Module 4 – Investing: Money Working for You
I. Savings vs. Investing:
A. SAVINGS
1. Depositing money into a financial institution (banks & credit unions) for safekeeping & to earn [a small amount of] interest
2. Money put away for a temporary (short-term) time-frame
3. Easy to get to, easy access
4. Used to pay for short-term goals
5. Liquid – can get converted into cash quickly
6. AKA: Income Investments
B. INVESTING
1. Buying something (Asset) with the expectation that it will make money for you
2. Money put away for a longer period of time
3. Used to pay for longer-term goals or retirement income
4. Risky but can earn more than a savings account
5. Fluctuates in value – Have to deal with the rollercoaster of ups & downs
6. AKA: Growth Investments
II. Elements of Saving and Investing Money
Time Value of Money – refers to 3 elements (p. 15):
1. Time – the sooner you start saving/investing, the more likely you will earn more “new” money
2. Money – the more money you invest, the more money you will earn on it
3. Rate of Interest – the higher the interest rate, the more money you will earn
III. Popular SAVINGS OPTIONS (p. 8)
A. Savings Accounts (Time Deposits)
· Money put into an account for more long-term savings (but for short-term goals); very liquid
· Withdraw money using a withdrawal slip provided by the bank
· Earns Interest (“earned income”)
1. Money you earn when you leave money in a savings account.
· Banks LEND it to other people (via loans)
· APY (Annual Percentage Yield)
2. Money you pay when BORROWING money from the bank (via loans) – APR (Annual Percentage Rate)
3. Simple Interest – I = P x R x T
Interest ($$ amt.) = Principal x Interest Rate x Time in years
4. Compound Interest – when you earn interest on previously earned interest + principal (p. 11); TI-84 Calculator!!
5. Interest rates on savings accounts may NOT keep pace with inflation (price increases)
6. Rule of 72 (see handout) – On Exam!
a. How many years will it take to double the money?
72 divided by interest rate = amount of years
· How long will it take to double $5,000 at a 9% interest rate? 72 / 9 = 8 years
b. What interest rate do I need to double the money?
72 divided by # of years = required interest rate
· What interest rate do I need to double $5,000 in 2 years? 72 / 2 = 36%
B. Certificate of Deposit (CD)
1. A type of “time deposit” account
2. Must leave $$ in bank until it matures (3 mths, 6 mths, 1 yr, 2 yrs, etc.). The longer you keep it in, the higher the interest rate
3. At maturation date, you can remove it or keep it in
4. Interest rates adjust every time it renews
5. Severe penalties if remove money before it matures
C. Money Market Deposit Account (MMDA)
1. Like a savings account but pays a higher interest rate (but lower than CDs)
2. Can withdraw/write checks from it, but limited in number as to how many you can write (4x per month)
3. Must maintain a HIGH balance
D. U.S. Savings Bonds (Series EE) – YOU are the lender, government is the borrower!
1. Sold on-line only by the U.S. Treasury: www.treasurydirect.gov
2. Purchase in amounts: $25, $50, $100
3. Fixed interest rate for up to 30 years
4. Low interest rates and lowest RISK (safest bond to buy)
5. “Loaning” money to the government
6. War Bonds – to fund WWII
7. Purchase at ½ of the face value ($50 buy for $25)
8. Can be cashed after 20+ years
9. Penalized if cashed within the 1st 5 years of owning
10. AKA: Treasury Bonds
E. Other Types of Bonds (p. 18)
1. Municipal Bonds – issued by STATE & CITY governments
2. Corporate Bonds – Issued by COMPANIES
· Pay the highest interest rates
· But, are the riskiest to buy as company may go bankrupt!!
