Download 11-1 Low-Risk Choices - St. Pius X High School

Chapter 11
Saving and Investing Options
What Are Low-Risk Savings
Options?
• Liquid savings include
cash or investments
that can be changed
into cash quickly.
• Savings and checking
accounts are liquid.
• Illiquid investments cannot be
converted to cash quickly or without a
penalty.
11-1 Low-Risk Choices
Slide 2
What Are Low-Risk Savings
Options?
•
•
Savings accounts
• Usually at a bank, credit union, or other insured
financial institution.
• Good for meeting short term need because
money can be drawn at any time without penalty.
Money market accounts
o Two types: deposit account or fund
o A deposit account is similar to a savings account,
but it offers a higher rate of interest in exchange
for larger than normal deposits
o A minimum balance, such as 1,000 or 5,000, is
often required to maintain a money market
account.
11-1 Low-Risk Choices
Slide 3
What Are Low-Risk Savings
Options?
•
Money market accounts
• A money market fund is a type of mutual fund
the invests in low risk securities (such as US
Treasury bills).
• On average, money market funds pay a
higher rate than deposit accounts
• Why invest in a checking or savings account
when money market accounts pay higher
interest?
• Money market accounts are usually limited
in the number of withdrawals each month.
• They also required higher balances
11-1 Low-Risk Choices
Slide 4
What Are Low-Risk Savings
Options?
•
Certificates of deposit
• Money set aside for specific length of time at
a fixed interest rate
• Pays higher interest than a money market or
savings account.
• Not a liquid investment, Why?
• You must pay a heavy penalty if you
withdraw the money before the stated time.
• They are safe because they are insured by
the FDIC
• The biggest risk is inflation risk.
• Inflation may be higher than the return thus
causing you money to lose value.
11-1 Low-Risk Choices
Slide 5
What Are Low-Risk Savings
Options?
• Certificates of deposit
• Early withdrawal penalty: fee imposed
to discourage depositors from
withdrawing the money before the
stated time period.
• The penalty may be 6 months interest
or more.
• CD’s pay higher interest when money
is set aside for a long period of time
11-1 Low-Risk Choices
Slide 6
Early Withdrawal Penalty
Early Withdrawal Penalty
Certificate of Deposit
Amount deposited: $5,000
Interest rate: 5% yearly
Term: 5 years
Penalty for Early Withdrawal
If the money is withdrawn before 5 years, the penalty imposed will equal 365
days’ interest, whether earned or not.
Sample Scenario
The money is withdrawn after 180 days.
$5,000 x 0.05 x 180/365 = $123.29 interest earned
$5,00 x 0.05 x 365/365 = $250.00 penalty
$5,000.00
+ 123.29
$5,123.29
- 250.00
$4,873.29
amount deposited
interest earned
early withdrawal penalty
amount received at early withdrawal
11-1 Low-Risk Choices
Slide 7
What Are Low-Risk Savings
Options?
• Life insurance savings plans
o Borrow against the policy’s cash value
o If this benefit is not repaid, the life
insurance death benefit is reduced by
the amount of the loan.
o These are illiquid
• Brokerage accounts
o An account at an investment company
11-1 Low-Risk Choices
Slide 8
What Are Low-Risk Savings
Options?
•
Brokerage accounts
o An account at an investment company
o This account may pay interest like a savings
account or it may be a clearing account.
o A clearing account is used to buy and sell
investments.
o Money is taken from the account to buy
them and put back in the account when
they are sold
o These account earn low interest rates.
o Brokerage accounts are not insured however
they are considered low risk when placed with
a reputable investment company.
11-1 Low-Risk Choices
Slide 9
What Are Low-Risk Investing
Options?
Bonds
•
•
•
•
•
A bond is a loan that a buyer makes to a bond
issuer.
Government and corporations issue bonds.
The face value is the amount the bondholder
will be repaid on the maturity date.
The maturity date is the date the borrowed
money must be repaid.
Bonds can be purchased at a discount or
premium.
11-1 Low-Risk Choices
Slide 10
What Are Low-Risk Investing
Options?
