Teens

Saving & Investing

Types of Investments

Teens – Lesson 12 - Slide 12-A

TYPE RISK ROY (Rate of Yield)

• Checking / Savings Safest Lowest

• Certificate of Deposit [CD] Safest Lower

• Money Market Funds [MMF] Safe Low

• Bonds – U.S. Treasuries Safe Low Municipal Rated Medium

Corporate Rated Medium Non-Rated [Junk] High Risk High

• Mutual Funds Varies/Safer Higher

• Stocks Highest Highest

Pay yourself first (a little can add up)

Teens – Lesson 12 - Slide 12-A

•A little can add up!

•Save this each week … at % interest … in 10 years you’ll have•$7.00 5% $4,720•14.00 5% $9,440•21.00 5% $14,160•28.00 5% $18,880•35.00 5% $23,600

•You can buy … a fast food meal or one matinee movie ticket (and a candy bar) or save $7.00 this week.

•What can you give up to save for your financial goals?

How simple and compound interest are calculated

Simple Interest Calculation•Dollar Amount x Interest rate x Length of Time (in years) = Amount Earnedexample

– If you had $100 in a savings account that paid 6% simple interest, during the first year you would earn $6 in interest.

$100 x 0.06 x 1 = $6– At the end of two years you would have earned $12.– The account would continue to grow at a rate of $6 per year, despite the accumulated interest.

Compound Interest Calculation•Interest is paid on original amount of deposit, plus any interest earned.(Original $ Amount + Earned Interest) x Interest Rate x Length of Time = Amount Earnedexample•If you had $100 in a savings account that paid 6% interest compounded annually, the first year you would earn $6.36 in interest.

$100 x 0.06 x 1 = $6$100 + $6 = $106

•With compound interest, the second year you would earn $6.36 in interest.•The calculation the second year would look like this:

$106 x 0.06 x 1 = $6.36$106 + 6.36 = $112.36

Teens – Lesson 12 - Slide 12-E

types of savings accounts

Passbook account•Depositor receives a booklet in which deposits, withdrawals, and interest are recorded.•Average interest rate is lower at banks and savings and loans than at credit unions.•Funds are easily accessible.

Interest-earning checking account•Combines benefits of checking and savings.•Depositor earns interest on any unused money in his/her account.

• LIQUIDITY – the ability to convert to cash. These types of funds are very “liquid.”

• FDIC insured up to $250,000

Teens – Lesson 12 - Slide 12-B

certificates of deposit (CDs)

What they are and how they work•Bank pays a fixed amount of interest for a fixed amount of money during a fixed amount of time.•Essentially, they are a “LOAN” to the institution issuing them.

Benefits•No risk (Fed), Little Risk (Municipal), Low to High Risk (Corporate depending on type)•Simple•No fees•Offers higher interest rates than savings accounts.

trade-offs•Restricted access to your money•Withdrawal penalty if cashed before expiration date (penalty might be higher than the interest earned)

Types of certificates of deposit1. Rising-rate CDs with higher rates at various intervals, such as every six months.2. Stock-indexed CDs with earnings based on the stock market.3. Callable CDs with higher rates and long-term maturities, as high as 10–15 years. However, the bank may “call” the account after a stipulated period, such as one or two years, if interest rates drop.4. Global CDs combine higher interest with a hedge on future changes in the dollar compared to other currencies.5. Promotional CDs attempt to attract savers with gifts or special rates.

Teens – Lesson 12 - Slide 12-D

certificates of deposit (CDs)

Callable CDs

If interest rates fall, the issuer might be able to borrow money for less than it’s pay you. This means the bank will likely call back the CD and force you to find a new vehicle to invest your money.

Example - Callable CD When Rates Decline

Suppose you have a $10,000 one-year callable CD that pays 5% with a five-year maturity. As the one-year call date approaches, prevailing interest rates drop to 4%. The bank has therefore dropped its rates too, and is only paying 4% on its newly issued one-year callable CDs.

