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1Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
2Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Chapter 5Banking
What You’ll Learn Section 5.1
• Identify types of financial services.• Describe the various types of financial institutions.
Section 5.2• Compare the costs and benefits of different savings
plans.• Explain features of different savings plans.• Compare the costs and benefits of different types of
checking accounts.• Explain how to use a checking account effectively.
3Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
How to Manage Your CashToday, with more than 11,000 banks, 2,000 savings and loan associations, and 12,000 credit unions in the United States, you have a wide array of financial services from which to choose.
Your choice of financial services will depend on your:
Daily cash needs Savings goals
Section 5.1Financial Services and Institutions
4Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Section 5.1Financial Services and Institutions
Types of Financial ServicesIn order to stay competitive in today’s marketplace, banks and other financial institutions have expanded the range of services that they offer.
These services can be divided into three main categories:
Savings Payment services Borrowing
5Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Section 5.1Financial Services and Institutions
SavingsSafe storage of funds for future use is a basic need for everyone.
Some examples of time deposit funds include: Money that you keep in any type of
savings account Certificates of deposit or CDs
Having a savings account is essential for any personal finance plan.
6Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Section 5.1Financial Services and Institutions
Payment ServicesTransferring money from a personal account to businesses or individuals for payments is a basic function of day-to-day financial activity at a bank.
The most commonly used payment service is a checking account. Money that you place in a checking account is:
Called a demand deposit Able to be withdrawn at any time, or on
demand
7Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Section 5.1Financial Services and Institutions
BorrowingMost people use credit at some time during their lives. If you need to borrow money, financial institutions allow you to:
Borrow money for a short term by using a credit card or taking out a personal cash loan.
Borrow money for a longer term by applying for a mortgage or auto loan.
8Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Section 5.1Financial Services and Institutions
Other Financial ServicesFinancial institutions may also offer a variety of services, such as:
Insurance protection Stock, bond, and mutual fund investment
accounts Income tax assistance Financial planning services
9Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Section 5.1Financial Services and Institutions
Electronic Banking ServicesYour bank’s electronic services allow you to:
Check the status of your account. Make a transaction from an ATM, by
telephone, or online. Get up-to-date information with personal
financial management software.
Security is the number one issue for online customers. The way to ensure online security is to:
Use a security code, or password. Use a customer identification name or
number.
10Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Section 5.1Financial Services and Institutions
Direct DepositMany businesses offer their employees direct deposit. Instead of a paper paycheck, employees receive a printed statement that lists:
Deductions Other information about their earnings
Direct deposit offers a safe way to transfer funds and saves:
Time Money Effort
direct deposit
an automatic deposit of net pay to an employee’s designated bank account
11Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Section 5.1Financial Services and Institutions
Automatic PaymentsWith your authorization, your bank can withdraw the amount of your monthly payments or bills from your bank account.
In order to use automatic payments, you will need to:
Make sure you always have enough money in your account for the payment.
Arrange your payments according to when you receive your paycheck.
Check your bank statements each month to make sure that the payments were made correctly.
12Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Section 5.1Financial Services and Institutions
Automated Teller Machines (ATMs)A cash machine, or automated teller machine (ATM), allows you to:
Withdraw cash from an account Make deposits Transfer money from one account to
another
To use an ATM for banking, you must apply for a debit card from your financial institution. Unlike a credit card, a debit card enables you to spend only the money that you have in your account.
automated teller machine (ATM)
a computer terminal that allows a withdrawal of cash from an account
debit card
a cash card that allows you to withdraw money or pay for purchases from your checking or savings account
13Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Section 5.1Financial Services and Institutions
ATM FeesThe fees that some financial institutions charge for the convenience of using an ATM can add up over time. You might consider these suggestions:
Compare ATM fees before opening an account.
Use your bank’s ATM machines to avoid the additional fees that other banks charge when you use their machines.
Consider using traveler’s checks, credit cards, personal checks, and prepaid cash cards when you are away from home.
14Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Section 5.1Financial Services and Institutions
Plastic PaymentsAlthough cash and checks are very common methods of paying for goods and services, various access cards are also available. These include:
Point-of-sale transactions Store-value cards Electronic cash
point-of-sale transaction
a purchase by a debit card of a good or service at a retail store, a restaurant, or elsewhere
15Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Section 5.1Financial Services and Institutions
Opportunity Costs of Financial ServicesWhen you are making decisions about saving and spending:
Try to find a balance between your short-term needs and your future financial security.
Consider the opportunity costs, or trade-offs, of each choice you make as you select financial services.
Remember to consider the value of your time in addition to the money you are saving.
16Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Section 5.1Financial Services and Institutions
Types of Financial InstitutionsAfter you have identified the services you want, you can choose from among many types of financial institutions.
You may select an institution that: Offers a wide range of services Specializes in certain services Provides the option of cyber-banking, or
banking via the Internet Operates exclusively on the Internet
17Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Section 5.1Financial Services and Institutions
Federal Deposit Insurance CorporationThe Federal Deposit Insurance Corporation (FDIC):
Protects deposits in banks Insures each account in a federally
chartered bank up to $100,000 per account
Administers the Savings Association Insurance Fund (SAIF) for savings and loan associations
All federally chartered banks must participate in the FDIC program.
18Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Section 5.1Financial Services and Institutions
Deposit InstitutionsMost people use deposit-type institutions to handle their banking needs. These institutions include:
Commercial banks Savings and loan associations Mutual savings banks Credit unions
commercial bank
a for-profit institution that offers a full range of financial services, including checking, savings, and lending
credit union
a nonprofit financial institution that is owned by its members and organized for their benefit
19Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Section 5.1Financial Services and Institutions
Non-Deposit InstitutionsFinancial services are also available at institutions such as:
Life insurance companies Investment companies Finance companies Mortgage companies
20Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Section 5.1Financial Services and Institutions
Comparing Financial InstitutionsWhen you compare banks and other financial institutions, you should ask these questions to help choose the best one:
Where can you get the highest rate of interest on your savings?
Where can you obtain a checking account with low (or no) fees?
Will you be able to borrow money from the institution when you need it?
Does it have online banking services? Does it have convenient locations?
21
• STOP HERE – The rest is Standard 4
Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
22Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Section 5.2Savings Plans and Payment Methods
Types of Checking AccountsChecking accounts can be divided into three main categories:
Regular accounts Activity accounts Interest-earning accounts
23Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Section 5.2Savings Plans and Payment Methods
Regular Checking AccountsRegular checking accounts usually do not require a minimum balance. You may have to pay a monthly service charge, however, if:
The account requires a minimum balance. Your account drops below that amount.
Some institutions will waive a service charge if you keep a certain balance in your savings account.
24Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Section 5.2Savings Plans and Payment Methods
Activity AccountsAn activity account might be right for you if you:
Write only a few checks each month Are unable to maintain a minimum
balance
The financial institution may charge a fee for: Each check you write Each deposit
In addition, a monthly service fee will be charged.
25Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Section 5.2Savings Plans and Payment Methods
Interest-Earning Checking AccountsInterest-earning checking accounts are a combination of:
Checking accounts Savings accounts
These accounts pay interest if you maintain a minimum balance.
26Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Section 5.2Savings Plans and Payment Methods
Evaluating Checking AccountsHow do you decide which type of checking account will meet your needs? You will need to weigh several factors:
Restrictions Fees and charges Interest Special services
27Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Section 5.2Savings Plans and Payment Methods
RestrictionsThe most common restriction is the requirement that you keep a minimum balance. Other restrictions may include:
The number of transactions allowed The number of checks you may write in a
month
28Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Section 5.2Savings Plans and Payment Methods
Fees and ChargesYou may pay a monthly service charge as well as fees for:
Check printing Overdrafts Stop-payment orders
29Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Section 5.2Savings Plans and Payment Methods
InterestAn interest-earning checking account will be affected by:
Interest rates Frequency of compounding The way in which interest is calculated
30Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Section 5.2Savings Plans and Payment Methods
Special ServicesChecking account services include:
ATMs Banking by telephone and online
As a checking account customer, you may also receive overdraft protection.
overdraft protection
an automatic loan made to an account if the balance will not cover checks written
31Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Section 5.2Savings Plans and Payment Methods
Using a Checking AccountAfter you select the type of checking account that best fits your needs, you need to know how to use it effectively.
32Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Section 5.2Savings Plans and Payment Methods
Opening a Checking AccountBefore you open a checking account, decide whether you want:
An individual account A joint account
Personal joint accounts are usually “or” accounts, which means that only one of the owners needs to sign a check.
33Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Section 5.2Savings Plans and Payment Methods
Writing ChecksBefore writing a check, use your check register to record the:
Date Number of the check Name of the party who will receive the
payment Exact amount of the check
Be sure to keep a current balance of the money you have by deducting from or adding to your balance the amount of any check transaction.
34Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Section 5.2Savings Plans and Payment Methods
Steps in Writing a CheckFollow these steps when you write a check:
Write the current date. Write the name of the party who will
receive the check. Record the amount of the payment in
numerals. Write the amount in words. Sign the check. Make a note of the reason for the
payment.
35
Writing a Check
Step 1 – Current date
Step 2 – Name (Payee)
Step 3 – Dollar amount (numbers)
Step 4 – Dollar amount (words)
Step 5 – Sign your name
Step 6 – Notes about the transaction 3
5
Step 1 Step 2 Step 3
Step 4
Step 5 Step 6
36
Writing a Check
Step 7 – Write the check number, date, payee, amount of the check or ATM transaction.
Step 8 – Subtract amount of check from the balance. 3
6
37Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Stop-Payment OrderYou may ask the bank to issue a stop-payment order if:
A check is lost or stolen. You want to take back your payment for a
business transaction.
Fees for this service can range from $10 to $20 or more.
stop-payment order
a request that a bank or other financial institution not cash a particular check
Section 5.2Savings Plans and Payment Methods
38Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Section 5.2Savings Plans and Payment Methods
Making DepositsTo add money to your checking account:
Fill out a deposit ticket. Endorse the back of each check you
want to deposit.
Here are some tips to follow when endorsing a check:
Do not endorse a check until you are ready to cash or deposit it.
Use a pen so that your signature cannot be erased.
If depositing a check by mail, write “For deposit only” above your signature.
endorsement
the signature of the payee, the party to whom the check has been written
39
Depositing Money Into Your Account
Step 1 – Write today’s date.
Step 2 – Write down any currency deposited by the word “Currency.”
Step 3 – Write down any coins deposited by the word “Coin.”
39
40
Depositing Money Into Your Account
Step 4 - Write checks down individually.
Step 5 – Total deposits and write in space marked “Subtotal.”
Step 6 – Write down cash withdrawn following the words “Less Cash Received.” 4
0
41
Depositing Money Into Your Account
Step 7 – Subtract cash received from subtotal and write that amount after “Net Deposit.”
Step 8 – If withdrawing cash, sign your name on the line below the date.
41
42Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Section 5.2Savings Plans and Payment Methods
Keeping Track of a Checking AccountEach month your bank will send you a statement that shows your checking account activity for the month. Your bank statement will list:
Deposits Checks you have written ATM withdrawals Debit card charges Interest earned Fees
The balance reported on the bank statement may be different from the balance in your check register.
43Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
ReconciliationYou can fill out a bank reconciliation form to determine your true balance.To balance, or reconcile, your account, follow these steps:
Compare the checks you have written during the month with those that are listed on the bank statement as paid, or cleared.
Determine whether any recent deposits are not on the bank statement.
Subtract fees and charges listed on the statement from your checkbook balance.
Add interest earned to your checkbook balance.
bank reconciliation
a report that accounts for the differences between the bank statement and a checkbook balance
Section 5.2Savings Plans and Payment Methods
44Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Section 5.2Savings Plans and Payment Methods
Other Payment MethodsYou can make payments using methods other than writing a personal check. Some alternatives include:
Certified checks Cashier’s checks Money orders Travelers check Prepaid travelers cards
45
Standard 5
• Stop Here - this is for Standard 5 Savings Information
Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
46
Savings and Investing: Getting Started
Standard 5.
47
Deciding to Save
Decisions about savings involves opportunity costs.
