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Basics of Saving and Investing: How They Relate

Learn the connection between saving and investing and how they can help you achieve your financial goals. Discover the importance of having a reserve fund, setting personal goals, preparing for retirement, and managing risk.

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Basics of Saving and Investing: How They Relate

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  1. Chapter 10 Basics of Saving and Investing

  2. How Are Saving and Investing Related? • Savings is money set aside for the future. • Investing is a strategy to earn more on your money than the rate of inflation. • Wealth is the accumulation of assets over time. 10-1 Reasons for Saving and Investing Slide 2

  3. How Are Saving and Investing Related? • When you set money aside, you have a reserve or emergency fund that you can count on • Emergency Fund: amount of money set aside for unexplained expenses. • Liquidity: a measure of how quickly an asset can be turned into cash. • It is important to have some liquid assets, such as a savings account, that are available to cover unexpected needs. 10-1 Reasons for Saving and Investing Slide 3

  4. How Do Saving and Investing Meet Personal Goals? • Short-Term Goals • Contingency planning • Contingencies: unplanned or possible events. • Vacation planning • Used to engage in enjoyable activities 10-1 Reasons for Saving and Investing Slide 4

  5. How Do Saving and Investing Meet Personal Goals? • Medium-Term Goals: 2 to 5 years • Buying a car • Paying for college • Planning a wedding • Long-Term Goals • Providing for a family • Cost to raise a child from birth to 17 is between $207,000 to $475,000. • Buying a house • Financial Security • The ability to meet current and future needs while living comfortably. 10-1 Reasons for Saving and Investing Slide 5

  6. How Does Investing Prepare You for Retirement and Beyond? • Retirement is the period of time when you are not working but are able to meet expenses. • Should begin at a young age • Sources of income include: • Retirement plans • Social security • Savings • Investments 10-1 Reasons for Saving and Investing Slide 6

  7. Estate Planning • Estate: all the a person owns (assets), less debt owed, at the time of the persons death. • Estate planning is the process of preparing a plan fro transferring property during one’s lifetime and at one’s death. • A person may request that their money go towards a foundation. • A foundation is a fund or organization establishes and maintained for the purpose of supporting an institution or cause.

  8. Investment Growth Over Time 10-1 Reasons for Saving and Investing Slide 8

  9. Success Skills • Having a Will and Health Care Directive • A will is a document that passes title of property after a person dies. • A simple will describes your wishes for distribution of property. • A trust will leaves your estate in trusts to benefit your children and other heirs. • A health care directive is also a “living will.” • It describes your wishes at the end of life. 10-1 Reasons for Saving and Investing Slide 9

  10. How Is Risk Related to Return? • The higher the risk, the greater your possible return. • Risk-free investments are guaranteed by the government—U.S. savings bonds, Treasury bills. 10-2 Principles of Saving and Investing Slide 10

  11. How Is Risk Related to Return? • Ideal Investments will have the features: • The principal is safe (no risk) • The rate of return (earnings) is high • The investment is liquid (you can get your money quickly without a penalty) • You can invest quickly and easily • The costs of investing are low, both in terms of the amount invested as well as investment fees • The earnings and long-term gains from the investment are tax-free or tax-deferred. 10-2 Principles of Saving and Investing Slide 11

  12. Growth of Principal • Money set aside for savings should be growing. • If it is not growing you are losing money and buying power • The principal, base amount on which interest is computed, should get larger over time. • Principal grows through compounding of interest. • Example: Principal gains interest and is added to the principal amount, which becomes the next principle amount. This cycle continues and investment grows. 10-2 Principles of Saving and Investing Slide 12

  13. How Is Risk Related to Return? • Return on Investment (ROI) is the amount that savings or investments grow expressed as a percentage. 10-2 Principles of Saving and Investing Slide 13

  14. Return on Investment 10-2 Principles of Saving and Investing Slide 14

  15. What Types of Risk Do Investors Face? Investment risk is the potential for change in the value of an investment. 10-2 Principles of Saving and Investing Slide 15 Inflation risk Industry risk Political risk Stock risk

  16. What Types of Risk Do Investors Face? 10-2 Principles of Saving and Investing Slide 16 • Inflation risk: the chance that the rate of inflation will be higher than your investment rate of return. • i.e. your investment loses value • Assume you buy a bond, a debt instrument issues by a corporation or government. This bond has a 5% fixed rate interest. If inflation is lower than 5% than your investment is holding its value. If inflation rises to 7% or 8% your investment is losing value.