"Why should I pay you 5%, when I can borrow the same $10,000 for 4%?," your banker is going ask. "Here's your principal back plus any interest we owe you. Thank you very much for your business.“

Teens – Lesson 12 - Slide 12-D

money-market deposit accounts or money market fundsWhat they are and how they work•Works like a checking/savings account.•Interest rate paid built on a complex structure that varies with size of balance and current level of market interest rates (Fed Discount Rate).

Benefits•Immediate access to your money.

Trade-offs•Usually requires a minimum balance of $1,000 to $2,500.•Limited number of checks can be written each month.•Cannot write a check usually for less than $500.•Average yield (rate of return) higher than regular savings accounts.

Parking Spot – Money Market Funds are often use to when stock or bond investments are sold. The owner puts the now cash assets in a MMF until they decide to reinvest the money.

•NOT insured by FDIC unless offered through a bank (but still considered “very” safe).

Teens – Lesson 12 - Slide 12-C

truth in savings law

The Truth in Savings Act – 1968

requires financial institutions to disclose the following information on savings account plans they offer:

• Fees on deposit accounts• The interest rate• Other terms and conditions• The annual percent yield (APY), which is the percentage rate

expressing the total amount of interest that would be received on a $100 deposit based on the annual rate and frequency of compounding for a 365-day period. Truth in Savings defines the year as 365 days rather than 360, 366, or some other number. This law eliminates confusion caused by the more than eight million variations of interest calculation methods previously used by financial institutions.

Teens – Lesson 12 - Slide 12-G

the rule of 72

Teens – Lesson 12 - Slide 12-H

How many years will it take to double my money?

72 DIVIDED BY= YEARS TO DOUBLE A SUM OF

MONEYINTEREST RATE

At what interest rate will my money double in a set number of years?

72 DIVIDED BY = INTEREST RATE REQUIREDYEARS TO DOUBLEA SUM OF MONEY

bonds

What they are• A bond is an “IOU,” certifying that you loaned money to a government (Fed,

State, or Local) or a corporation and it outlines the terms of repayment.

How they work• The bond issuer pays a fixed interest rate over the life of the bond at

predetermined intervals (usually once or twice annually), and returns the principal (originally loaned amount) on the maturity date, ending the loan.

TypesCorporate• Sold by private companies to raise money.• If company goes bankrupt, bondholders have first claim to the assets, before

stockholders.Municipal• Issued by any non-federal government.• Interest paid comes from taxes or from revenues from special projects. Earned

interest is exempt from federal income tax.Federal government• The safest investment you can make. Even if U.S. government “goes bankrupt,”

it is obligated to repay bonds.

• Bond yields are tied to interest rates (lower the rate, lower the return)

Teens – Lesson 12 - Slide 12-I

bonds

The BOND MARKET

• Like any other commodity, bonds are bought and sold over the open market (“over the counter”).

• The “primary” market is when the issuer of the bond is selling to the “first” buyer.

• The “secondary” market is where buyers sell their bond “holdings” to one another.

• Why would you sell? (It’s complicated – but like anything else, someone believes selling the bond is a “good” deal and someone else believes “buying the bond is a good deal).

• Yield to Maturity (YTM) – both buyer and seller know how long the bond has been issued, how much interest it yields, how often it pays that interest, and most importantly when the bond matures (ends and the principal is paid).

• The seller is betting that they can get a better return by investing his/her money elsewhere (believes interest rates will fall). The buyer is betting that they can get a better return with this bond than they are presently getting (interest rates will fall), and they will be holding a more “profitable” bond than bonds issued in the future.

Teens – Lesson 12 - Slide 12-I

stocksWhat they are• Stock represents ownership of a corporation. Stockholders own a share of the

company and are entitled to a share of the profits as well as a vote in how the company is run.

How earnings are made• Company profits may be divided among shareholders in the form of dividends.

Dividends are usually paid quarterly.• Larger profits can be made through an increase in the value of the stock on the

open market.Advantages• If the market value goes up, the gain can be considerable.

• Money is easily accessible.*Disadvantages• If market value goes down, the loss can be considerable.• Selecting and managing stock often requires study, patience and a “lack of

emotion” – or an expert to do the investing “for you.”

