Chapter Objectives • Define personal savings goals. • Calculate compound interest. • Use the Rule of 72 to determine savings outcomes. • Compare different types of savings products.
Creating a Savings Plan • Saving is setting money aside for future use • A savings plan is • a vital part of an overall financial plan • a strategy for using money to reach important goals and advance your financial security
Budget for Saving • Strategies for growing your savings: • Pay yourself first • Use direct deposit • Let your savings grow • Reduce spending; increase saving
Create an Emergency Fund • Build an emergency fund, covering 6–8 months of living expenses, to be used in case of job layoff or illness
Set Goals for Saving • Clearly defined goals make saving easier • Make a list of what you want to achieve with your money (savings goals) • Goals should be • realistic • specific and measurable • time related
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
Calculating Compound Interest 1. Multiply the deposit amount by the annual interest rate 2. Divide Step 1 answer by rate of compounding 3. Add Step 2 answer to deposit amount to get new balance with interest continued
Future Value Tables • Provides an easy way to calculate compound interest earnings at different interest rates and times • Find the future value of a single $100 deposit after 5 years at a 6% interest rate continued
Future Value Tables continued
Future Value Tables • Look along the “5 years” row to the number in the “6%” column • Multiply 1.3382 by $100 • The $100 deposit would be worth $133.82
Rule of 72 • Use Rule of 72 to estimate the amount of time or interest needed to double savings • To find the number of years to double savings, divide 72 by interest rate • To find the annual interest rate needed to double savings, divide 72 by number of years continued
Rule of 72 • How long will it take $1000 deposited at a 4% interest rate to double in value? • Find the annual interest rate you need to double your savings if your savings was in an account for 20 years continued
Rule of 72 • 72 divided by 4 is 18; in 18 years your $1,000 will be worth approximately $2,000 • 72 divided by 20 is 3.6; your savings must be in an account paying 3.6% for it to double in 20 years
Consider Inflation and Taxes • Inflation and taxes reduce the value of savings • Due to inflation, • goods and services bought with future savings will cost more than they do today • you need a savings plan that pays an interest rate higher than today’s rate of inflation continued
Consider Inflation and Taxes • Your earnings and the interest earned on your savings are taxed continued
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
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
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
In Your Opinion • Why do you think the Truth in Savings Act was necessary?
Savings Choices • Check that the savings product you choose is insured by either • Federal Deposit Insurance Corporation (FDIC) • National Credit Union Administration (NCUA) • Liquidity is the ease with which an asset can be converted into cash without losing value
Savings Accounts • Regular savings accounts • pay interest • allow you to make deposits and withdrawals • usually offer lowest interest earnings, but most liquidity continued
Savings Accounts • Passbook savings—deposits and withdrawals are recorded in a book • Statement savings—you receive regular statements of account activity; may include a debit/ATM card and online banking continued
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
Money Market Deposit Accounts • Pay higher interest rates than savings accounts • Are liquid • Require higher minimum balances than savings accounts • Offer limited check-writing and money-transfer privileges
In Your Opinion • What has your experience been with savings accounts? What would you do differently if you could?
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
Online-Only Savings Accounts • Disadvantages: • Can have a time lag for deposits and withdrawals to clear • Can have technical difficulties, making funds and account info temporarily inaccessible • May have a different person available each time you call
Certificate of Deposit • A certificate of deposit (CD) • pays interest rates higher than other savings • earns more interest the longer you agree to hold a CD • is not liquid: early withdrawal penalties
U.S. Savings Bonds • Buyers of U.S. savings bonds loan money to the government • On a specified date, the government repays the loan with interest continued
U.S. Savings Bonds • I Bonds pay a fixed interest rate determined by the Secretary of Treasury (plus a semiannual inflation add-on rate) • EE Bonds earn fixed interest rates based on market yields of Treasury Notes • Tax benefits if used to finance education; can also defer income tax on interest earnings
Central Ideas of the Chapter • A savings plan is an essential piece of an overall financial program. • Compound interest helps your savings grow over time.
Glossary of Key Terms Back • annual percentage yield (APY). The rate of yearly earnings from an account, including compound interest. • certificate of deposit (CD). Money deposited for a set period of time that earns a set annual rate of interest. • compound interest. Interest figured on money deposited plus interest.
Glossary of Key Terms Back • Rule of 72. A method used to estimate the amount of time or interest it will take for savings to double in value. • simple interest. Interest computed only on the principal. • tax deferred. Savings or earnings that are not taxed until the funds are withdrawn.
Glossary of Key Terms Back • tax exempt. Earnings that are free of certain taxes. • U.S. savings bond. A savings tool that loans money to the U.S. government for a specified period of time. The bondholder is repaid with interest at the time of maturity.