Chapter 10 Basics of Saving and Investing How

Chapter 10 Basics of Saving and Investing

How Are Saving and Investing Related? • Savings is money set aside for the future. • Investing is a strategy to earn more on your money than the rate of inflation. • Wealth is the accumulation of assets over time. 10 -1 Reasons for Saving and Investing Slide 2

How Are Saving and Investing Related? • When you set money aside, you have a reserve or emergency fund that you can count on • Emergency Fund: amount of money set aside for unexplained expenses. • Liquidity: a measure of how quickly an asset can be turned into cash. • It is important to have some liquid assets, such as a savings account, that are available to cover unexpected needs. 10 -1 Reasons for Saving and Investing Slide 3

How Do Saving and Investing Meet Personal Goals? • Short-Term Goals o Contingency planning o Contingencies: unplanned or possible events. o Vacation planning o Used to engage in enjoyable activities 10 -1 Reasons for Saving and Investing Slide 4

How Do Saving and Investing Meet Personal Goals? • • • Medium-Term Goals: 2 to 5 years o Buying a car o Paying for college o Planning a wedding Long-Term Goals o Providing for a family o Cost to raise a child from birth to 17 is between $207, 000 to $475, 000. o Buying a house Financial Security • The ability to meet current and future needs while living comfortably. 10 -1 Reasons for Saving and Investing Slide 5

How Does Investing Prepare You for Retirement and Beyond? • Retirement is the period of time when you are not working but are able to meet expenses. • Should begin at a young age • Sources of income include: o Retirement plans o Social security o Savings o Investments 10 -1 Reasons for Saving and Investing Slide 6

Estate Planning • Estate: all the a person owns (assets), less debt owed, at the time of the persons death. • Estate planning is the process of preparing a plan fro transferring property during one’s lifetime and at one’s death. • A person may request that their money go towards a foundation. • A foundation is a fund or organization establishes and maintained for the purpose of supporting an institution or cause.

Investment Growth Over Time Amount Invested $10, 000 investment Interest Investment Rate Term Maturity Value 6% 6% 20 years 30 years $32, 071 $57, 435 $1, 000 investment 8% 8% 30 years 40 years $10, 063 $21, 725 $1, 000 per year investment 5% 5% 5% 20 years 30 years 40 years $33, 066 $66, 439 $120, 800 $100 per month investment 7% 7% 7% 25 years 30 years 40 years $81, 007 $121, 997 $262, 481 10 -1 Reasons for Saving and Investing Slide 8

Success Skills Having a Will and Health Care Directive • A will is a document that passes title of property after a person dies. o A simple will describes your wishes for distribution of property. o A trust will leaves your estate in trusts to benefit your children and other heirs. • A health care directive is also a “living will. ” o It describes your wishes at the end of life. 10 -1 Reasons for Saving and Investing Slide 9

How Is Risk Related to Return? • The higher the risk, the greater your possible return. • Risk-free investments are guaranteed by the government—U. S. savings bonds, Treasury bills. 10 -2 Principles of Saving and Investing Slide 10

How Is Risk Related to Return? Ideal Investments will have the features: • The principal is safe (no risk) • The rate of return (earnings) is high • The investment is liquid (you can get your money quickly without a penalty) • You can invest quickly and easily • The costs of investing are low, both in terms of the amount invested as well as investment fees • The earnings and long-term gains from the investment are tax-free or tax-deferred. 10 -2 Principles of Saving and Investing Slide 11

Growth of Principal • Money set aside for savings should be growing. • If it is not growing you are losing money and buying power • The principal, base amount on which interest is computed, should get larger over time. • Principal grows through compounding of interest. • Example: Principal gains interest and is added to the principal amount, which becomes the next principle amount. This cycle continues and investment grows. 10 -2 Principles of Saving and Investing Slide 12

How Is Risk Related to Return? • Return on Investment (ROI) is the amount that savings or investments grow expressed as a percentage. 10 -2 Principles of Saving and Investing Slide 13

Return on Investment Example 1: Bought an investment for $500; received dividends of $18 for the year Return: $18 Rate of return: $18 ÷ $500 = 3. 6% (annual rate of return) Example 2: Bought an investment for $500 on March 1; sold it on October 1 for $525. Return: $25 Rate of return: $25 ÷ $500 = 5% Note: The 5% return was received after only 7 months. The annual return would be higher. Calculate the annual ROI as follows: 0. 05 ÷ 7 months × 12 months = 8. 6% (annual rate of return) 10 -2 Principles of Saving and Investing Slide 14

