Financial Smarts for Winning Straight Talk on Your Financial Future Andrew Behnke, Ph.D.

The Perfect Storm

What was the Perfect Storm? In the late October of 1991, a confluence of unforeseen weather conditions combined to form a “killer storm” in the North Atlantic. The “Andrea Gail” had left Gloucester to face an event that had never occurred in recorded history. No one was prepared for this storm with waves higher that a ten story building and wind speeds greater than 120 miles per hour.

Is Debt the Perfect Storm?

Yeah there's a storm baby! About 1.6 million were foreclosed on last year, up from 717,522 in Debt typical U.S. household carries $9,200 in credit card debt 76% have outstanding balances on their credit cards or have personal loans 37% of those make only the minimum monthly payment 5.6 billion credit card offers each year 80% at or near their limit

Some Startling Statistics In 2007, 1.8 million Americans filed for bankruptcy, the highest amount in history. (Amer. Bankruptcy Inst.) 43% of American families spend more than they earn. (Federal Reserve) The average American family saw its credit card debt grow by 53% in the 1990s. (Demos) The typical cardholder has 7-10 credit cards

How to Avoid the Perfect Storm? Meteorologists look at the big picture in an effort to forecast weather patterns using sophisticated tools like Doppler radar and super computers. Sailors and fishermen also look at the big picture, but must deal with the microenvironment of the visible signs of the seas they are sailing.

First Make A Plan and Live It!

Spend Cash – Avoid Credit 37% higher on credit card at McDonalds 12-18% more spent on average 70% of flyer miles never redeemed 60% don’t pay off their credit cards every month

Scenario #1: You charge $2,500 You pay $50 a month Yearly interest rate is 20% How long will it take to pay the balance?

Scenario #1: You charge $2,500 You pay $50 a month Yearly interest rate is 20% How long will it take to pay the balance?

Answer: 9 years 1 month!

Recap: You charged $2,500 You paid $2,920 in interest over the 9 years You paid 116 % interest Not a good deal!

Scenario #2: You charge $2,500 Payments are $100 per month Yearly interest rate is 20% How long will it take to pay the balance?

2 years 9 months! Answer:

Recap: You charged $2,500 You paid $761 in interest over the 2 years You paid 30.4% interest Compare to saving $2,500 in the bank for 2 years 9 months, earning 3% per year interest = $214.72

Debit Cards vs. CCs DCs Can replace CCs almost completely But what about hotels and rental cars? Can you say Travelocity, Priceline, Orbitz? Yeah only Hertz and Avis require CCs Thrifty, Budget, Alamo, National, Dollar, Enterprise, Advantage, Rent a Wreck, E-Z Rent A Car Debit Cards can be dangerous So get a free overdraft protection CC Use online banking and check your account weekly

Investments versus Liabilities What’s and investment? What’s a liability? The Big Liabilities… If you didn’t own it today would you buy it today? Estimate how often you will use it – rent it?

The Car Debt Myth

$378 average car pmt – invested for 40 years will likely equal $4,500,000 at 12% Buy the $20,000 car for $378 a month and at 12% interest over 6 years you pay $8,000 in interest Instead save $378 a month for a year = $5,000 Buy a $5,000 car Save the same amount for 5 more years and buy a $20,000 car plus have $11,000 in the bank Save the same amt plus the $11k and have 51,000 in another 5yrs

The Other Side of Compound Interest When you invest, compound interest is your friend :-) When you pay interest on credit cards and loans, compound interest is your enemy :-(

Save First and Save Smart -2.2% Savings Rate Nationally = broke! Rainy Day Fund k for emergencies Money market – online savings account Shop for a rate like you’d shop for a car! Carolyn Lackey – Fence Sections Pay yourself first – automatic withdrawal John Wesley said “Save 10% Give 10%” But at least 5%

Hans Invested $15 k Hans Earned $1.6 M Susan Invested $24 k Susan Earned $1.5 M Kim Invested $117 k Kim Earned $1.3 M Invest Early!

The Snowball Method

Compare The Outcomes

Future Values Suppose you invest $1000 for one year at 5% per year. What is the future value in one year? Interest = 1000(.05) = 50 Value in one year = principal + interest = = 1050 Future Value (FV) = 1000(1 +.05) = 1050 Suppose you leave the money in for another year. How much will you have two years from now? FV = 1000(1.05)(1.05) = 1000(1.05) 2 =

Future Values: General Formula FV = PV(1 + r) t FV = future value PV = present value r = period interest rate, expressed as a decimal T = number of periods Future value interest factor = (1 + r) t

Effects of Compounding Simple interest Compound interest Consider the previous example FV with simple interest = = 1100 FV with compound interest = The extra 2.50 comes from the interest of.05(50) = 2.50 earned on the first interest payment

Future Values – Example 2 Suppose you invest the $1000 from the previous example for 5 years. How much would you have? FV = 1000(1.05) 5 = The effect of compounding is small for a small number of periods, but increases as the number of periods increases. (Simple interest would have a future value of $1250, for a difference of $26.28.)

Future Values – Example 3 Suppose you had a relative deposit $10 at 5.5% interest 200 years ago. How much would the investment be worth today? FV = 10(1.055) 200 = 447, What is the effect of compounding? Simple interest = (10)(.055) = Compounding added $446, to the value of the investment

Future Value as a General Growth Formula Suppose your company expects to increase unit sales of widgets by 15% per year for the next 5 years. If you currently sell 3 million widgets in one year, how many widgets do you expect to sell in 5 years? FV = 3,000,000(1.15) 5 = 6,034,072

Quick Knowledge Check Suppose you have $500 to invest and you believe that you can earn 8% per year over the next 15 years. How much would you have at the end of 15 years using compound interest? How much would you have using simple interest?