Savings vs. Investing: Understanding the Differences and Benefits

1. Savings

2. Differences Between Saving and Investing Now that you know how important it is to pay yourself first you must decide what to do with that money.

3. Savings • what people usually do to meet short-term goals. • money is safe in a savings account. • usually earn a small amount of interest. • It’s also easy to get to (high liquidity).

4. How INVESTING is Different • Setting money aside for longer-term goals. • In the long run, investments can earn a lot more than you can usually make in a savings account. • There is some risk that you may lose money on an investment

5. Why It’s Important Savings/Investments are money put aside for future use. Savings plans will allow you to put money aside and help you make your money grow. The amount of money you save depends on how much of your income you’re willing not to spend. Opportunity cost of savings—when you save money, you are putting off spending money on something now to get something else later.

7. Reasons to Save • Major purchases • Emergencies • Retirement

8. Major Purchases If you purchase items on credit or borrow money to make purchases, you have to pay finance charges. If you use cash for the purchase, you don’t have to pay those charges.

9. Emergencies Experts recommend that you have at least 8 months of income set aside in case of an emergency. Worse yet, 28 percent of respondents had less than two weeks' worthof expenses in savings.

10. Retirement The three main sources of retirement income are: Social Security Retirement Plans Savings

11. Retirement For most people, social security and retirement plans still don’t provide enough money to retire comfortably. If you put away just $20 per week starting now, by the time you retire you would have $50,000. With interest earned on a savings account, it could come to several times more than that.

12. Advantages of Starting to Save Early!

13. Budget for Saving • Strategies for growing your savings: • Pay yourself first • Use direct deposit • Let your savings grow • Reduce spending; increase saving..

14. Maximizing Savings • Maximize your savings by considering • total amount deposited • interest rate • time span of deposit • interest type: simple interest or compound interest • frequency of compounding.. continued

15. Insurance Against Loss Banks, savings and loans, and credit unions all have insurance. The Federal Deposit Insurance Corporation (FDIC), a government agency, insures bank accounts for up to $250,000.

16. Evaluating Savings Plans When evaluating savings plans, consider these factors: • Risk • Liquidity • Rate of Return • Inflation • Restrictions and Fees

17. Risk Pyramid • Savings Accounts • Least risky, easy to get to • Money Market Accounts • Little Risk, but required to maintain high balances • Bonds/Cds • Little Risk from changing interest rates • Money is tied up for period of time

18. Liquidity Liquidity means the ability to quickly turn an investment into cash. • Savings accounts are highly liquid because you can easily withdraw cash from them. • Houses are NOT liquid because someone has to want to buy it to get a value from it

19. Rate of Return Rate of Return is the percentage increase in the value of your savings from earned interest.

20. Rate of Return • How much interest can you make on your investment? • Are you Locked into a rate? • Is it adjustable

21. The Time Value of Money A dollar is not always worth a dollar. The value of a dollar changes dramatically depending on when you get it and what you do with it. So time is a critical variable in the exact value of a dollar. Time value of money refers to the relationship among time, money, and rate of interest.

22. Inflation Risk Inflation risk is the risk that the rate of inflation will increase more than the rate of interest on savings. (Inflation is the rise in prices)

23. Inflation Risk • If you put all your money in the savings at 1% interest and the rate of inflation (rise in the cost of prices) is 3% you LOSE Money due to being able to buy less! • Your rate of savings MUST be higher than the inflation rate to make savings worthwhile. • If it is not, you may need to invest some of your savings

24. Inflation Risk • The interest rates on most savings accounts increase with inflation. • The main risk is with CDs, where you are locked into an interest rate over a long period of time. • If you need your money early you will have to pay a penalty fee.

25. Consider Inflation and Taxes • By reducing or deferring taxes on savings, you accumulate more money over time • Minimize taxes by putting money into tax-exempt or tax-deferred savings..

26. Cost of Savings Plans-fees Some accounts charge a penalty fee for early withdrawal or is the account balance falls below a certain minimum. Some accounts charge a fee for each deposit and withdrawal. You have to pay income tax on the interest you earn on savings accounts.