* Paper loss – when the share price goes down but you do not sell. The price can always go back up. You only “lock in” a loss (or a gain) well you sell the shares. It’s true you can sell your shares anytime (liquidity), but you may not want to if you have lost money, or are making money and believe the you can make more!)

Teens – Lesson 12 - Slide 12-K

stocksWhat are DIVIDENDS???• Some companies pay them (usually long established companies). Some

companies do not (usually “start-ups” or businesses still working to establish themselves)

• A dividend is a share of the company’s profits generated in the last period (usually quarterly) – Dividends are paid typically four times a year.

• EXAMPLE: You own 100 shares of ABC Corp at $10.00 per share = $1000.The company pays a $1 dividend per share, so you have and additional $10.

• You can take that dividend in a cash payment (company sends you a check) – many retired folks do this to supplement their retirement income.

• Or you can reinvest the dividend (most common). The $10 is used to purchase more stock. In this example, the stock price has risen to $11 per share. So, without investing any money, you now own 100.9 shares (10/11=.90)

• Long Term / Short Term Capital Gains – Long term gains (you’ve held them for more than 365 days) are taxed at 20%. Short term are gains you’ve realized (bought and then sold) within the year. They are taxed at your income tax rate.

Teens – Lesson 12 - Slide 12-K

stocks

WHAT ARE STOCK INDEXES?

• A sampling of public traded companies share prices at a given moment in time. An index is intended to show trends in the broader market

• Dow Jones Industrial AverageDow Jones Industrial Average – 30 large corporations. Second oldest index established in 1896. Most companies today are no longer “industrial.”

• NASDAQNASDAQ – Founded in 1971 (first “electronic” trading stock exchange) and second largest in the U.S. after the NYSE.

• S&P 500S&P 500 – Broadest of all indexes with 500 U.S. companies across all business sectors. Really the best index to understand market conditions.

Teens – Lesson 12 - Slide 12-K

stocks

SUMMARY

• Owning a share of stock is owning a “piece” of the company

• Companies issue stock to the public to raise capital

• Investors purchase stock to make profit

• Investors make money in two ways: increase in share price and dividends

• Stocks are the riskiest investment.

• Investing in stock requires research, knowledge, patience, and nerves of steel… or a good “broker” who knows what they’re doing

• Pigs get fat. Hogs get slaughtered!Pigs get fat. Hogs get slaughtered!

Teens – Lesson 12 - Slide 12-K

mutual fundsWhat they are• Professionally managed portfolios made up of stocks, bonds, and other

investments.

How they work• Individuals buy shares, and fund uses money to purchase stocks, bonds, and

other investments.• Profits returned to shareholders monthly, quarterly, or semi-annually in the form

of dividends or an increase in the mutual fund share price.Advantages• Allows small investors to take advantage of professional account management

and diversification normally only available to large investors (the risk is spread).Types of mutual fundsBalanced Fund includes a variety of stocks and bonds.Global Bond Fund has corporate bonds of companies from around the world.Global Stock Fund has stocks from companies in many parts of the world.Growth Fund emphasizes companies that are expected to increase in value; also

has higher risk.Income Fund features stock and bonds with high dividends and interest.Industry Fund invests in stocks of companies in a single industry (such as

technology, health care, banking).Municipal Bond Fund features debt instruments of state and local governments.Regional Stock Fund involves stocks of companies from one geographic region of

the world (such as Asia or Latin America).

Teens – Lesson 12 - Slide 12-J

real estate

Ways to invest• Buy a house, live in it, and sell it later at a profit.• Buy income property (such as an apartment house or a commercial building) and

rent it.• Buy land and hold it until it rises in value.

Advantages• Excellent protection against inflation.

Disadvantages• Can be difficult to convert into cash.• A specialized type of investment requiring study and knowledge of business.