Opportunity Costs - things you give up today to fund your future goals.
Before purchasing, ask yourself: “Do I want this more than reaching my personal or financial goals?”
48
Strategies for Saving
“Pay yourself first” is saving a portion of your earnings before spending any.
Saving money can be done in two different ways.• In a safe place, where it will earn
interest – such as a savings account• In government savings bonds, money
market accounts, or certificates of deposit (CDs)
49Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Savings Plans and Payment Methods
Types of Savings Plans
To achieve your financial goals, you will need a savings program. Various types of savings programs include:
Regular savings accounts Certificates of deposit Money market accounts U.S. Savings Bonds
50Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Savings Plans and Payment Methods
Regular Savings AccountsRegular savings accounts are ideal if you plan to make frequent deposits and withdrawals. These accounts:
Require little to no minimum balance Earns Interest Allow you to withdraw money on demand Are very Liquid
The trade-off for this convenience is that the interest you earn will be low compared with other savings plans.
51Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Savings Plans and Payment Methods
Certificates of Deposit
A certificate of deposit (CD) is a relatively low-risk way to invest your money.
It offers a higher interest rate than a regular savings account pays, but you will have to accept three key limitations:
You may have to leave your money on deposit for one month to five or more years.
You probably will pay a penalty if you take the money out before the maturity date.
Financial institutions require that you deposit a minimum amount to buy a certificate of deposit.
certificate of deposit (CD)
a savings alternative in which money is left on deposit for a stated period of time to earn a specific rate of return
52Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Savings Plans and Payment Methods
CD Investment Strategies
Here are some tips for investing in CDs: Find out where you can get the best rate. Consider the economy as you decide what
maturity date to choose. Never let a financial institution “roll over” a
CD. Consider when you will need the money. If you have enough funds to have several
accounts, you might consider creating a CD portfolio, which includes CDs that mature at different times.
53
Savings Plans and Payment Methods
Certificate of Deposit• A CD requires a certain amount of time
to mature.• The longer the term of maturity, the
higher interest rate you will receive.• CDs are less liquid than savings
accounts
Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
54Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Savings Plans and Payment Methods
Money Market AccountsThe interest rates of a money market account float, or go up and down, as market rates change.Although the interest rate of a money market account is usually higher than that of a regular savings account:
A money market account also requires a higher minimum balance, typically $1,000.
You may have to pay a penalty if your balance goes below the minimum amount.
money market account
a savings account that requires a minimum balance and earns interest that varies from month to month
55
Savings Plans and Payment Methods
Money Market Mutual Funds• These are invested in very
short-term investments with low risk.
• Banks and credit unions insure through FDIC, while other institutions do not.
• Uninsured accounts generally pay a higher interest rate because of additional risk.
56Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Savings Plans and Payment Methods
U.S. Savings BondsAnother savings option is purchasing a U.S. Savings Bond. The maturity date of a bond depends on:
The date it was bought The interest rate the bond is earning
Your bond’s worth will depend on current interest rates and on the month and year in which the bond was issued.
57
Savings Plans and Payment Methods
US Savings Bonds• Backed by the U. S. Government.• Have little or no default risk.• Designed to be held a minimum number
of years.• Because of the length of maturity,
government bonds have a higher rate of return than savings accounts or CDs.
58
Investing Plans and Payment Methods
Mutual Funds• Investors pool money to buy shares of a fund that
invests in many financial products (stocks, bonds, and securities).
• Great for people with limited funds or knowledge about investing.
• Have professional money managers who closely monitor accounts.
• Rate of return is affected by a variety of economic factors that can vary over time.
• Highly recommended by financial experts because potential benefit of gains is greater than potential costs of losing.
59
Investing Plans and Payment Methods
Stocks• Stocks allow partial ownership in a
company.• Owning stock carries more risk than
mutual funds.• Advisable to diversify your portfolio and
spread your risk.• Investors should own at least ten
different single stocks in different industries.
60
Investing Plans and Payment Methods
Corporate Bonds• When you own a corporate bond, you
are basically loaning money to a company.
• The interest you receive is the value of your investment.