27. Three Elements of Time Value of Money • The more money you have to save or invest, the more money you are likely to earn. • The higher the rate of interest you earn, the more money you are likely to have. • The sooner you invest your money, the moretime it has to make new money.

28. Earning Interest on Savings • Interest Income- Payments you receive for letting the bank use your money. • Banks use the money in your savings account to lend to other people, so they pay you a rental fee, or interest.

29. Simple Interest Simple interest is interest earned only on the money you deposited into your savings account, or the principal.

30. Simple Interest The three main factors determining the amount of interest are: The amount of savings. The interest rate. Length of time of the account.

31. Simple Interest If you have a savings account that pays you 5 percent annual interest and $1,000 is the account the entire year, you will receive $50 in interest. $1,000 x .05 (5%) x 1 = $50 interest

32. Compound Interest Compound interest is interest earned on both the principal—the money you deposited in your savings account—and any interest you earned on it. You are earning interest on interest.

33. Compound Interest Compound interest is usually earned daily, monthly, quarterly, or annually. The more often interest is compounded, the more you make in extra interest.

34. Compound Interest $100 in savings that earns 10 percent a year $100 x 10% = $10 At the end of year 1, you will have $110. $100 + $10 = $110 At the end of year two you will have $121. $110 x 10% = $11 $110 + $11 = $121

35. Calculating Compound Interest

36. The Power of Compound Interest Compound interest makes your money grow faster when interest is left to accrue.

37. Rule of 72 • Use Rule of 72 to estimate the amount of time or interest needed to double savings • The Rule of 72 can also tell you the interest rate you need to earn to double your money in a certain amount of time by dividing 72 by the number of years. continued

38. Rule of 72 • To find the number of years to double savings, divide 72 by interest rate • How many years to double your money at an 8% interest rate • 72/8 = 9 years • To find the annual interest rate needed to double savings, divide 72 by number of years.. • What interest rate do I need to double money money in 10 years • 72/10 = 7.2 years continued

39. 72 Years Needed to Double Investment = Interest Rate Rule of 72 • You can see how long it will take to double your money by dividing 72 by the interest rate. • $200 will take 12 years to double to $400 at 6%. • 72/6% interest = 12 years

40. 72 = Interest Rate Required Years Needed to Double Investment Rule of 72 • To double your $200 to $400 in 4 years, you would need an 18% interest rate. • 72/4 years = 18% interest.

41. Rule of 72 Practice • You have $5,000 from savings bonds that just matured. You want to double that money in time to use it to purchase a house in 8 years. What rate of return would you need to do this? • You are getting 3% on a $1,000 CD. How long will it take to double your principle at this rate? • As part of your long term planning, you set aside $25,000 for your child’s college savings plan. Your child will be going to college in approximately 15 years. What rate of return would you need to double that investment in 15 years? • You have $725 in your savings account and you are getting 0.5% interest. How long will it take to double your savings?

42. Savings Choices • The Truth in Savings Act • requires financial institutions to provide information about costs and interest-earning accounts in uniform terms • helps consumers compare savings products and make informed decisions.. continued

43. Savings Choices • Info financial institutions must provide: • minimum required to open an account • interest rate • annual percentage yield (APY) and effective period • minimum deposit, time requirements, other terms of APY • description of fees, conditions, and penalties.. continued

44. Types of Savings Plans The basic types of savings accounts are: Traditional Certificates of Deposit Money Market Deposit Accounts U.S. Savings Bonds

46. Savings Accounts • Traditional savings accounts • pay interest • allow you to make deposits and withdrawals • usually offer lowest interest earnings, but most liquidity.. continued

47. Traditional Savings Account Advantages: Low risk—safety guaranteed by the federal government. High level of liquidity.

48. Traditional Savings Account Disadvantages: Interest rates are usually quite low. Many banks charge a service fee if the savings account falls below a certain minimum balance.

49. Savings Accounts • Special purpose accounts • encourage consumers to set aside money in separate accounts for specific purposes: holiday gifts, college tuition • Interest may be tax free or tax-deferred, allowing savings to accumulate faster..

50. Online-Only Savings Accounts • Offered by Internet banks • Customers access bank’s Web site to check balances and make electronic deposits, withdrawals, fund transfers • Pay higher interest rates due to lower overhead costs.. continued