Teens – Lesson 12 - Slide 12-L

retirement plansWhat they are and how they work• Plans that help individuals set aside money to be used after they retire.• Federal income tax not immediately due on money put into a retirement

account, or on the interest it makes.• Income tax paid when money is withdrawn.• Penalty charges apply if money is withdrawn before retirement age, except

under certain circumstances.• Income after retirement is usually lower, so tax rate is lower.TypesIndividual Retirement Account (IRA)• Allows a person to contribute up to $2,000 of earnings per year. Contributions

can be made in installments or in a lump sum.Roth IRA (also called the IRA Plus)• While the $2,000 annual contribution to this plan is not tax deductible, the

earnings on the account are tax-free after five years. The funds from the Roth IRA may be withdrawn after age 59, if the account owner is disabled, for educational expenses, or for the purchase of a first home.

401(k)• Allows a person to contribute to a savings plan from his or her pre-tax earnings,

reducing the amount of tax that must be paid. Employer matches contributions up to a certain level.

Keogh Plan• Allows a self-employed person to set aside up to 15% of income (but not more

than $35,000 per year).

Teens – Lesson 12 - Slide 12-M

retirement plans401K Plans – The best investment plan for the Middle Class!

The most lucrative aspect of a 401K plan is the that the company matches your savings at 50%, usually up to 6% of your income. The money you save is tax deferred until you retire.

EXAMPLE: You make $50,000 a year.

6% = $3000 (You are then only taxed on $47,000). This income is taxed currently at 15%, so you save in taxes $450!

You can usually save up to 12% of your income, but the company does not match the additional monies.

With company matching, the total amount you have to invest is $$4,500 (50% return before you have invested anything!)

Your employer’s 401K plan is professional managed by an “outside” investment company. Each year, usually from Oct 1 through Dec 31, you allocate how your money will be invested – most aggressive (growth mutual funds) to safest (money market account). You can split your investment (i.e. 25% in money market, 25% in an income fund, 50% in a growth fund). This is a nice diversification for a “20 something.”

Teens – Lesson 12 - Slide 12-M

IRAs – an example of a return on investment

contributions made only between ages of 22–30 (9 years)• $2,000 contributed each year• Total investment of $18,000• At an interest rate of 9%, by age 65 will have $579,471

contributions made only between ages of 31–65 (35 years)• $2,000 made contributed each year• Total investment of $70,000• At an interest rate of 9%, by age 65 will have $470,249

This is the power of compounding!

Teens – Lesson 12 - Slide 12-N

comparing savings and investment plans

Teens – Lesson 12 - Slide 12-O

instrument maturity risk yield minimum balance

taxable?

Savings Account

Immediate None if insured Low $5 Yes

Certificate of Deposit

90 days or more None if insured Moderate Varies Yes

Bonds

Corporate 5–30 years Some Moderate $1,000 Yes

Municipal 1–20 years Some Moderate $5,000 No federal,some states

Stocks Immediate Low to high Low to high Varies Yes

U.S. Treasury

Bills 1 year or less None Moderate $10,000 Federal only

Notes 1–10 years None $1,000 Federal only

Bonds 10–30 years None $1,000 Federal only

Mutual Funds

Varies Low to high Moderate Varies Usually

Retirement Funds

When buyer is60 years old

Low Moderate Varies At maturity

avoid investment fraud

Each year billions of dollars are lost to fraudulent investments. Some of the most common include:

• Illegal pyramids, insider trading, and unlicensed investment brokers• High-risk “penny” stocks and fraudulent securities• Fraudulent franchises and business opportunities• Internet services, 900-numbers, and high-tech investments promising high profits

and minimal risk• Opportunities to invest in movie deals and other entertainment ventures with

promises of guaranteed profits and failure to disclose risk

To protect yourself from becoming a victim of investment fraud, take the following actions:

• Become informed about investments and industries before investing• Talk with others who have made similar investments• Obtain information from state and federal regulatory agencies• Never buy over the phone without first investigating the situation• Avoid investment opportunities promising large returns in a short amount of time

that seem “too good to be true”—they probably are!

For additional information, contact the following Web sites:www.ftc.gov; www.fraud.org; www.sec.gov; www.nasaa.org

Teens – Lesson 12 - Slide 12-P