What Types of Risk Do Investors Face? Investment risk is the potential for change in the value of an investment. • Inflation risk • Industry risk • Political risk • Stock risk 10 -2 Principles of Saving and Investing Slide 15

What Types of Risk Do Investors Face? • Inflation risk: the chance that the rate of inflation will be higher than your investment rate of return. – i. e. your investment loses value – Assume you buy a bond, a debt instrument issues by a corporation or government. This bond has a 5% fixed rate interest. If inflation is lower than 5% than your investment is holding its value. If inflation rises to 7% or 8% your investment is losing value. 10 -2 Principles of Saving and Investing Slide 16

What Types of Risk Do Investors Face? • • Industry risk: the chance that factors affecting an industry as a whole will negatively affect the value of an investment. – Example: you invest in oil company and profits and oil prices rise. Your investment will gain value. Political risk: the chance that a political event ( such as a new law or policy, a war, or an election) will affect the value of an investment. – When a new president is elected, stock markets usually go up. 10 -2 Principles of Saving and Investing Slide 17

What Types of Risk Do Investors Face? • • Most people invest by buying stock, which is ownership interest in a publicly held company Stock Risk: the chance that activities or events that affect a company will change the value of an investment in the company. – Ex: poor management or product recalls 10 -2 Principles of Saving and Investing Slide 18

Investment Risk vs. Gambling • When gambling the chance of winning are less than 50 percent • Some gambling odds are so low than you will lose 90% of the time. • Gambling in most cases should be considered entertainment and not an investment

What Are Tax Advantages of Investing? • Tax deferral is a postponement of taxes to be paid. o Taxes on gains are not paid until the money is withdrawn. • Tax exemption means savings and investments are not taxed. o Example: US Series EE and Series I savings bonds are tax-free if used for education. 10 -2 Principles of Saving and Investing Slide 20

Investment Comparison Taxable Tax Free • Corporate bond at 7% • Government bond at 5% interest • The investor pays federal tax at a rate of • The investor keeps all 35% the interest earned at 5% • The invest keeps 65% (100 -35) of the interest earned. The rest is paid in tax • 0. 07 X 0. 65 = 4. 55% earnings after taxes

Employer-Sponsored Plans • Plans in which employer sets aside money on employees behalf • For example, a employer-sponsored retirement plan offers to match 10% of employees contributions. If the employee contributes $100 to their 401 k then the employer would put in $10. This is an automatic 10% return on investment that is not taxed until retirement.

What Are Systematic Saving and Investing Strategies? • Systematic saving involves regularly setting aside cash to achieve goals. • Systematic investing is a planned approach to making investments on a regular basis. 10 -3 Strategies for Saving and Investing Slide 23

What Are Systematic Saving and Investing Strategies? • Investment tracking is a technique for making investment choices by following the prices of stocks and investments over time. • Tracking stock helps determine if this is the right investment for your portfolio 10 -3 Strategies for Saving and Investing Slide 24

What Are Systematic Saving and Investing Strategies? • • Market timing involves buying and selling stocks based on what the market is expected to do. Requires a good understanding of the economy and financial market conditions. Having good timing is critical to building a portfolio and earning returns. Dollar cost averaging: a person invests the same amount of money on a regular basis, such as monthly, regardless of market conditions. 10 -3 Strategies for Saving and Investing Slide 25

Focus On. . . Dollar-Cost Averaging The systematic purchase of an equal dollar amount of the same stock at regular intervals 10 -3 Strategies for Saving and Investing Slide 26

Stock Trend Line Investment tracking involves making investment choices by following stock prices over time. 10 -3 Strategies for Saving and Investing Slide 27

Reducing Investment Risk • Diversification: holding a variety of investments for the purpose of reducing overall risks. • One type of stock may go down while others go up. The overall loss is reduced. • Investment Portfolio: a collection of assets that provides diversification for an investor. – Example: bonds, stocks, real estate, cd’s, etc. – Should have relatively safe low risk investments. These include conservative mutual funds which is a professionally managed group of stocks, bonds, and other investments. – Some people have speculative investments, which have high earning potential but carry a high risk.

How Can You Reduce Investment Risk? 10 -3 Strategies for Saving and Investing Slide 29

Markets • The financial market refers to any place where investments are bought and sold. • Ex: stock markets and bond markets • The term market is also used to refer to price levels or other market conditions – Ex: “The market was off today” refers to the price levels being low for that day.

How Can You Maximize Investment Return? • A bull market exists when stock prices are steadily increasing. • A bear market exists when prices are steadily decreasing. • Economic conditions (growth or decline) can affect investment strategies. 10 -3 Strategies for Saving and Investing Slide 31