Download Saving and Investing in the New Economy

Welcome to Saving and Investing in the New Economy.
This presentation is an overview of savings and investing and should NOT be taken
as investment advice.
Any reference to financial products and companies are for educational purposes only.
If you are looking for investment advice please contact a financial professional in your
area.
This is one of several presentations developed for AFI grantees on a variety of
financial education topics, including Budgeting, Credit Scores, Making Green Home
Energy Improvements and Working with Income Tax Preparation Sites. More
information about these other presentations and other useful materials from the AFI
Resource Center is available at the end of the show.
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Faced with an increasingly complex economy, unrelenting news and information, as
well as an increase in available financial products and services, people tend to be
overwhelmed.
As an AFI grantees, you may find participants wondering about saving and investing
in this new economy—whether financial institutions in general and the economic
system as a whole can be trusted. You may also recognize that your participants face
a number of barriers or obstacles that prevent them from saving money. The purpose
of this webinar is to provide you with information about saving and investing including
some of the barriers that may keep people you serve from saving.
By the end of this training, you will be able to explain key differences between saving
and investing as well as be able to list some of the common savings and investment
vehicles available in the market today.
You will get information about professional networks to contact for additional
information or assistance in your community. And finally, you’ll get information about
key questions to ask when shopping around for a professional advisor for your own
personal needs or to support the financial education component of your IDA program
as a volunteer.
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The presentation will begin with a brief discussion of aspects of the ―New Economy.‖
The presentation will then focus on tips and strategies for saving money and conclude
with a discussion of investing your money.
While this session will cover many specific uses for the various types of savings and
investing vehicles , it’s important to note that these are examples and not presented
as specific advice.
This presentation will help you explain this information to your participants so they
can begin to understand their saving and investment options, understand some of the
language used by financial professionals, and ask better, more informed questions of
individuals that may be selling advice or specific financial instruments to them.
Offering investment advice requires specific licensing that varies from state to state.
The information presented here will help you understand when a participant may be
ready to invest and how to refer them to the appropriate professionals.
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The current economy, termed as the ―new economy,‖ presents both challenges and
opportunities for saving and investing.
The ―new economy‖ is not new; it is a current manifestation of the cyclical nature of
the economy. Periods of growth are always countered by periods of contraction or
recession.
Despite this pattern, different conditions existed during this most recent recession.
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First, the economic system has developed into a sophisticated web of financial tools and products with new risks and
opportunities. The ―mortgage- backed securities‖ and ―collateralized debt obligations‖ that have been discussed in
the news during the past few years represent a small number of financial products that have emerged over the last
two decades. The economy has been further complicated by the increased globalization of financial markets, but with
fragmentation at the local level – a nearby bank may generate a home mortgage, but that bank may turn around and
sell it on the secondary market immediately. As a result, often borrowers have been left dealing with a business not
located nearby if they should have questions about or problems with their loans.
The second major trend that defines the ―new economy‖ is the growing expectation of individuals to fund their own
retirement, healthcare and post-secondary education expenses for themselves and their children. For example, there
has been a shift from ―defined-benefit plans,‖ commonly called pensions, to ―defined contribution plans‖ where the
employee shares the burdens of the fluctuations of the markets. Employers are less likely to take on financial risks
and future liabilities of pensions and healthcare for their retired workers. Now, 401(k) plans represent the largest
growth in retirement accounts, which means more people are taking on the responsibility and risk of their retirement
investments. In the past, companies would create pension plans that guaranteed a certain monthly payment in
retirement; these companies would hire professional investment companies to administer the plans. Other retirement
plans such as IRAs, Roth IRAs, SEPs and SIMPLEs are self-directed plans where the individual account holder
takes on the full investment responsibility and risk.
The third aspect of the ―new economy‖ is the increasing ease of access for citizens to access investment markets
and sophisticated trading tools. With little information or knowledge, individuals can invest in broad range of
investments vehicles directly with companies, through discount brokerage firms and even online. Additionally, there
is overwhelming and constant flow of business and financial information that a few decades ago was available to
professional money managers only.