· Investing in a company directly
IV. INVESTING FOR “GROWTH” (p. 18)
· The riskier it is, the potential for growth is higher
· Look at the rate of return – The degree to which an ASSET gains (or loses) value over a given period of time
Income Investments: provide regular earnings (monthly interest, quarterly dividends, rent payments); provide a steady income
Growth Investments: buying assets that hopefully will increase in value over time; no money collected on the investment until the asset is SOLD; potential for greater gains/losses than income investments
A. Real Estate – land, buildings, malls, apartment buildings; “flipping” houses
B. Collectibles (p. 26)
1. No money earned unless the piece is SOLD
2. High risk as there is a small market for people to buy it from you, at your asking price
i.e. artwork, baseball cards, antiques, coins, comic books
C. [Money Market] Mutual Funds (p. 24) – a portfolio manager invests your money based on your wishes: 20% international; 50% conservatively; 10% in corporate bonds; 20% in stocks
1. When a company invests money for you into different stocks & bonds of other companies
2. Earns a higher interest rate than the Money Market Deposit Accounts
D. Stock Market (high risk) – purchase a “share” of ownership in a company; “stockholder”
1. TYPES OF STOCK
a. Common Stock – lower priced; have voting rights; last ones to get paid a “dividend” (only if there are “leftovers”)
b. Preferred Stock – sold at a higher price than common stock; NO voting rights; if dividends are paid out to stockholders, YOU get it first
2. SELLING YOUR STOCK
a. Capital Gains – when you sell your shares of stock at a higher price than what you paid for it: Pay taxes on it!!
b. Capital Loss – when you sell your shares of stock at a lower price than what you paid for it: Get a tax “break” (can use as a tax “deduction”)
3. Stock Exchanges (pp. 22-23):
a. NYSE – New York Stock Exchange
· A physical place that securities are bought & sold “auction style”
· Has a trading floor
b. NASDAQ – National Association of Securities Dealers Automated Quotation System
· Trading done via telecommunications
4. MISC. Stock Market Terms
a. Proxy – a voting device, like an absentee ballot
b. Bull Market – people trust the stock market and are actively buying & selling shares of stock; high amounts of transactions are occurring
c. Bear Market – people are hoarding their money to themselves, not buying & selling in the stock market; low amount of transactions
d. Insider Trading – illegal!! Federal Trade Commission (FTC) & Securities Exchange Commission (SEC) will bust you if you get confidential information (INSIDER INFORMATION) about a company that influences you to buy or sell your stocks/investment in the company AND you PROFIT from this information
V. How to buy STOCKS & BONDS (pp. 19 & 21):
A. Through a registered BROKER – give advice & buy it for you
B. Get advice through INVESTMENT ADVISOR (but they CAN’T make the purchase for you)
C. Banks & Investment FIRMS have investment advisors/portfolio managers
D. Online discount stock brokerage firms
VI. Do Your Homework Before Investing! (pp. 32-35)
A. Avoid trusting others blindly – research where your money is going!
B. Avoid falling for fairy tales – if it sounds too good to be true, it probably is [NOT true]
C. Avoid relying ONLY on past performance – economy changes, management changes
D. Avoid borrowing money to invest it
E. Avoid holding only ONE investment – diversify!
F. Don’t get emotional about your investments! – Wall Street movie
VII. Tax Shelter Investments (p. 38)
A. 401(k) – employer-sponsored retirement program
1. Many employers will “match” what you contribute, so double the money is invested
2. Funds pulled from your check BEFORE taxes are taken out
3. Must pay taxes once you start to withdraw it (at any age)
B. TRADITIONAL IRA – Individual Retirement Account
1. Have tax advantages if deposit money into IRA’s vs. in a savings account
2. The “growth” of the funds is TAX FREE
3. It’s NOT an investment, but an ACCOUNT
4. Inside the account, you invest in many different types of things:
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§ CD
§ Government bonds
§ Mutual funds
§ Stocks
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5. Can withdraw after 60 yrs. old
6. Pay taxes upon withdrawal of the funds
C. ROTH IRA
1. Funds are TAXED when you deposit into the account
2. The “growth” of the funds is TAX FREE
3. BUT: can withdraw early IF use it for higher education or if you leave the job
DIVERSIFICATION IS THE KEY!!! Don’t put all of your eggs into one basket!!
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