Savings

Ms. Nwaolu3-7-13

Objectives

Students willDefine savingsUnderstand simple and compounded interest

Learn about the time value of money

Define and review the rule of 72

What is SavingsWhat is Savings

Savings is the storage of money for future Savings is the storage of money for future use.use.

People save different amounts of money People save different amounts of money for different reasons:for different reasons:◦Some people even save for years in order to Some people even save for years in order to

make a down payment on a home.make a down payment on a home.◦Financial Planners often encourage people to Financial Planners often encourage people to

save at least 10% of the earnings.save at least 10% of the earnings.◦PAY YOURSELF FIRST!PAY YOURSELF FIRST!

Savings & Time Value of Savings & Time Value of MoneyMoney

There is an There is an opportunity costopportunity cost associated associated with Saving money. with Saving money. ◦This means you give up having some things you This means you give up having some things you

want now in order to save money for later. want now in order to save money for later. When saving, it is important to understand When saving, it is important to understand

the time value of money.the time value of money.Time value of money – increase in the Time value of money – increase in the

amount of money as a result of interest.amount of money as a result of interest.Investing-Using ones savings to earn more Investing-Using ones savings to earn more

moneymoney

Savings & Time Value of Savings & Time Value of MoneyMoney

Usually when you save money you earn interestUsually when you save money you earn interest◦Interest applies to the principal Interest applies to the principal ◦Simple interest does not include interest in Simple interest does not include interest in

future. future. ◦The formula for SI is I=Principal x Rate x TimeThe formula for SI is I=Principal x Rate x Time

Compound interest is computed on the amount Compound interest is computed on the amount saved plus the pervious interest. saved plus the pervious interest. ◦Money grows faster when you compound Money grows faster when you compound

interest.interest.

Time Value of MoneyTime Value of Money

Present value – value at current time in Present value – value at current time in order to have desired value in futureorder to have desired value in future

Future value – value in the future of Future value – value in the future of current amountcurrent amount

Annuity – series of regular payments Annuity – series of regular payments Principal – amount of money on which Principal – amount of money on which

interest is paid; always includes amount of interest is paid; always includes amount of depositdeposit

Time Value of Money ExampleTime Value of Money Example

If you wanted to know how much you had If you wanted to know how much you had to put aside today in order to have $1000 to put aside today in order to have $1000 SAVED IN 5 YRS FOR A DOWNPAYMENT SAVED IN 5 YRS FOR A DOWNPAYMENT FOR A CAR and THE INTEREST RATE IS 5%, FOR A CAR and THE INTEREST RATE IS 5%, HOW MUCH WILL YOU HAVE TO DEPOSIT HOW MUCH WILL YOU HAVE TO DEPOSIT NOW? NOW? Use the PV of a single deposit Use the PV of a single deposit table.table.

Time Value of Money ExampleTime Value of Money Example

If you deposited 4000/yr into a savings If you deposited 4000/yr into a savings account with a 3% interest rate, how much account with a 3% interest rate, how much would you have after 3 years? would you have after 3 years?

Note: look at the FV of an annuity tableNote: look at the FV of an annuity table

Rule of 72Rule of 72

The rule of 72 is -rule of thumb used to The rule of 72 is -rule of thumb used to determine how long to double an determine how long to double an investment at a given rate of return.investment at a given rate of return.

72/interest rate=years to double72/interest rate=years to double

Ex. 72/25=Ex. 72/25=

Closure QuestionsClosure Questions

There is a __________cost associated with savings and There is a __________cost associated with savings and investing.investing.

The formula for simple interest is______.The formula for simple interest is______. What is compound interest?What is compound interest? Define Present Value.Define Present Value. Define Future Value.Define Future Value. What is the principal?What is the principal? What is the formula for the Rule of 72?What is the formula for the Rule of 72? Using the rule of 72 if my interest rate was 20%, how long Using the rule of 72 if my interest rate was 20%, how long

would it take to double my money?would it take to double my money? Which table would I use if I want to know how much 400/yr Which table would I use if I want to know how much 400/yr

would yield at a rate of 5% for 3 yrs?would yield at a rate of 5% for 3 yrs? What is an annuity?What is an annuity?

INVESTINGINVESTINGMs. Nwaolu

IBM3-12-13

Investment ObjectivesInvestment Objectives

Students willDefine InvestingExamine Investing Risk & RewardsExamine the different Investment

AlternativesEvaluate different savings and

investing programs based on safety, return, liquidity, and taxes

What is Investing?What is Investing?