• If something happens to the company, you can lose most or all of your money.
• Investing in bonds is a lower risk option with lower returns on your investment.
61
Investing Plans and Payment Methods
• Collectables – Are rare items in number– High risk, not as liquid
• Include: Paintings, sculptures, other art, Trading cards, sports motif, coins, toys, and Antiques
62
Investing Plans and Payment Methods
• Real Estate – Not very liquid–Residential–Commercial–Corporate Apartments–Land–Farmland
63Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Evaluating Savings and Investment Plans
Your selection of a savings or investment plan will be influenced by several factors. You should consider:
The rate of return Inflation Tax considerations Liquidity Restrictions Fees
64Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Savings Plans and Payment Methods
Rate of Return
Earnings on savings can be measured by the rate of return, or yield.
Compounding can have a great impact on large amounts of money that are held in savings accounts for long periods.
The more frequently your balance is compounded, the greater your rate of return will be.
rate of return
the percentages of increase in the value of your savings from earned interest
compounding
the process in which interest is earned on both the principal—the original amount you deposited—and on any previously earned interest
65
Rates of Return
Rate of return - amount of money you can earn when saving and investing.
The higher the average return, the more risk you are taking as an investor.
Asset Class Rate of Return*
Common stocks 10%-13%
Stocks of smaller companies 14%-16%
Long term corporate bonds 6.5%-8%
Long term US government bonds 5%-7.5%
Short term US Treasury bills 3.5%-5%
*Average rate of return since 1926, Ibbotson and Associates
66Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Savings Plans and Payment Methods
InflationYou should compare the rate of interest you earn on your savings with the rate of inflation. Usually, the interest rates offered on savings accounts increase if the rate of inflation increases.The biggest problem with inflation occurs if you are locked into a lower interest rate for a long period of time.
67Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Savings Plans and Payment Methods
Tax Considerations
Like inflation, taxes reduce the interest earned on savings. You may want to look into:
Tax-exempt saving plans Tax-deferred savings
plans
68Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Savings Plans and Payment Methods
Liquidity
Ease of turning an item into cash without losing money
Check the savings plans you are considering to determine whether early withdrawal of funds will cause them to:
Charge a penalty Pay a lower rate of interest
If you are saving for long-term goals, a high interest rate may be more important than liquidity.
69Personal Finance Unit 2 Chapter 5 © 2007 Glencoe/McGraw-Hill
Savings Plans and Payment Methods
Restrictions and Fees
Be aware of any restrictions on savings plans, such as:
A delay between the time when interest is earned and when it is actually paid into your account
Fees for making deposits and withdrawals Service charges you may have to pay if your
balance drops below a certain amount or if you do not use your account for a certain period
70
FinancialPlanningPyramid
Penny Stock
Commo- dities
Collectibles
Speculative Stock / Bonds / Mutual Funds
Real Estate
Blue-Chip Common Stock
Growth Mutual Funds
High-Grade Convertible Bonds
High-Grade Preferred Stock
Balanced Mutual Funds
High-Grade Corporate Bonds or Mutual Funds
High-Grade Municipal Bonds or Mutual Funds
Money Market Accounts or Mutual Funds
Certificates of Deposit
U.S. Savings Bonds
Insured Savings / Checking Accounts
Treasury Issues
Highest Risk Highest Earnings
Lower Risk
Lower Earnings
71
Do review sheets 5.1 and 5.3
Do Review Sheets
72
Interest Calculations and The Rule Of 72
Standard 5. 2 Savings and Investing
73
Calculating Interest
Interest:• Paid when someone else uses your
money.• Higher the risk, the greater the
return.
Two methods for calculating interest:• Simple interest• Compound interest
74
Calculating Simple Interest
• Simple Interest Formula: • Principle X interest X number of years
75
Simple Interest Example1. You save $50 at 10% for 5 years
50 x .10 x 5
= $25 interest earned
$50 + $25 = $75 In Account Now
2. You save $750 at 3% for 8 years
750 x .03 x 8
= $180 interest earned
$750 + $180 = $930 In Account Now
76
Simple Interest Examples
3. You save $2,500 at 8% for 20 years2500 x .08 x 20
= $4,000 interest earned
$2,500 + $4,000 = $6,500 In Account Now
4. You save $10,000 at 5% for 25 years10,000 x .05 x 25
= $12,500 interest earned
$10,000 + $12,500 = $22,500 In account Now
77
Calculating Interest
Compound Interest• Calculated on money
you invest or loan, plus any interest already paid.