Faced with an increasingly complex economy, unrelenting news and information, as well as an increase in available
financial products and services, people tend to be overwhelmed and confused about saving and investing.
As an AFI Grantee, you may find your participants wondering about saving and investing in this new economy—as
well as whether financial institutions in general and the economic system as a whole can be trusted. AFI staff
members may also recognize that their participants face a number of barriers or obstacles that prevent them from
saving.
One place to start with participants is helping them understand the differences between saving and investing.
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The terms saving and investing are often used interchangeably.
But before putting money into a savings or investing vehicle, individuals must first
save. Saving in this context is setting money aside to be used for another day or
another purpose. Once money is set aside, an individual must chose the appropriate
vehicle to protect or ―grow‖ their money. Generally, the choice between a savings or
investment vehicle comes down to three factors: 1) the goal for the money, 2) when
the money is needed, and 3) the individual’s tolerance for risk or the chance of loss.
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When we discuss savings, we are beginning with the premise that consumers want to
have an amount of money available and accessible to meet a specific need or goal.
This may be for a specific purpose, a short-term financial goal, or simply to have a
safety net in the event of unforeseen circumstances. Because we want the money to
be secure and accessible, we do not take risks with the amounts that we save. This is
fundamental to the choice between saving and investing.
Savings accounts are the most common types of savings vehicle for short-term
goals—those goals for which you do not want to take a chance of loss with the
principal.
Savings accounts offer a lower, usually fixed-rate of return without the risk of losing
the amount an individual deposits into the account. Savings accounts are also ―liquid,‖
which means that the individual can retrieve their money with few restrictions and at
little or no cost.
So how do you know when a client is ready to save?
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A client is ready to save when they have developed a budget and they know how much money is available for
saving. AFI participants can prepare for saving by determining what is needed for daily living expenses and creating
SMART savings goals. More information about SMART goals can be found in the glossary and on the resources
slide at the end of this presentation.
The first step is to Identify the Target Amount or Goal – Guide the client through a goal-setting process to determine
their financial goals. These goals may be short- or long-term. This process can help clients determine how much they
need to save to reach their goals and the amount of time they have to save for their goals. This, in turn, will help
identify whether a savings vehicle or investment is more appropriate. Guiding clients in the process of breaking down
larger goals into manageable action steps often increases their chances for success.
Next, Develop the Strategy by helping clients identify their personal barriers to achieving savings goals and the
solutions to address those barriers. Discuss the issues or challenges they may have faced in the past. Finally, create
a specific action plan that defines how much will they save, in which account, and how will they restore the account if
they have to use the money for unexpected expenses.
Creating a habit of regular saving is often more important than the amount the client saves. The amount the
participant has available to save often becomes the amount they elect to ―pay themselves first‖ to ensure savings
becomes a priority. How will they implement the strategy? Do they have access to bank accounts that offer automatic
transfers between accounts or are they employed by organizations that offer direct deposits from their paychecks? If
not, brainstorm some other ways to create a savings habit.
Clarify the difference between ―Saving & Investing‖ because participants may be confused about the difference. This
step offers a ―checkpoint‖ for the timeframe in which the money will be needed. Shorter-term goals will generally
indicate the need for savings accounts and longer-term goals may call for investment vehicles.
Ensure the participants Understand the Types of Savings Vehicles and their Features by explaining different saving
vehicles, aligning goals with these choices, and the generally understood risk and return associated with each type.
Some savings vehicles are more appropriate than others. The following slides in the presentation will highlight the
key features and most appropriate use s of different savings vehicles.
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There are basically three options for saving:
Most banks and credit unions offer savings accounts (credit unions call these ―share‖
accounts), certificates of deposit and money market accounts.
AFI participants may be concerned about the recent news of bank failures and may
consider banks to be unsafe.
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You can reassure them that savings accounts, Money Market Deposit Accounts, and
Certificates of Deposits held at a regulated bank are insured against loss by the
Federal Deposit Insurance Company (FDIC) for up to $250,000 per account owner
per bank. Credit unions have this same amount of coverage through the National
Credit Union Administration (NCUA).