Investing is the act of committing money or capital to an endeavor with the expectation of obtaining an additional income or profit.

◦ investing means putting your money to work for you.◦ people invest because they want to increase their personal

freedom, sense of security and ability to afford the things they want in life.

Investing money does come with some risk, but it is not the same thing as gambling (putting money at risk by betting on an uncertain outcome with the hope that you might win money).

◦ The wise investor performs thorough analysis and commits capital only when there is a reasonable expectation of profit.

Investment Risk & Reward

Business risk – the Business risk – the business could failbusiness could fail

Financial market risk – Financial market risk – economic melt downeconomic melt down

Global investment risk Global investment risk –foreign economic –foreign economic meltdownmeltdown

Inflation risk – Inflation risk – inflation increases inflation increases faster than earningsfaster than earnings

Laying a good foundation for your investment program will help ensure that you meet you future financial goals.

Saving and preparing for your future now helps make you financial future more comfortable and foreseeable.

Investment ChoicesInvestment Choices

Securities

A security is generally an exchangeable or replaceable, negotiable financial instrument

representing financial value.Stock Investment- ownership of a percentage of

a company. When a stock increases in value and is sold for more than the original price this is a capital gain.

Bond Investment-bonds represent debt. When you purchase a bond you are lending funds to a company or the government to use for business.

Mutual Funds- Instead of buying individual stocks and bonds, people invest in mutual funds. Money is invested in a variety of companies. Spreading the risk.

Other Investment ChoicesOther Investment Choices

Alternative Investments

Real Estate- Property consisting of land and the buildings on it, along with its natural resources such as crops, minerals, or water

◦ People invest in real-estate for different reasons. Some invest for security and stability. Some purchase for rental income. Ex. Farmland, apartments, & malls.

Commodities-A raw material or primary agricultural product that can be bought and sold incl. grain, livestock, precious metals, currency, and financial instruments.

◦ Investors buy commodity contracts in hopes of a higher market price in the near future.

Collectibles- An item valued & sought by collectors like Coins, works of art, & other rare items are bought in hopes that there value will increase.

Evaluating Savings and Evaluating Savings and InvestmentInvestment

The are 4 things to look at when evaluating savings and investment: Safety, Return, Liquidity, and Taxes.

Safety-the assurance that the money you have invested will be returned to you. The FDIC insures up to $250,000 in your savings accounts.

It is a good practice to spread out your risk (diversify) so that one loss will not hurt your portfolio.

Evaluating Savings and Evaluating Savings and InvestmentInvestment

Return-A good savings plan or investment should earn a reasonable return.◦ A yield is the percentage of money

earned on your savings or investment over a year. Other names incl. rate of return or annual yield.

Usually, the higher the yield the greater the risk.

Evaluating Savings and Evaluating Savings and InvestmentInvestment

Liquidity-the ease in which an investment can be turned into cash without losing its value.

◦ Cash, savings, and checking accounts are examples of liquid assets.

◦ A home, however is not liquid. You may need to sell your house right away but may not be able to do so w/o losing money.

Evaluating Savings and Evaluating Savings and InvestmentInvestment

Taxes- A fee charged (levied) by a government on a product, income, or activity. ◦ Earnings from certain types of savings and

investments are taxed. ◦ TAXES REDUCE YOUR RATE OF RETURN.◦ Some investments are tax-exempt-meaning

that you do not have to pay taxes and the yield may be higher. Ex. Tax-exempt government securities

EX. YOU EARN $100 IN TEREST BUT PAY 20% IN TAXES, YOU HAVE ONLY EARNED $80.

Closing QuestionsClosing Questions

What is Investing?Why is investing so Important?What is the difference between investing and

gambling?List & Describe 2 risk and 2 rewards associated with

investing.What is a security? List & Describe 3 types of Securities.Define & give examples of real estate, commodities,

& collectibles?Describe safety and return.Describe liquidity and taxes.Give an example of a liquid asset.

Stock Investments Stock Investments Stock or share – ownership of a Stock or share – ownership of a

percentage of a companypercentage of a company◦Owners of stock are called Owners of stock are called StockholdersStockholders..

When a business is profitable When a business is profitable (Revenue-Expenses=Profit) it may (Revenue-Expenses=Profit) it may pay out part of its profits to its pay out part of its profits to its stockholders. stockholders. ◦This payment is called a This payment is called a dividenddividend..

