Personal Finance and the Stock Market Challenge August 2012

Personal Finance and the Stock Market

Challenge

Personal Finance and the Stock Market

Challenge

August 2012

Materials• Financial Fitness for Life (3-5)• Financial Fitness for Life (6-8)• Earning, Learning, and Investing

(High School)• Financial Freedom

What do we need to teach?

• Earning Income• Buying Goods and Services• Saving• Using Credit• Financial Investing• Protecting and Insuring

Earning Income• Income for most people is determined by the market

value of their labor, paid as wages and salaries. People can increase their income and job opportunities by acquiring more education, work experience, and job skills. The decision to undertake an activity that increases income or job opportunities is affected by the expected benefits and costs of such an activity. Income also is obtained from other sources such as interest, rents, capital gains, dividends and profits.

Buying Goods and Services

• People cannot buy or make all the goods and services they want; as a result, people choose to buy some goods and services and not buy others. People can improve their economic well-being by making informed decisions, which entails collecting information, planning, and budgeting.

Saving• Saving is the part of income that people choose to put

away for future consumption. People save for different reasons during the course of their lives. People make different choices about how they save and how much they save. Time, interest rates and inflation affect the value of savings.

Using Credit• Credit allows people to purchase goods and services

that they can use today and pay for those goods and services in the future with interest. People choose among different credit options that have different costs. Lenders approve or deny applications for loans based on an evaluation of the borrower’s past credit history and expected ability to pay in the future. Higher-risk borrowers are charged higher interest rates; lower risk borrowers are charged lower interest rates.

Financial Investing• Financial investment is the purchase of financial assets

to increase income or wealth in the future. Investors must choose among investments that have different risks and expected rates of return. Investments with higher expected rates of return tend to have greater risk. Diversification of investment among a number of choices can lower investment risk.

Protecting and Insuring• People make choices to protect themselves from the

financial risk of lost income, assets, health, or identity. They can choose to accept risk, reduce risk, or transfer the risk to others. Insurance allows people to transfer risk by paying a fee now to avoid the possibility of a larger loss later. The price of insurance is influenced by an individual’s behavior.

Stock Market Challenge:Saving and Financial

Investing• Saving

– Interest– Budgeting– Saving Early

• Financial Investing– Types of investments– Risk / Return– Diversification

Why Save?• New phone• Car• College education• House• Retirement• Emergencies

Short-term, Medium-term, Long-term Goals

• Short-term goals can be achieved in fewer than two months.

• Medium-term goals may take from two months to three years to achieve.

• Long-term goals require three or more years to achieve.

What is the Relationship Between Long-term and

Short-term Goals?• Breaking long-term goals into

short-term goals helps them seem achievable.

Opportunity Cost of Saving

• Opportunity Cost – the value of the next best alternative you give up to obtain something

Budget• Income (what is it per month)• Expenses

– Fixed (car payment, WoW payment)– Variable (food, movies, etc.)

• Saving (pay yourself first)

What can get in your way?

• A budget that includes saving is a good way to get to your goals.

• But what can happen to a planned budget?

• Each month, what can happen that will eat into your savings plan?

Teaching About Interest• Principal x interest rate = total

interest• P x i = total interest• Total Balance after one year

= (1 + i) x P

Teaching About InterestTotal Balance after n years, simple = (1 + n i) x P

Total Balance after n years, compounded =

(1 + i)n x P

Interest: Simple and Compound

Simple Interest Yields

Total Saving - Simple Interest

Compound Interest Adds

Total Savings Using Compound Interest

Begin $100 $100

1 $8.00 $108.00 $8.00 $108.00

2 $8.00 $116.00 $8.64 $116.64

3 $8.00 $124.00 $9.33 $125.97

4 $8.00 $132.00 $10.08 $136.05

5 $8.00 $140.00 $10.88 $146.93

6 $8.00 $148.00 $11.75 $158.69

7 $8.00 $156.00 $12.69 $171.38

8 $8.00 $164.00 $13.71 $185.09

9 $8.00 $172.00 $14.81 $199.90

Rule of 72• How long does it take the total amount

of savings put into an interest-earning account to double?