  17. What Types of Risk Do Investors Face? 10-2 Principles of Saving and Investing Slide 17 • Industry risk: the chance that factors affecting an industry as a whole will negatively affect the value of an investment. • Example: you invest in oil company and profits and oil prices rise. Your investment will gain value. • Political risk: the chance that a political event ( such as a new law or policy, a war, or an election) will affect the value of an investment. • When a new president is elected, stock markets usually go up.

  18. What Types of Risk Do Investors Face? 10-2 Principles of Saving and Investing Slide 18 • Most people invest by buying stock, which is ownership interest in a publicly held company • Stock Risk: the chance that activities or events that affect a company will change the value of an investment in the company. • Ex: poor management or product recalls

  19. Investment Risk vs. Gambling • When gambling the chance of winning are less than 50 percent • Some gambling odds are so low than you will lose 90% of the time. • Gambling in most cases should be considered entertainment and not an investment

  20. What Are Tax Advantages of Investing? • Tax deferral is a postponement of taxes to be paid. • Taxes on gains are not paid until the money is withdrawn. • Tax exemption means savings and investments are not taxed. • Example: US Series EE and Series I savings bonds are tax-free if used for education. 10-2 Principles of Saving and Investing Slide 20

  21. Taxable Corporate bond at 7% The investor pays federal tax at a rate of 35% The invest keeps 65% (100-35) of the interest earned. The rest is paid in tax 0.07 X 0.65 = 4.55% earnings after taxes Tax Free Government bond at 5% interest The investor keeps all the interest earned at 5% Investment Comparison

  22. Employer-Sponsored Plans • Plans in which employer sets aside money on employees behalf • For example, a employer-sponsored retirement plan offers to match 10% of employees contributions. If the employee contributes $100 to their 401k then the employer would put in $10. This is an automatic 10% return on investment that is not taxed until retirement.

  23. What Are Systematic Saving and Investing Strategies? • Systematic saving involves regularly setting aside cash to achieve goals. • Systematic investing is a planned approach to making investments on a regular basis. 10-3 Strategies for Saving and Investing Slide 23

  24. What Are Systematic Saving and Investing Strategies? • Investment tracking is a technique for making investment choices by following the prices of stocks and investments over time. • Tracking stock helps determine if this is the right investment for your portfolio 10-3 Strategies for Saving and Investing Slide 24

  25. What Are Systematic Saving and Investing Strategies? • Market timing involves buying and selling stocks based on what the market is expected to do. • Requires a good understanding of the economy and financial market conditions. • Having good timing is critical to building a portfolio and earning returns. • Dollar cost averaging: a person invests the same amount of money on a regular basis, such as monthly, regardless of market conditions. 10-3 Strategies for Saving and Investing Slide 25

  26. Focus On . . . Dollar-Cost Averaging The systematic purchase of an equal dollar amount of the same stock at regular intervals 10-3 Strategies for Saving and Investing Slide 26

  27. Stock Trend Line Investment tracking involves making investment choices by following stock prices over time. 10-3 Strategies for Saving and Investing Slide 27

  28. Reducing Investment Risk • Diversification: holding a variety of investments for the purpose of reducing overall risks. • One type of stock may go down while others go up. The overall loss is reduced. • Investment Portfolio: a collection of assets that provides diversification for an investor. • Example: bonds, stocks, real estate, cd’s, etc. • Should have relatively safe low risk investments. These include conservative mutual funds which is a professionally managed group of stocks, bonds, and other investments. • Some people have speculative investments, which have high earning potential but carry a high risk.

  29. How Can You Reduce Investment Risk? 10-3 Strategies for Saving and Investing Slide 29

  30. Markets • The financial market refers to any place where investments are bought and sold. • Ex: stock markets and bond markets • The term market is also used to refer to price levels or other market conditions • Ex: “The market was off today” refers to the price levels being low for that day.

  31. How Can You Maximize Investment Return? • A bull market exists when stock prices are steadily increasing. • A bear market exists when prices are steadily decreasing. • Economic conditions (growth or decline) can affect investment strategies. 10-3 Strategies for Saving and Investing Slide 31

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