Bonds
•
•
•
A discount bond is one that is sold for less than its face value
– For example, a bond that is 5,000 and you pay 4,900, the
discount is $100.
Bonds are sold at a discount to increase the overall profit of
the bond and attract more investors.
A premium bond is one that is sold for more than its face
value
– Bonds are very attractive to investors because they are
safer than other choice and pay a good interest rate.
– These may sell at a premium.
11-1 Low-Risk Choices
Slide 11
Return on a Corporate Bond
Corporate Bond
Face value: $5,000
Discount rate: 4%
Coupon rate: 4% yearly (paid semiannually)
Term: 2 years
Purchase price:
$5,000 × 0.04 = $200 discount amount
$5,000  $200 = $4,800 discounted purchase price
Semiannual interest:
$5,000 × 0.04 = $200 interest per year ($100 semiannual payment)
$200 × 2 years = $400 total interest received
Return on investment:
At the end of the second year, the bond is redeemed for $5,000 (face value).
$ 5,400 total amount received ($5,000 face value + $400 interest)
 4,800 amount invested
$ 600 total profit in dollars
$600 ÷ $4,800 = 0.125 = 12.5% total return on investment
11-1 Low-Risk Choices
Slide 12
What Are Low-Risk Investing
Options?
Bonds
•
•
•
You must pay taxes on interest and gains you
make from bonds.
A bond may be callable
A callable bond has a clause that allows the
issuer to repay the bond early (before the
maturity date) at a set amount
– The amount is typically higher than the face value
– If interest rates are dropping, corporations may
choose to call the bonds because they can re-issue
them at a lower interest rate.
11-1 Low-Risk Choices
Slide 13
What Are Low-Risk Investing
Options?
Bonds
•
•
A convertible bond is one that may be exchanged for
shares of common stock at the option of the
bondholder.
– If you see the company is doing well and/or is willing
to take more risk. You can exchange you bond for an
equivalent number of shares of stock.
A zero coupon bond is a discount corporate bond that
does not provide the typical semiannual interest
payments.
– The bond is sold at a deep discount and grows in
value over time.
11-1 Low-Risk Choices
Slide 14
What Are Low-Risk Investing
Options?
Bonds
•
•
Bond rating services study the financial health of
bond issuers
They risk ratings based to judge the risk of buying
the bond
– Investment grade bonds have high ratings (AAA,AA,A and
BBB)
– Speculative grade bonds have low ratings (BB and lower)
• These are sometimes called junk bonds
• These are medium to high risk but pay higher interest rates
11-1 Low-Risk Choices
Slide 15
What Are Low-Risk Investing
Options?
Government Bonds and Securities
• Issued by the US Treasury and US government
agencies.
• The interest earned from these investments is
subject to federal taxes but not state and local taxes.
• These bonds are considered tax shelters
– A tax shelter is an investment that allows you to
legally avoid or reduce income taxes
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Slide 16
What Are Low-Risk Investing
Options?
Government Bonds and Securities
• Treasury Bills (T-Bills): these securities are sold in terms
ranging from two to ten years
– Sold at a discount from face value
• Treasury Notes: Sold in terms of two to ten years at a fixed rate
of interest, which is paid every six months until maturity
• Treasury Bonds: These bonds are available for a minimum
purchase of $100 and have a 30-year term. They pay interest
every six months until they mature.
• Other types
– EE Savings Bond
– I Savings Bond
– Treasury Inflation Protected Securities
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Slide 17
What Are Low-Risk Investing
Options?
State and Local Securities
• Municipal Bonds
– Issued by states, counties, cities, and towns.
– Used to pay for projects, such as roads or public buildings
– You do not have to pay federal, state, or local taxes on the
income from municipal bonds.
– These bonds are considered a tax shelter.
11-1 Low-Risk Choices
Slide 18
What Are Low-Risk Investing
Options?
Annuities
• Annuity
– A contact purchased from an insurance company that guarantees a series
of regular monthly payments for a set time.
