Unit 3 – Inves ting ○ S aving vs . Inves ting ○ Time Value of Money ○ Inves tment Options ○ Ris k and Reward of Inves ting
“ What Do You Think? ” True or Fals e Adam started saving $50/month when he turned 18, while Beth started saving $100/month when she turned 24. They both earn 6% on their money. Beth will have more money by the time they both turn 30. False A dollar today is worth less than a dollar in the future. False The higher the interest rate, the less time it takes to reach a savings goal. True The smaller the down payment someone makes on a car, the less interest the owner pays for a car loan. False
S aving vs . Inves ting Why it’s important to save and invest your money? What is the difference between saving and investing? Investing: You will be less tempted to spend your money. Your money will make money for you (interest).
S aving vs . Inves ting Last unit we talked about “PYF” (Paying Yourself First), but what do you do with that money? Invest it so that it makes you more money!
S aving vs . Inves ting Saving – what people do to meet short- term goals. Safe Earns a small amount of interest Easy to access Investing – setting money aside for long- term goals. Might not grow because they rise and fall in value over time. In the long run they earn a lot more than savings accounts.
Ways to S ave and Inves t Brainstorm at least 3 ways that you know people save money to use later. Example: stash money in a dresser drawer Brainstorm at least 3 ways people invest money for future income and profit. Example: buy shares of stock
The A dvantage of S tarting E arly The Impact of Time on the Value of Money Did You Know? Figure 3-1
Time Value of Money A dollar is not always worth a dollar. Sometimes it’s worth more, sometimes less. The value of a dollar changes dramatically depending on when you get it and what you do with it. Relationship among time, money, and rate of interest.
Time Value of Money Say you have $100 today. If you keep it in your dresser drawer for a year, you will still have $100 in a year. In a year, $100 may buy less than it does now because of Inflation. A rise in the cost of goods and services over time. Inflation decreases the spending power of each dollar you have. Think back to what a candy bar cost when you were in elementary school. Ask your parents how much gas cost when they started driving!
Time Value of Money Now, say you put that $100 into a savings account that pays 3% interest a year. A year later you will have $103 because of earned interest. Earned interest is the payment you receive for allowing a financial institute or corporation use your money.Interest = Principal ($) x Interest Rate x Time ? = $100 x 3% (0.3) x 1 yr
Time Value of Money The more money you have to save or invest, the more money you are likely to earn. The higher the rate of interest you earn, the more money you are likely to have. The sooner you invest your money, the more time it has to make new money, making it likely that you could earn much more as a result.
The Power of C ompounding Time value of money works because of compounding. Compound interest earns you interest on your interest A = P (1 + i) ^ n A is the amount in the account P is the principal ($ invested) i is expressed as a decimal n is the number of years compounded
The Power of C ompounding Assume you have $10 to invest. Using the two interest rates below, 4% and 8%, determine the compound value of your $10 for each of the time periods listed. $11.70 $12.66 $10.80 $11.66 $13.60 $15.87 A = P (1 + i) ^ n
The Price of Procras tination The more time you have to invest, the more money you are likely to end up having. By waiting to invest, you’re paying an opportunity cost. How much less money would you have if you waited 10 years to invest $100 per month at 8%, versus starting to do it right now? A = P (1+i) ^ n A = $100 (1+.08)^10 = $215.89 vs. $0 While saving for your goals involves delayed gratification, procrastinating in saving for your goals is really delayed gratification.
The Rule of 72:Double Your Money You can see how long it will take to double your money by dividing 72 by the interest rate. Your grandparents give you $200 for your birthday and you want to use it to start saving for your own car. If you put the money into an account that earns 6% interest a year, how long will it take to grow $400? 72 / 6 = 12 So, in 12 years your money will have doubled to $400.
The Rule of 72:Double Your Money What if your dad tells you about an account where you could earn 9% a year on your money? 72 / 9 = 8 What if 8 years is too long to wait and you want that $400 in four years instead? 72 / 4 = .18 With only 4 years to invest, your money will double if you can find an investment that earns 18%.
