-term maturities, as high as 10–15 years. However, the bank may “call” the account after a stipulated period, such as one or two years, if interest rates drop. 4. Global CDs combine higher interest with a hedge on future changes in the dollar compared to other currencies. 5. Promotional CDs attempt to attract savers with gifts or special rates.

Money Market Accounts what they are and how they work Checking/savings account. Interest rate paid built on a complex structure that varies with size of balance and current level of market interest rates. Can access your money from an ATM, a teller, or by writing up to three-six checks a month. benefits Immediate access to your money. (liquidity) trade-offs Usually requires a minimum balance of $1,000 to $2,500. Limited number of checks can be written each month. Average yield (rate of return) higher than regular savings accounts.

Money Market Accounts what they are and how they work Checking/savings account. Interest rate paid built on a complex structure that varies with size of balance and current level of market interest rates. Can access your money from an ATM, a teller, or by writing up to three-six checks a month. benefits Immediate access to your money. (liquidity) trade-offs Usually requires a minimum balance of $1,000 to $2,500. Limited number of checks can be written each month. Average yield (rate of return) higher than regular savings accounts.

Choosing a savings account factors that determine the dollar yield on an account: Interest rate (also called rate of return, or annual yield) All money earned comes from this factor. the following factors reduce money earned and can even turn it into a loss: Fees, charges, and penalties Usually based on minimum balance requirements, or transaction fees. Balance requirements Some accounts require a certain balance before paying any interest. On money-market accounts, most banks will pay different interest rates for different size balances. (Higher balance earns a higher rate.) Balance calculation method Most calculate daily. Some use average of all daily balances.

Federal Reserve System Is the central bank of the United States Seeks to provide the nation with safe, flexible, and stable monetary and financial systems

Monetary Policy Key interest rates are controlled by the Fed –Discount rate –Federal funds rate –Prime rate The Fed sells and buys U.S. government securities in open-market transactions –Government bills (Treasury bills) –Treasury notes –Treasury bonds

Monetary Policy The Fed plays a major role in operating the country’s payment systems –Reserve banks act as a clearinghouse for checks –Checks may be deducted from your account in a single business day The Fed regulates the banking industry –All interstate banks must be Fed members –Intrastate banks are also subject to Fed rules

Commercial Bank vs Credit Union – Part 1 1.Credit Union (general information)Credit Union 2.Overview of Credit UnionsOverview of Credit Unions 3.How Banks WorkHow Banks Work 4.Credit Union DefinitionCredit Union Definition 5.Bank DefinitionBank Definition Slide 25 Complete the Bank vs Credit Union Venn Diagram using the websites listed below (one per group)

Commercial Bank vs Credit Union – Part 2 Locate Local Banks (Enter “banks” in the place for name and enter your zip code)Locate Local Banks Locate Local Credit Unions ; General Credit Union InformationLocate Local Credit Unions Locate ONE BANK and ONE CREDIT UNION in this area (using web sites above) Fill this information in to the Criteria for Choosing a Bank or Credit Union worksheet. Slide 26

Commercial Bank vs Credit Union – Part 3 Complete the Bank Criteria worksheet (one per group) Present your group’s findings to the class Slide 27

Slide 28 Computing Interest Money deposited in a savings account typically earns a set rate of interest –Simple interest 5-2 Savings Accounts SIMPLE INTEREST Interest (I) = Principal (P) x Rate (R) x Time (T) Interest = $1,000 x 6% annual rate x 6 months $30 = $1,000 x 0.06 x 0.5

Slide 29 Computing Interest –Compounding is known as the time value of money 5-2 Savings Accounts $119.57$1.77$1.74$1.72$ $ $1.66$1.64$1.62$ $ $1.57$1.55$1.52$ $ Ending Balance4321Rate Beginning BalanceYear Quarterly Interest QUARTERLY COMPOUNDING Annual Interest Rate 6%

Pay yourself first ( a little can add up!) Save this each week … at % interest … in 10 years you’ll have $7.00 5% $4,720 $ % $9,440 $ % $14,160 $ % $18,880 $ % $23,600 You can buy … two fast food meals or one movie ticket….. OR SAVE $7.00 THIS WEEK You can buy … two small cheese pizzas or one large pepperoni pizza…. OR SAVE $14.00 THIS WEEK What can you give up to save for your financial goals?

Savings Tip If you save the following… Week 1 - $1 Week 2 - $2 Week 3 - $3 and so on…. Week 51 - $51 Week 52 - $52 You will save $1, 378 in one year!

Compound interest Monthly vs. yearly do now You deposit $100 in a savings account. The bank is paying you 4% interest annually, which is compounded monthly. How much interest will you earn for the year? What if the interest was paid yearly. How much interest would you earn? Slide 32

Formula Slide 33

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Compound interest do now How much is your interest for 1 month on your beginning balance of $1000 with an annual interest rate of 3%. What is your ending balance after 1 month? Month interest beginning interest ending balance payment balance 1.25% $ $ And so on.. What would be your ending balance after 1 year? What if you calculated interest after 1 year Slide 35

Compounding Interest You are interested in opening a savings account that pays interest at a rate of 6% compounded annually. You deposit $523 as your starting balance. How much will you have in the account at the end of 2 years? 523 x.06 = x.06 = $587.64

Compounding Interest What if the yearly rate was compounded monthly. What would your ending balance be after 2 months? 6% / 12 = 0.5% 523 x.005 = x.005 =

.Why do interest payments increase over time?.How long do you think it takes to double your money over time?

Definition of future value- is how much a set amount will be worth in the future So in our spreadsheet above the one-year future value is $ , two-year future value is and three-year future value is

Present value – the value of money right now, today. So from the spreadsheet we can see the value of $ occurring in one- year has a value today of $1000. Discount factor – the amount that $1 at some point in the future is worth today Slide 40

Slide 41 Meeting Financial Goals When choosing a savings option, consider –The amount to save –The length of time you will save –The interest you can earn Use the Rule of 72 to estimate how long it will take the money to double at a certain interest rate 5-2 Savings Accounts

The Rule of 72 How many years will it take to double my money? 72 DIVIDED BY = YEARS TO DOUBLE A SUM OF MONEY INTEREST RATE At what interest rate will my money double in a set number of years? 72 DIVIDED BY = INTEREST RATE REQUIRED YEARS TO DOUBLE INVESTMENT

Rule of 72 How quickly can we double our money If you have $5000 in a bank account. How long will it take to double our money with a 9% interest rate? 72/9% = 8 years Round to the nearest year

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Savings Accounts Secure place to store your cash while earning interest. Interest Money paid to you by the bank for being able to use your money (+) Deposit Put money into your savings account (+) Withdrawal Take money from your savings account Accounts at banks are insured by the Federal Deposit Insurance Corporation (FDIC). This insurance is for up to $250,000 per depositor per bank.

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