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.
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)
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.
Types of Financial Institutions Depository Commercial Banks Savings & Loans Savings Banks Credit Unions Nondepository Stock Brokerage Firms Mutual Funds Life Insurance Companies Finance Companies
Traditional Financial Institutions • Commonly referred to as “banks” • Include • Commercial banks • Savings & loan associations • Savings banks • Credit unions • Set apart from their nonbank counterparts by their ability to accept deposits
Types of Depository Financial Institutions • Commercial Banks • Largest type of traditional financial institution. • Offer full array of financial services. • Only type of financial institution that can offer noninterest-paying checking accounts (demand deposits).
Offer many of the same services as commercial banks. • Typically pay slightly more on savings deposits • Typically pay slightly more on savings deposits. • Channel depositors’ savings into mortgage loans for purchasing and improving homes. • Some are mutual associations. • Savings and Loan Associations
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 (their depositors are their owners and receive a portion of the profits in the form of interest on their savings). • Savings Banks
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. • Credit Unions
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. • Internet Banks
Stockbrokerage firms—offer cash management accounts, money market mutual funds, credit cards • Mutual funds—offer money market mutual funds • Life insurance companies • Finance companies • Types of Nondepository Financial Institutions
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 $250,000 per depositor. How Safe is Your Money?
Cash Management Products With sufficient funds, banks must immediately pay the amount of your check or ATM withdrawal. Checking Accounts = Demand Deposits
Types 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
Money Market Deposit Accounts • Compete for deposits with money market mutual funds • Are federally insured • Can use check-writing privileges or ATMs to access account • Minimum balance of $1,000 or more usually required • Pay highest interest rate of any bank account on which checks can be written
Money Market Mutual Funds • Offered by investment (mutual fund) companies • Not federally insured; trade on open market • Interest bearing; limited checks
Asset Management Accounts • Combines checking, investing, & borrowing activities • Primarily offered by brokerage firms; consolidate financial activities • Not covered by deposit insurance; Insured by SIPC (Securities Investor Protection Corporation) • Interest bearing; check writing privileges • Automatically “sweep” excess balances into a higher-return MMMF daily or weekly
Savings Accounts= Time Deposits • 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.
Other Money Management Services • Electronic Banking Services Electronic 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
Electronic Funds Transfer Act of 1978: • Regulates EFTS Services. • States that errors must be reported within 60 days. • Notification within 2 business days limits loss to $50. • Limit your losses by immediately reporting theft, loss, or unauthorized use of your card or account!
Safe Deposit Boxes—rented drawer in bank’s vault; you receive one key and bank retains the other. • Trust Services—provide investment and estate planning advice and management for trust accounts. Other Bank Services:
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.
Special Types of Checks: • Cashier’s—drawn on the bank. • Traveler’s—used for making purchases worldwide. • Certified—drawn on your account but guaranteed by the bank. When personal checks are not accepted, special checks can be used to guarantee payment.
Establishing A Savings Program • PAY YOURSELF FIRST: On payday, write yourself a check and deposit it into a savings account, or transfer a set amount to savings through your debit card. • Establish an emergency fund. • Dave Ramsey • Regularly set aside funds for financial goals. • Utilize direct deposits and automatic transfers. • Choose instruments best suited to your goals and time horizon.
Earning Interest on Your Money Interest 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.
How is the interest calculated? • Simple Interest—interest paid only on initial amount of deposit. • Compound Interest—interest paid at set intervals and added back to principal.
Effective rate—the annual rate of return actually earned. 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 =Annual amount of interest earned Amount of money invested Example: Invest $1000 at 5% for 1 year.
If simple interestis used, there is no compounding: • Interest = Principal x rate x time • = $1000 x .05 x 1 • = $50
If compound interestis 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
The nominal rate is 5% which is the stated rate of interest. • The effective rate is 5.063%. Effective Rate = $50.63 $1000 = 0.05063 = 5.063%
How much interest will you earn? Amount of interest earned depends on: • Frequency of compounding • Balance on which interest is paid • Interest rate applied Time value of money concepts are used in compounding to find interest earned.
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.
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). • Series EE Bonds (Savings Bonds)