• The longer the money is invested, the more impact you will receive from compounding.
78
Compounding Interest Formula
M = P( 1 + i )n • M is the final amount including the
principal. • P is the principal amount. • i is the rate of interest per year. • n is the number of years invested.
79
Compound Interest ExamplesLet's say that I have $1000.00 to invest for
3 years at rate of 5% compound interest.
M = P( 1 + i )n
M = 1000 (1 + 0.05)3
= 1000(1.05)3
= 1000 x 1.157625
= 1,157.63 (round up)
You can see that my $1000.00 is worth $1157.63.
80
Compound Interest Examples
$1000 invested with compound interest at a rate of 15% per year for 9 years.
M = P( 1 + i )n
M = 1000(1+.15)9
= 1000(1.15)9
= 1000 X 3.517876
= $3517.88 (round up)
You can see that my $1000.00 is worth $3517.88.
81
Compound Interest Examples
Compound interest calculator
http://math.about.com/library/blcompoundinterest.htm
82
Rule of 72
3-H
72 Interest Rate
= Years Needed to
Double Investment
72 Interest Rate
Required=
Years Needed to
Double Investment
72 divided by the expected rate of return equals the number of years it will take the investment to double.
83
The Rule of 72
The Rule of 72 Examples:• Years needed to double• 72/6% = 12 years• 72/3% = 24 years
Interest Rate Required• 72/9 year = 8%• 72/10 years = 7.2%
84
Compounding interest explains why it is important to start saving NOW!
Earnings
Understanding how to get your money to work for you will help you to get the most of your savings.
85
Time Is Money
Standard 5. 4 Savings and Investing
86
Time Factors
Time is one of the most important factors to consider when making decisions about savings or investing.
The longer your “time horizon,” the more aggressively you can invest your money.
87
Time Factors
List of asset classes, from least to more risky:
Fixed Income Items
Bank Accounts Immediate access to cash, insured
Certificates of Deposits
Time varies based on contract, insured
Government Bonds Money loaned to U. S. Government
Municipal Bonds Money loaned to a municipality
Corporate Bonds Money loaned to a business corporation
88
Time Factors
In general, fixed income items are associated with “loaning” your money to someone else.
Equity Items
Large Cap Stocks Ownership in large companies
Small Cap Stocks Ownership in small companies
International Stocks Ownership in international companies
Commodities Ownership of hard assets
Microcap Stocks Ownership in very small companies with a high rate of failure
89
Time Factors
Fixed income items tend to have low risk, and therefore, pay lower interest rates.
Equities are generally associated with “ownership.”
Financial experts recommend equities as the better option if you have at least seven years until your financial goal.
89
90
Risk Factors
• Risk tolerance relates to how much negative change or potential for loss you can handle with your investment.
• Portfolio is a common name given to all of your personal assets.
• Losses in your portfolio can be difficult to replace.
91
Risk Factors
• That is the reason most financial experts recommend investments with less risk to meet short-term goals.
• Choosing low risk investments to meet long-term goals is not the best option.
• Low risk savings and investments have less potential for growth than equity items, which could leave you short of your long-term goals.
92
Inflation Factors
• Leaving unspent money in a non-interest bearing checking account can result in a loss of money.
• Inflation - increases in average prices of goods and services from one year to the next.
• If you are not earning interest, your savings may not keep up with future prices.
93
REMEMBER
Is your “savings goal” seven or more years away? Investing is a good way to make money.
Or is your “savings goal” less than seven years away? Probably better to put your money in a savings account or short-term CD.
94
Lots of options are available for saving and investing your money.
Remember to consider the following in making your choices:• Time horizons,• Risk tolerance, and• The impact of inflation.
Earnings