Stock InvestmentsStock Investments

Even though stockholders may get a higher Even though stockholders may get a higher return, stockholders may not receive return, stockholders may not receive dividends at all. dividends at all.

The company must pay its debt first. This The company must pay its debt first. This included any bondholders (ppl/companies included any bondholders (ppl/companies that have lent the company money to do that have lent the company money to do business) and the rate of interest promised business) and the rate of interest promised to them. to them.

Additionally, if a company wants to expand Additionally, if a company wants to expand its business then a stock holder may get its business then a stock holder may get little to no dividends.little to no dividends.

Stock InvestmentsStock Investments

There are 2 main classes of stock issued There are 2 main classes of stock issued by a corporation: Preferred and Common by a corporation: Preferred and Common Stock.Stock.

Preferred Stock- priority over common Preferred Stock- priority over common stock. stock. ◦Dividends paid to preferred stock holders is Dividends paid to preferred stock holders is

usually at a set rate. usually at a set rate. ◦Preferred stock is also less risky however Preferred stock is also less risky however

preferred stock holders have no voting rights in preferred stock holders have no voting rights in the corporation.the corporation.

Stock InvestmentsStock Investments

Common stock is ownership in a company Common stock is ownership in a company and represents the right to share in its and represents the right to share in its profits.profits.◦With common stock, there is no set With common stock, there is no set dividend rate. dividend rate.

◦Common stock holders are invited to the Common stock holders are invited to the corporations annual meeting and are corporations annual meeting and are entitled to one vote/share of stock.entitled to one vote/share of stock.

Consider This!Consider This!

A company earns a A company earns a profit and wants to pay profit and wants to pay it ALL out in dividends. it ALL out in dividends. If they earn $20000 If they earn $20000 and they have to pay and they have to pay the preferred stock the preferred stock holders 6% how much holders 6% how much $ would they pay each.$ would they pay each.

PreferredPreferred20000 X .06 = 1200.0020000 X .06 = 1200.00CommonCommonThe remainder 18800 The remainder 18800

common stock holders common stock holders earned a return of 94%earned a return of 94%

Which would one would Which would one would you choose and why?you choose and why?

Stock TransactionsStock Transactions

A stockbroker is a licensed specialist in the A stockbroker is a licensed specialist in the buying and selling of stocks and bonds. buying and selling of stocks and bonds.

Stockbrokers can either be full-service or Stockbrokers can either be full-service or discount.discount.◦Full-service brokers usually charge a higher Full-service brokers usually charge a higher

commission (fee for service) because they offer a commission (fee for service) because they offer a wealth of information and research about wealth of information and research about securities.securities.

◦Discount brokers carry out buy and sell orders at a Discount brokers carry out buy and sell orders at a reduced commission compared to a full-service reduced commission compared to a full-service broker, but provides no investment advice. broker, but provides no investment advice.

Stock TransactionsStock Transactions

The The market valuemarket value of a stock is the price of a stock is the price at which a share of stock can be bought at which a share of stock can be bought and sold on the stock market.and sold on the stock market.◦Market value can be affected by economic Market value can be affected by economic

conditions as well as national and global politics.conditions as well as national and global politics.

Another measurement of investment Another measurement of investment values is the stock index which can be values is the stock index which can be found in newspaper listings, online, found in newspaper listings, online, television, & radio (i.e. DJIA and S&P)television, & radio (i.e. DJIA and S&P)

Stock SelectionStock Selection

There is a four step process for deciding There is a four step process for deciding what stocks to purchase:what stocks to purchase:1.1.Observe and analyze economic and social Observe and analyze economic and social

trends.trends.2.2.Determine industries that will be affected.Determine industries that will be affected.3.3.Identify companies in those industries.Identify companies in those industries.4.4.Decide whether to buy, sell, or hold stock in Decide whether to buy, sell, or hold stock in

those companies. those companies.

Factors to Consider!Factors to Consider!

1.1. Has the company been profitable for a sustained Has the company been profitable for a sustained period of time? (Affects stockholders and div.)period of time? (Affects stockholders and div.)