The Impac t of Higher Returns What interest rate would be necessary to double a $100 investment in 24 years? 72 / 24 = 3% How many years would it take to double $100 if it earned interest at a rate of 8% per year? 72 / 8 = 12.5 years What interest rate would be necessary to double a $100 investment in 11 years? 72 / 11 = 6.55% How many years would it take to double $100 if it earned 7.75% interest per year? 72 / 7.75 = 9 years
Ris ky B us ines s Risk is the uncertainty that the anticipated return will be achieved. All investments involve some degree of risk. Reward is your return on investment. The risk/reward trade-off is the principle that an investment must offer higher potential returns to compensate for the increased potential unpredictability. The greater the risk you take with your money, the higher the potential returns on your investments. The lower the amount of risk you take, the lower the potential returns will likely be.
Financial Planning Pyramid
Ris ky B us ines s Return can be made up of income such as interest or dividends (a share of the profits you receive as a stockholder) and capital gains (growth stock prices). The rate of return (rate of interest) determines how fast your money is growing. If you bought Stock Z for $10 per share in 2000, then sold it for $25 per share in 2005, your profit or capital gain is $15 per share. If you bought Stock Z for $25 per share in 2005, then sold it for $15 per share in 2009, your capital loss is $10 per share.
Income vs . GrowthInves tments Income means you get paid, in cash, for owning the account or investment. Set aside money for a few months or a few years - less risky than growth investments – value tends to fluctuate less, providing steadier returns over time.
Income Inves tments
Income Inves tments
Income vs . GrowthInves tments Income means you get paid, in cash, for owning the account or investment. Set aside money for a few months or a few years - less risky than growth investments – value tends to fluctuate less, providing steadier returns over time. Growth means they buy and hold an investment with the hope that it will increase in price, over time. Longer periods of time, several years or even decades - earn higher returns than income investments – fluctuates more, higher long-term returns.
Growth Inves tments
Growth Inves tments
Divers ification:S pread Your Money A round Reduce investment risk by putting money in several different types of investments. By spreading your money around, you’re reducing the impact that a drop in any one investment’s value can have on your overall investment portfolio.
Divers ification You get $100 and decide to put $50 into both a money market account and a stock. Five years later, the stock company collapses from a scandal, and the stock you invested in is worthless. You’ve now lost $50, but you would have lost the entire $100 if you hadn’t split your investment between the money market account and the stock.
Dollar C os t A veraging The practice of investing a fixed amount in the same investment at regular intervals, regardless of what the market is doing. Eliminates worrying about investing at the “right” or “wrong” time. Evens out the ups and downs of the market. As the price of the investment rises, you simply end up purchasing fewer shares and when the price falls, you end up purchasing more.
Dollar C os t A veragingSay Eddie decides to invest $50 into ABC Mutual Fund every month. At the end of the year, Eddie would own 43.21 shares purchased at varying prices. More shares were purchased when the mutual fund share price was low. Fewer shares were bought when the share price was high. Since he got 43.21 shares for $600 during the year, he paid only $13.89 per share. If you look at the price per share he paid each month, the average monthly price was $14.20 a share. So, by using dollar cost averaging, Eddie received a discount of about 31 cents on every share he purchased. If Eddie had waited until December when he had all $600 saved and was ready to invest, he would have only been able to buy 36.47 shares at that price.
Vocabulary Saving Short-term goals, safe, earn small amount of interest, easy access to money Investing Longer-term goals, no guarantee money will grow, investments rise and fall in value over time, usually make more than savings account in long run Time Value of Money Relationship among time, money, and rate of interest Inflation A rise in the cost of goods and services over time Earned Interest Payment you receive for allowing a financial institution or corporation to use your money Compound Interest Earning interest on interest
Vocabulary Rule of 72 How long it’ll take to double your money (divide 72 by the interest rate) Stock Market Place where stocks are bought and sold Dividends A share of the profits you receive as a stockholder Capital Gains Investor buys a stock and sells it later at a higher price Capital Loss Investor ends up selling a stock at a lower price Rate of Return Annual percentage return on an investment Diversification Reducing investment risk by putting money in several different types of investments