– To buy an annuity you would pay a monthly payment into the account for a
set number of years (such as 20).
– You could also invest a lump sum
– Then at the end of the set number of years, the annuity would start pay you
monthly payments.
– These are commonly used as retirement income
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Slide 19
What Are Good Financial Market
Investments?
• A mutual fund is a
professionally managed
group of investments.
• It is bought using a pool
of money from many
investors.
11-2 Medium-Risk Choices
Slide 20
What Are Good Financial Market
Investments?
• Mutual funds consist of stocks, bonds, and other
investments
• Because mutual funds have a variety of investments,
they are diversified which lowers their risk
• Buying a mutual fund is a form of indirect investing.
• Indirect investing: buying shares of a mutual fund
instead of buying individual shares of stock in various
companies.
• Asset Allocation: choosing a combination of funds
within a single mutual fund company
11-2 Medium-Risk Choices
Slide 21
Mutual Funds
• Balanced Funds: Diversified portfolio that includes some lowrisk, some medium-risk, and some high-risk stocks
• Bond Funds: Invests primarily in bonds
• Global Funds: Invests in international companies, new
industries in foreign countries, and companies in the world
marketplace
• Growth Funds: Invest in companies that are expected to grow in
the long run
• Income Funds: Invest in bonds and stocks that produce steady
and reliable dividend and interest payments
• Index Funds: Invest in securities to match a market index with
the goal of having returns similar to those of that index
• Money Market Funds: Invest in short term securities that go up
or down with current interest rates and the economy.
11-2 Medium-Risk Choices
Slide 22
Mutual Funds
• New Venture Funds: Invest in new and emerging
businesses and industries. High risk
• Precious Metal funds: Invest in companies that are
associated with precious metals, such as gold, silver,
and platinum
• Stock Funds: Invest primarily in stocks.
11-2 Medium-Risk Choices
Slide 23
Asset Allocation in a Mutual
Fund
ASSET ALLOCATION
Percent of
Holdings
Type of Fund
Reason for Choice
20%
Bond fund
For stability and to offset risk of other
funds
20%
Growth fund
To invest in high-risk choices that could
grow greatly over time
20%
Global fund
To benefit from world economic growth
20%
Money market
fund
To provide liquidity and short-term gains
15%
Income fund
To receive income in the form of dividends
New venture fund
To invest in emerging, young businesses
that could become highly profitable and
provide a high return
5%
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Slide 24
What Are Individual Retirement
Account Options?
•
•
•
An IRA allows you to deposit money into an account during your
working years and withdraw it upon retirement.
– You can begin withdrawing money from an IRA at age 59 ½ or
later.
– If money is withdrawn earlier than 59 ½ you are subject to a 10%
early withdrawal fee and still taxed at regular rates.
Traditional IRA: an individual retirement account that allows individuals
to contribute pretax income to an account that grows tax-deferred.
– Withdrawals from a traditional IRA must begin by age 70 ½
Roth IRA: an account in which contributions are taxed but earnings are
not.
– You cannot deduct the amount you contribute from your gross
income.
– Do not have to begin withdrawals by 70 ½
11-2 Medium-Risk Choices
Slide 25
What Are Individual Retirement
Account Options?
• Spousal IRA: Individual retirement account set up to benefit a
spouse that has no income.
– Working spouse contributes money
– Can be traditional or Roth
– Must file a joint tax return
• SEP (simplified employee pension) plan is a tax deferred
retirement plan for small business owners and their employees.
– Employer can make a contribution of 25% of the employees
salary
• Keogh Account is a tax deferred retirement plan for selfemployed professionals.
– Used more by higher income business owners because it
can have higher contribution limits
11-2 Medium-Risk Choices
Slide 26
What Retirement Plans Are
Available through Employers?
• Defined-contribution plans
o 401(k) plans: tax-deferred plans for employees of
profit-seeking businesses
o There is a limit to the amount a employee can contribute
o Not taxed until money is withdrawn
o Early withdrawal penalties
o 403 (b) plans: tax-deferred plans for government
and nonprofit organization employees
o Operates the same as a 401k except employers cannot
contribute to this account
11-2 Medium-Risk Choices
Slide 27
What Retirement Plans Are
Available through Employers?
