pfl - secondary saveing and investing

8/6/2019 PFL - Secondary Saveing and Investing

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Saving & Investing

Dr. Katie Sauer

Metropolitan State College of Denver

([email protected])

Presented at

Junior Achievements Elementary School Personal Financial Literacy Workshop

in collaboration with

the Colorado Council for Economic Education


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Session Overview

I. Basic TerminologyII. Saving

III. Turning Savings into Investment

IV. Time Value of Money

V. Managing Risk

VI. The Big Picture


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I. Basic Terminology

savings = income taxes spending on goods and services

investment = something acquired for future income or benefit

- investments can generate income(e.g. interest, dividends)

- investments can appreciate in value

(e.g. house, gold)


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By itself, savings is just what is left over from your income

after taxes and your spending.

When you take your savings and put it in an account that earns

interest or buy a stock or a house, you are investing.


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II. Saving

Why do people save?

According to the Federal Reserves triennial Survey of Consumer

Finances:

http://www.federalreserve.gov/pubs/bulletin/2009/pdf/scf09.pdf


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How much do people save?

Thesavings rate is the percent of after-tax income that is saved.

The Bureau of Economic Analysis (www.bea.gov) has been

tracking US household saving rates since 1959.

Year Average Savings Rate

1960s 8.21%

1970s 9.6%

1980s 8.61%

1990s 5.5%2000- Oct 2008 2.82%

Since Oct 2008 5.77%

http://research.stlouisfed.org/fred2/data/PSAVERT.txt


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The saving rate has been trending down since the early 1980s.

In recessions, people tend to save more.


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How much do people want to have saved

for emergencies and unexpected situations?


As income rises, so does the amount that households want to

have saved.

As income rises, the percent of income that households need to

save to meet their goal tends to fall.


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A household with income of $15,000, wanting to save $2,000 will

have to save what percent of their income?

percent of income saved = $2,000 x 100

$15,000

percent of income saved = 13.3%


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A household with income of $250,000 wanting to save $20,000

will have to save what percent of their income?

percent of income saved = $20,000 x 100$250,000

percent of income saved = 8%


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Not all households have a saving account.



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Common Types of Savings Accounts

Regular Savings account

Can be readily accessed

Easy to transfer funds

Money market accountOften a minimum balance

Some allow checking

Certificate of deposit (CD)

Specific term

- all earn interest

- all are FDIC insured to $250,000


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III. Turning Savings into Investment

The Financial System is the group of institutions in an economy

that help to match savers with borrowers

The US economy has two basic types of financial institutions:

- financial markets

- financial intermediaries


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A.Financial Intermediaries are institutions where funds are

transferred indirectly from savers to investors.

Examples:

1. Banks accept savings deposits and make loans.

- pay interest to depositors, charge interest to borrowers

2. Mutual Funds are institutions that sell shares to the public and

use the proceeds to buy a portfolio of stocks and bonds.

- allows individuals with a small amount of money to

diversify


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B.Financial Markets are institutions where funds are transferred

directly from savers to investors.

Examples:

1.Bond Market

A bond is a certificate ofindebtedness.

IOU

When a firm or government issues a bond, they are borrowing

money from anyone who buys the bond.

They are promising to pay you back a certain value in the future.

A bond has a date of maturity and a rate of interest associated

with it.


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Suppose you buy a $1,000 bond that matures in 5 years and pays

6% interest.

- Today, you give up $1,000 and receive the bond.

- You will receive periodic interest payments of 6% for

the next 5 years.

1,000 x 0.06 = $60

- At the end of the 5 years, you receive $1,000.


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Bonds can be sold at par value (face value) or at a discount or at a

premium.

Characteristics that determine a bonds value:

term: length of time until the bond matures- longer maturity time riskier

credit risk: the probability that the borrower will fail to pay the

interest or the principal

tax treatment: some bonds have interest that is tax free


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Issue price: $18.75

Maturity date: May 2008

Interest over 30 years: $87.92

Final value: $106.67 Treasurydirect.gov

US Government Bond:


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2. Stock Market

A stock is a claim of partial ownership of a firm.

- shareholder

If you buy a stock, you are not guaranteed to get your money back.

The price of a stock generally reflects the perception of a firms

future profitability.


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What determines the price of a stock?

a. Fundamental analysis is the study of a companys accounting

statements and future prospects.

It includes doing an economic analysis, industry analysis, and

company analysis.

- P/E ratio (stock price / net income per share)

- competitors

- the market for its product

- management- credit risk


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b. The Efficient Markets Hypothesis is the theory that asset prices

reflect all publicly available information about the value of theasset.

- each company listed on a stock exchange is followed

closely by many many people

- equilibrium of supply and demand sets the price

According to this theory, at the market price, the number of people

wanting to sell exactly equals the number wanting to buy.

Remember, any stock that you think is hot and about to increase

in value, someone else thought it was not hot and was willing to

sell it.


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c. Market Irrationality

Stock prices sometimes seem to be driven by psychological

reasons.