• Answer: 72 / interest rate• Example: 72 / 8 = 9, so it takes about

9 years for money to double at an interest rate of 8%

Rule of 72 works for other things…

• If a country’s population is growing at 3% a year, how long will it be before the population has doubled? Quadrupled?

• Answer: 72/3 = 24 years• Answer: 48 years (doubled

doubled)

What impacts total saving?

• Amount saved each year• Interest rate• Number of years saved

What to double?• $5,000 at 5% for 5 years = $6,381• Do you double the amount,

interest rate or years?• Amount: $12,762• Interest Rate: $8,053• Years: $8,144• (Not generalizable…)

Assessment

Saving Early / Late• Most important lesson…

Save Early / Late

Save Early: Save Late:

Age Save Total with Interest Saving

Total With Interest

20 $ 2,000 $ 2,000 $ - 21 $ 2,000 $ 4,160 $ - 22 $ 2,000 $ 6,493 $ - 23 $ 2,000 $ 9,012 $ - 24 $ 2,000 $ 11,733 $ - 25 $ 2,000 $ 14,672 $ - 26 $ 2,000 $ 17,846 $ - 27 $ 2,000 $ 21,273 $ - 28 $ 2,000 $ 24,975 $ - 29 $ 2,000 $ 28,973 $ - 30 $ 2,000 $ 33,291 $ - 31 $ 2,000 $ 37,954 $ - 32 $ 2,000 $ 42,991 $ - 33 $ 2,000 $ 48,430 $ - 34 $ 2,000 $ 54,304 $ -

Save Early / Late

Save Early: Save Late:35 $ 58,649 $ 2,000 $ 2,000 36 $ 63,340 $ 2,000 $ 4,160 37 $ 68,408 $ 2,000 $ 6,493 38 $ 73,880 $ 2,000 $ 9,012 39 $ 79,791 $ 2,000 $ 11,733 40 $ 86,174 $ 2,000 $ 14,672 41 $ 93,068 $ 2,000 $ 17,846 42 $ 100,513 $ 2,000 $ 21,273 43 $ 108,554 $ 2,000 $ 24,975 44 $ 117,239 $ 2,000 $ 28,973 45 $ 126,618 $ 2,000 $ 33,291 46 $ 136,747 $ 2,000 $ 37,954 47 $ 147,687 $ 2,000 $ 42,991 48 $ 159,502 $ 2,000 $ 48,430 49 $ 172,262 $ 2,000 $ 54,304 50 $ 186,043 $ 2,000 $ 60,649

Save Early / Late

Save Early: Save Late:51 $ 200,927 $ 2,000 $ 67,500 52 $ 217,001 $ 2,000 $ 74,900 53 $ 234,361 $ 2,000 $ 82,893 54 $ 253,110 $ 2,000 $ 91,524 55 $ 273,358 $ 2,000 $ 100,846 56 $ 295,227 $ 2,000 $ 110,914 57 $ 318,845 $ 2,000 $ 121,787 58 $ 344,353 $ 2,000 $ 133,530 59 $ 371,901 $ 2,000 $ 146,212 60 $ 401,653 $ 2,000 $ 159,909 61 $ 433,786 $ 2,000 $ 174,702 62 $ 468,488 $ 2,000 $ 190,678 63 $ 505,967 $ 2,000 $ 207,932 64 $ 546,445 $ 2,000 $ 226,566 65 $ 590,160 $ 2,000 $ 246,692 66 $ 637,373 $ 2,000 $ 268,427 67 $ 688,363 $ 2,000 $ 291,901

Closure• What is saving? How do you do it?• What is interest?• What impacts how much you will

have in the future?– Amount, time, interest rate– Simple vs. compound

Financial Investing• Learning, Earning, and Investing

for a New Generation• Attached to Gen I Revolution by

CEE• http://www.genirevolution.org/

Basics: Investment Instruments

• What is a stock?• What is a bond?• What are mutual funds?