• Defined-benefit plans
o An employer sponsored retirement plan in which
retire workers receive a set monthly or lump sum
payment base on their wages earned and number
of years of service.
o Must work for a certain number of years or
become vested in the plan.
• Retirement accounts may be portable, meaning you
can take the account with you when you leave a job.
– Rollover: the process of moving a retirement
account balance to another qualified account
without incurring a tax penalty.
11-2 Medium-Risk Choices
Slide 28
Success Skills
Tracking Investments Using a
Spreadsheet
• Set up a spreadsheet to show purchase
price and change in value of investments.
• Track investments over time.
• Use it to compare investments.
• Use it to help decide when to change your
investment strategy.
• Use Excel® to get updated stock quotes.
11-2 Medium-Risk Choices
Slide 29
How Can You Invest Directly in
Financial Markets?
• Direct investing is buying
stocks and other
investments directly from
companies and holding
them.
• If you buy the stock of only
one company, the risk is
high because your money
is invested in only one
place.
11-3 High-Risk Choices
Slide 30
How Can You Invest Directly in
Financial Markets?
• Buying stocks
o You become a stockholder and own
shares in a company.
o Make money in two ways
o Receiving dividends
o Selling stock at a higher price than bought
o Purchased through a stockbroker
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Slide 31
How Can You Invest Directly in
Financial Markets?
•
Types of stocks
– Common Stock: pays variable dividends and gives owners
voting rights.
• Can vote on company issues
• No guarantee on if stock with increase or decrease
• No guaranteed dividends
– Preferred Stock: guarantees fixed dividend but does not
provide voting rights
• Generally costs more than common stock because there
is less risk
• If a company goes bankrupt, preferred stockholders
would be paid first.
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Slide 32
How Can You Invest Directly in
Financial Markets?
•
Futures contracts and commodities
o Futures Contract: You agree to buy or sell a commodity at a set
price and date in the future.
o Commodity: an item that has the same value across the market
with little or not difference in quality among producers
o Meat, soybeans, cattle, coffee, etc.
o Buying and selling futures does not transfer ownership
o Used as a way to hedge or reduce the likelihood of losing money
in the future
o Ex: suppose a company has agreed to buy some fuel in the
future at a set price. The company might also want to buy some
fuel futures contracts. If the price of fuel rises, then the company
may make enough money on the futures contracts to pay for the
increased price of fuel itself.
11-3 High-Risk Choices
Slide 33
How Can You Invest Directly in
Financial Markets?
• Investment clubs
o You pool your money with other people
and invest together.
o Examples:
o May buy a timeshare
o Pool money to buy stocks
11-3 High-Risk Choices
Slide 34
How Do You Invest in Business
Ownership?
• A proprietorship is owned
by one person.
• A partnership is formed
by two or more persons.
• IPO (initial public offering): taking a
business public and making the owners
shareholders
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Slide 35
How Do You Invest in Business
Ownership?
• A franchise is a contract that gives you
the right to sell a company’s products
and services.
• A business venture is a business that is
backed by investors.
11-3 High-Risk Choices
Slide 36
What Are Other High-Risk
Investment Choices?
• Real estate
o Land or vacant lots
o Real estate
investment trusts
(REIT): a
corporation that
pools money of
many individuals to invest in real estate.
o Rental property
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Slide 37
What Are Other High-Risk
Investment Choices?
• Collectibles: rare, valuable objects, such
as fine art, coins, baseball cards, super
duper neato sneakers, etc.
• Precious metals: gold, silver, platinum
• Gems: natural precious stones
– Diamonds, rubies, etc.
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Slide 38
Focus On . . .
Day Traders
• Attempt to make money by buying and selling
stocks and bonds over short periods of time
• Sell stock when prices rise for a quick profit
• Must be aware of general market conditions
• Must be familiar with companies, products,
and industries
• Can make high profits over time
11-3 High-Risk Choices
Slide 39