Herd Mentality is the tendency for individuals to copy the

actions of a larger group, even though without the group theperson may not choose to take the action on their own.

- when the stock market is booming and everyone is

investing, a person might decide it is a great time to buy

some stocks, too


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Reading a stock page:

52W high / low: highest/lowest prices paid in past year

Stock: company name

Ticker (symb): stock symbolDiv: the dividend paid annually for each share owned

%: annual dividend divided by the current stock price

P/E: price of a share divided by last years earnings per share

Vol 00s: how many shares were traded yesterday add two zeros

High/Low: highest and lowest price paid yesterdayClose (last): last price paid yesterday at market close

Net chg (chg): difference between price of most recent trade and

close yesterday


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2 biggest stock exchanges in the world:

New York Stock ExchangeNASDAQ

Stock market indexes:

Dow Jones Industrial Average = price-weighted average of 30 large

companies

S&P 500 = index of 500 large-cap companies

cap stands for market capitalization which is the equityvalue of the company

- large-cap means $10billion = $100billion


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NASDAQ Composite = index of all stocks traded on theNASDAQ stock exchange

Russell 1000 = index of the highest 1,000 stocks in the Russell

3000 Index

Russell 2000 = small-cap index of the bottom 2,000 stocks in the

Russell 3000 Index

Russell 3000 = index of 3,000 publicly traded companies


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C. The Value of Household Assets


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Where do people get their information on investing?



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IV. The Time Value of Money

Intuitively we understand that an amount of money today is more

valuable than the same amount of money in the future.

- inflation

- earn interest


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Future Value is the amount of money that can result from an amount

of money we have today.

Future Value = Present Value x (1 + r )

Ex: $18,000 wedding, 4% interest, 40 years

Future Value = 18,000 x (1.04)

Future Value = $86,418

Ex: $18,000 wedding, 6% interest, 40 years

Future Value = 18,000 x (1.06)

Future Value = $185,142

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40

40


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Suppose you spend $1000 to go to a relaxing all-inclusive resort

in Mexico for spring break.

If you had invested the $1,000 at 5% interest, how much money

would you have had in 10 years?

Future Value = 1000 x (1.05)

Future Value = $1628.89

If you invested it for 20 years, how much would you have?

Future Value = 1000 x (1.05)

Future Value = $2653.30

10

20


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The higher the interest rate, the higher the future value of your

money saved today.

The longer the time frame, the higher the future value of your

money saved today.


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Present Value is the amount of money one would need today to

produce a given amount of money in the future.

Present Value = Future Value / (1 + r )

Ex. you want to have $1,000,000 in 25 years and the interest rate is5%

Present Value = 1,000,000 / (1.05)

Present Value = $295,303

If you put $295,303 in an account earning 5% interest, youd have

$1million in 25 years.

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Suppose instead you want the $1,000,000 in 40 years.

Present Value = 1,000,000 / (1.05)

Present Value = $142,045.68

40


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Suppose when your child begins his/her college education, you

promise to give you son/daughter $1000 cash if they graduate in 4

years. If your savings account earns 8% interest, how muchmoney would you need to put in today to have $1000 in 4 years?

Present Value = 1000 / (1.08)

Present Value = $735.03

Suppose instead your account earns 2% interest.

Present Value = 1000 / (1.02)

Present Value = $923.85

4

4


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The higher the interest rate, the smaller the amount of money

needed in the present to obtain a particular future amount.

The longer the time frame, the smaller the amount of moneyneeded in the present to obtain a particular future amount.


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V. Managing Risk

Risk Aversion is a dislike of uncertainty.

Practical advice for risk-averse people:dont put all your eggs in one basket

Diversify!


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Firm-specific riskonly affects a single company.

ex: a software firm that goes bankrupt because they sold

a low quality product that no one bought

Market riskis the risk associated with the entire economy.ex: in a recession, even good firms face hard times and

may have financial troubles

You can avoid firm-specific risk by diversifying but you cantavoid market risk.


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To some degree, you can avoid some of the market risk associated

with a particular nations economy.

ex: buy assets in nations outside the US

However, as nations become more and more engaged in the global

economy, there is a global market risk that is unavoidable.


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Keep in mind, there is always a tradeoff between risk and reward.- savings account is safe, but pays lower interest

- stocks are riskier, but pay a higher return

- US bonds are safer, 4% interest

- in spring 2010 Greek bonds were much riskier, 11% interest

If you ever hear of an investment that pays a high rate of return, you

should assume that it is risky and not a sure thing.


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Risk tolerance changes with age.

When a person is early in their working years, investing in

relatively riskier assets is okay.

- can ride out the ups and downs of the stock market

can have big payoffs and can recover from any losses

When a person is getting closer to retirement, investing in safer

assets is wise.

- if the stock market has a downturn in the few years

before retirement little time to make up that loss


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savings

business investment

physical capital

capital per worker

productivity

standard of living

Besides being

beneficial for

households,

savings is alsoimportant for the

economy as a

whole:

VI. The Big Picture

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