Fundamental Lesson

Risk vs. Return• The dartboard!!!

The Pyramid of Risks and Reward

Highest Risk--Highest Potential Return or Loss

Lowest Risk--Lowest Potential Return or Loss

AutoInsurance

Home-owners Insurance

LifeInsurance

MedicalDisabilityInsurance

LiabilityInsur.ance

InsuredCheckingSavings Accounts

U.S. SavingsBond

CDsTreasury Issues

Money Market Accounts

High-Grade Municipal Bonds

High-Grade Corporate Bonds

Balanced Mutual Funds

High-GradePreferred Stock

High-GradeConv.Bonds

BlueChip Stock

RealEstate

GrowthMutualFunds

Collectibles

Speculative Stocks or Bonds Bonds

Penny Stocks, Commondities

Higher Risk / HigherEarnings

Lower Risk /LowerEarnings

Diversification• Why do we diversify?

DiversificationExample

• Diversification• You are an investor and want to invest

$10.• You have a choice of investing in each

of the following stocks. The stocks cost $5.

DiversificationExample

• Stocks:– Bill’s Suntan Products– Brett’s Rain Umbrellas– Andrea’s Hamburgers

DiversificationExample

• We are going to flip two coins to determine if:– It is rainy (Heads) or sunny (Tails)– If people are hungry (Heads) or not

(Tails)

Your Stock’s Price Depends On:

Stock Rainy(Heads)

Sunny(Tails)

Hungry(Heads)

Not Hungry(Tails)

Bill’sSuntan

$5 $10

Brett’s Rain Umbrellas

$10 $5

Andrea’sHamburgers

$10 $5

Choose Your Stocks• With your $10, you can buy stock in either one

or two companies.• For example:• You can buy one share of Bill’s Suntan

products and one share of Andrea’s hamburgers.

• You could also buy two shares of Andrea’s hamburgers.

• You could also buy two of Bill’s or two of Brett’s – you get the idea…

The Flips• Weather?• Hungry?• How did you do? How much risk

did you face?

Choices• You could not diversify:

– Two shares in one company and had either $10 (50%) or $20 (50%).

• You could choose two companies whose risks are not related.– Bill / Andrea or Brett / Andrea means you

could have had $10 (25%), $15 (50%), or $20 (25%).

• You could try to buy companies whose risks offset each other.– Bill / Brett means no matter what, you had $15.

Reality• Investors diversify by choosing:

– A larger number of stocks– Stocks in different sectors– Stocks in sectors that might offset

risks.

Mutual Funds• A mutual fund pools investors’ money.• The fund puts its investors’ money into

the markets on their behalf.• In effect, investors own small amounts

of many different assets.• Mutual funds enable investors to avoid

the risk that comes from owning any one asset. In other words, mutual funds make it easy to diversify.

Choices: Depend on Situation

Investment Situations

• You have $5,000 to invest. No other information is available.

• Savings account, CD, Bonds, Stocks, or Real Estate?

Investment Situations

• You have $4,000 that you’ll need six months from now.

• Savings account, CD, Bonds, Stocks, or Real Estate?

Investment Situations

• You inherited $10,000 from your great-aunt; she has suggested that you save it for use in your old age.

• Savings account, CD, Bonds, Stocks, or Real Estate?

Investment Situations

• You are just starting a career and can save $50 per month for retirement.

• Savings account, CD, Bonds, Stocks, or Real Estate?

Investment Situations

• A new baby arrives, and Mom and Dad plan to save $100 a month for the child’s college education.

• Savings account, CD, Bonds, Stocks, or Real Estate?

Summary• Start Early• Choose your risk level• Diversify to reduce risk

• Know your situation…

How do I win?• You are the opposite of a long run

investor:– High risk– Low diversification

How do kids win?• Learn about savings and

compounding• Understand risk vs. reward

– No such thing as free lunch– If it is too good to be true, it probably

is– Understand diversification

• Know their goals through budgeting

Evaluation and Paperwork

• Books – • Tell the Center who you are• My evaluation…• Thanks!