2.2. Are there good managers making good decisions? Are there good managers making good decisions? (BP Tony Hayward, execs from Johnson & Johnson, (BP Tony Hayward, execs from Johnson & Johnson, AIG/WallStreet Bonuses)AIG/WallStreet Bonuses)

3.3. Does the company have growth potential? (Investing Does the company have growth potential? (Investing in clean energy, Apple, other technologies)in clean energy, Apple, other technologies)

4.4. Does the company have an unusually high amount of Does the company have an unusually high amount of debt? (income stmt. Bal. Sheet)debt? (income stmt. Bal. Sheet)

5.5. How does the company compare to others in its How does the company compare to others in its industry? (Company standing in the industry, market industry? (Company standing in the industry, market leaders) (Cars, Retailers, Phones)leaders) (Cars, Retailers, Phones)

Closure Questions

What is stock? Define dividend. List some reasons why stockholders may not

receive dividends. What is the difference between preferred stock and common

stock? If a preferred stockholder is paid 5% and the dividends are 14000,

what is the amount the common stockholders will receive? Describe the difference between full-service and discount

stockbrokers. What is market value? What are some things that might affect the market value? List some common stock indexes. What is the four step process for deciding what stocks to four step process for deciding what stocks to

purchase?purchase? What are some factors to consider before buying stock in a

company?

What is a Bond?

Bond-certificate representing a promise to pay a definite amount of money at a stated rate of interest on a specified due date. ◦ Bonds are similar to promissory notes

issued by individual borrowers.◦ Governments issue bonds to raise

money for funding public services. Federal, State, and local Gov. issue a variety of bonds.

Government Bonds

Bonds issued by state and local governments are called municipal bonds or munis. ◦ Munis bonds have an advantage over

other bonds because interest on municipal bonds are exempt from federal and most state income taxes.

◦ To avoid taxes ppl. may buy municipal bonds instead of corporate bonds even though the yield is lower. (Munis=Safer Investment)

US Savings Bonds

US savings bonds are also a safer investment and are usually for people with small amounts of money to invest.

Series EE SB’s come in denominations of $50-$10000. They pay interest through a process called discounting.◦ A discount bond is issued for less than its par

(or face) value.◦ Series EE bonds are bought for half the value.

($50 bond costs $25) At the end of the full term, it pays at least $50. The diff. is the interest earned.

US Savings Bonds

Series HH bonds are available for between $500-$10000. They are not discounted and pay a fixed rate of interest through a check mailed to the investor, twice a year.

Another type of savings bond is the series I bond. The interest rate is lower than other savings bonds, but it has a variable rate that increases with inflation.

Other Federal Securities

Other Federal Securities include: Treasury Bills (T-bills) Treasury Notes (T-notes) and before 2001, Treasury bonds (t-bonds).

T-bills involve short term borrowing with maturities (cash in date) from 91 days-1yr.

T-notes have maturities from 1-10 years.T-bonds involve long-term borrowing w/

maturities ranging from 10-30 years.

Corporate Bonds

Bonds issued by Corporations are called corporate bonds.

Each corporate bond has a face value which is the amount being borrowed by the corp. (most corp. bonds FV is $1000)◦ On corp. bonds, interest is paid usually twice a

year to the investor. ◦ Interest is paid based on the face value and the

stated interest rate.

Corporate Bonds

Corporate Bonds are bought and sold on the bond market. The value changes based on changing interest rates and the credit rating of the borrowing organization.

Corp. bond prices are stated in 100s but bonds are sold in 1000 denomination, or 10 X listed amount.◦ Ex. A bond reported at 100 is selling at a face

value of 1000, or 205 at face value 2050.

What is a Mutual Fund?

A mutual fund is an investment fund set up and managed by companies that receive money from many investors. The company then buys a variety of stocks and bonds. ◦ The are over 15000 different mutual funds

available to investors like: Aggressive growth stock funds, income funds, international funds, sector funds, bond funds, and balanced funds.

Bonds and Mutual funds

Mutual fund investors own shares of the mutual fund. The value of each share is based on the total value of all investments made by the mutual fund company.◦ Ex. If investments are worth $400,000 and

80,000 shares exist, then each share would be worth $5 or 400000/80000. this amount is called the net asset value or NAV.

A portion of interest and dividends earned are used for operating expenses, a major part is used for paying shareholders or reinvesting in the company.

Closure Questions

What is a bond (incl. what bonds are similar to and why they are issued)?

Describe the characteristics of a municipal bond. List and describe the characteristics of an EE savings bond, HH

savings bond, and I savings bond. If I bought a series EE savings bond for $50, what is the value of

the bond? What are the 3 other government securities? Which one of the three has the longest maturity date? Shortest? What is a corporate bond (incl. characteristics of a corporate

bond)? If a corporate bond is being reported at 500, what is the face

value? What is a mutual fund? If investments are worth $275,000 and 2500 shares exist, what is

the value of each share?