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CHAPTER 4:

MANAGING YOUR CASH AND SAVINGS

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Role of Cash Management in Personal Financial Planning

Cash management deals with the routine, day-to-day use of liquid assets.

Liquid assets consist of cash and other assets which can be readily converted to cash with little or no loss in value.

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Examples of Liquid Assets:

Cash Checking Accounts Savings Accounts Money Market Deposit Accounts Money Market Mutual Funds U.S. Treasury Bills EE Savings Bonds Certificates of Deposit (shorter-term)

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Purpose of Liquid Assets:

Make purchases.

Meet recurring living expenses.

Provide reserve for unexpected expenses or opportunities.

Used temporarily to accumulate funds for longer-term financial goals.

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The Financial Marketplace

Financial products– checking and

savings accounts

– credit cards

– loans and mortgages

– insurance

– mutual funds

Financial services– financial planning

– tax preparation

– brokerage services

– real estate

– trusts

– retirement

– estate planning

The financial services industry markets:

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Types of Financial Institutions

–Only type of financial institution that can offer noninterest-paying checking accounts.

Commercial Banks

–Largest type of traditional financial institution.–Offer full array of

financial services.

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Savings and Loan Associations

–Offer many of the same services as commercial banks.

–Typically pay slightly more on savings deposits.

–Channel depositors’ savings into mortgage loans for purchasing and improving homes.

–Some are mutual associations.

4-8 Savings Banks

–Similar to savings and loan associations.–Located primarily in New England states.–Offer interest-paying checking accounts.–Typically offer savings rates similar to

those of savings and loan associations.–Most are mutual associations.

4-9 Credit Unions–Provide financial products and services to specific

groups of people who have a common tie.–Qualified persons become members by purchasing a

share of ownership.–All are mutual associations; owned and sometimes

operated by members.–Typically pay interest rates higher than those of

other financial institutions.

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Internet Banks

–Offer online banking services.

–Feature lower fees and higher yields than “brick-and-mortar banks.”

–Suitable for people who do not need to physically go to a bank.

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Nondepository Financial Institutions–Stockbrokerage firms—offer cash management

accounts, money market mutual funds, wrap accounts, credit cards

–Mutual funds—offer money market mutual funds

–Life insurance companies

–Finance companies

4-12How Safe is Your Money?

Almost all financial institutions are federally insured by either:

Federal Deposit Insurance Corporation (FDIC) insures accounts at banks, savings banks, and S&Ls.

National Credit Union Administration (NCUA) insures accounts at credit unions.

Both provide government insurance up to $100,000 per depositor.

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Truth-in-Savings Act of 1993 Helps consumers evaluate terms and

costs of banking products.

Fees, interest rates, and terms of both checking and savings accounts must be fully and clearly disclosed.

Places strict controls on advertising and what constitutes a free account.

Standard formula for annual percentage yield (APY) must used.

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Cash Management Products

With sufficient funds, banks must immediately pay the amount of your check or ATM withdrawal.

1. Checking Accounts =

Demand Deposits

4-15Types of Checking Accounts:

Regular checking accounts

–Offered by commercial banks

–Pay no interest

Interest-bearing checking accounts–Examples include NOW, share draft,

and money market deposit accounts

–Offered by banks, savings banks, S&Ls, and credit unions

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–Offered by investment (mutual fund) companies

–Not federally insured; trade on open market

– Interest bearing; limited checks

Asset Management Accounts–Primarily offered by brokerage firms;

consolidate financial activities

– Insured by SIPC; open market

– Interest bearing; check writing privileges

Money Market Mutual Funds

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Funds are expected to remain on deposit for a longer time period than are demand deposits.

Generally pay higher interest rates than demand deposits.

At many institutions, the larger the balance, the higher the interest rate offered.

2. Savings Accounts =

Time Deposits

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Other Money Management Services

Electronic Banking ServicesElectronic Funds Transfer Systems (EFTS) make possible– ATM service– Debit cards—linked to your checking

account– Pre-authorized deposits and payments– Banking by phone– Online banking and bill payment services

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–Regulates EFTS Services.

–States that errors must be reported within 60 days.

Electronic Funds Transfer Act of 1978:

Limit your losses by immediately reporting theft, loss, or unauthorized use of your card or account!

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Other Bank Services:

Safe Deposit Boxes

Trust Services—provide investment and estate planning advice and management for trust accounts.

Mutual Fund Sales—along with other brokerage and investment services.

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Starting Your Savings Program

PAY YOURSELF FIRST!!!!

Establish an emergency fund.

Regularly set aside funds for financial goals.

Utilize direct deposits and automatic transfers.

Choose instruments best suited to your goals and time horizon.

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Earning Interest on Your MoneyInterest can be earned in two ways:

1. Some investments are sold on a Discount Basis.

–Security sold for a price lower than redemption value.

–Difference between sales price and redemption value is the amount of interest earned.

2. Other investments offer Direct Payment.

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Simple Interest—interest paid only on initial amount of deposit.

Compound Interest—interest paid at set intervals and added back to principal.

How is the interest calculated?

4-24 Nominal rate—the named or

stated rate of interest.

If interest is compounded more frequently than once a year, the effective rate will be greater than the nominal rate of interest.

Effective rate—the annual rate of return actually earned.

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Effective rate =

Annual amount of interest earned Amount of money invested

Example:

Invest $1000 at 5% for 1 year.

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If simple interest is used, there is no compounding:

Interest = Principal x rate x time

= $1000 x .05 x 1

= $50

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If compound interest is used and the compounding occurs semiannually—

First 6 months' interest:

$1000 x .05 x 6/12 = $25.00

Second 6 months' interest: +

$1025 x .05 x 6/12 = $25.63

Total annual interest = $50.63

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The nominal rate is 5%, the stated rate of interest.

Effective Rate = $50.63 $1000

= 0.05063

= 5.063%

The effective rate is 5.063%.

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Amount of interest earned depends on:

Frequency of compounding Balance on which interest is paid Interest rate applied

How much interest will you earn?

Time value of money concepts are used in compounding to find interest earned.

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A Variety of Ways to Save

Certificates of Deposit (CDs) – Funds are to remain on account for a given

time period.– Early withdrawals incur an interest penalty.

U.S. Treasury Bills– Debt securities issued by the U.S. Treasury.– Sold at a discount; $1000 minimum.–Mature in 1 year or less.

4-31 Series EE Bonds (Savings Bonds)–Purchased at 1/2 face value.

– Interest paid when bonds redeemed.

–Newly purchased bonds must be held at least 12 months; actual maturity date unspecified.

– Taxes not paid until bonds redeemed.

–Exempt from state and local taxes.

– If redeemed for educational purposes, income taxes may be avoided (subject to certain qualifications and limits).

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Maintaining a Checking Account Determine services needed. Consider costs involved. Keep track of checks written, automatic

deposits, and ATM withdrawals. Don’t write checks for more than you have

in the account (i.e., don’t bounce checks!). Arrange for overdraft protection. Know how to stop a payment. Periodically reconcile your account.

4-33Special Types of Checks:

When personal checks are not accepted, special checks can be used to guarantee payment.

Cashier’s—drawn on the bank.

Traveler’s—used for making purchases worldwide.

Certified—drawn on your account but guaranteed by the bank.

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THE END!