Individuals can ensure the safety of their savings by using only those institutions
covered by either the FDIC or the NCUA.
When you put your money into one of these savings vehicles you earn interest on the
account. Banks or credit unions want to encourage you to keep your deposits in the
bank so they can loan it out to other account holders in the form of mortgages,
business, or personal loans. Although savings vehicles generally pay very low
interest rates in comparison to longer-term investments, earning interest is yet
another way that AFI participants can make their money grow.
Next we will take an in-depth look at the three most common accounts for savings.
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Savings accounts are the most common type of account and are appropriate for many
savings goals. These accounts are available at most banks and credit unions. They
are also FDIC-insured at banks and NCUA-insured at credit unions. Savings
accounts do not require a large initial deposit. Finally, savings accounts are easily
accessible via withdrawal or transfer to checking or other accounts.
Savings accounts allow a depositor to keep money in a safe place, earning small
amounts of interest on the amount left in the bank. The interest rates on saving
accounts are generally higher than checking accounts but lower than other deposit
accounts. Interest is ―compounded‖ which means that the account holder earns
interest on the ―principal,‖ the amount deposited, and ―interest earned,‖ the amount
the bank has already paid each period. This compounding allows a depositor’s
money to ―grow‖ unlike money saved in a jar or under the mattress.
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Savings accounts are ideal for periodic or emergency fund reserves and for shortand intermediate-term saving goals.
Generally, the opening deposit is minimal and often there are no minimum balance
requirements. Again, developing a budget is an important first step in determining
how much money should be placed in this account for periodic expenses or
emergencies.
Some banks offer savings accounts in connection with their checking accounts and
encourage account holders to build a savings ―buffer‖ to protect against overdrafts
(that is, when consumers write a check for more than money than is in the checking
account).
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A Certificate of Deposit or CD entitles the account holder to a guaranteed rate of
interest for a specific period of time . This is called the term. The CD reaches it full
potential value on the maturity date. A CD can be issued in any denomination and the
maturity dates range from one month to five years. CDs issued by banks are
insured by the FDIC and if issued by a credit union, insured by the NCUA.
CDs are opened with a one-time deposit and often have a higher minimum balance
requirement than a savings account. Although CDs are low-risk accounts, there are
penalties and fees for withdrawing money before the maturity date.
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Because of the potential penalties and fees, CDs are ideal for saving goals above and
beyond periodic or emergency fund needs and are generally undesirable if the AFI
participant does not have an emergency fund or if it’s possible that the funds would
be needed before the maturity date.
CDs are a good tool for ―laddered‖ savings which can afford a depositor the option to
gain higher interest on some of their savings and to have access to funds in the event
of an emergency. Laddering CDs in differing amounts and terms (one month, three
month, six month, etc.) ensures frequent maturity dates and avoids ―locking in‖ low
interest rates for longer-terms deposits.
Laddering may not be practical, however, for some of your clients especially if they
struggle with basic record keeping. Keeping track of multiple CDs with different terms
and maturity dates may be too challenging for them.
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A Money Market Account has elements of a savings and a checking account. This
account is offered and insured by banks or credit unions and usually pays higher
interest rates than regular savings accounts. Money Market Accounts often have
higher minimum balance requirements than savings accounts and limits on the
number of withdrawals that the account holder may make each month.
There is often confusion between Money Market Accounts and Money Market Fund.
The Money Market Account is a savings product, and Money Market Fund is an
investment product and is therefore not insured.
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A Money Market Account has all of the benefits of a savings account (security and
liquidity) and the benefits of a CD (higher limits and interest) and avoids the pitfalls of
both (limited access and no penalties).
Consumers have access to their savings but are discouraged from withdrawing too
frequently.
There are a number of similarities between savings and investing but a key difference
is that investing opens up for many alternative money-vehicles that carries different
kinds of risk.
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So what is risk? Risk can be defined in a number of ways, but in the simplest form.
risk is any chance of loss. In the financial planning field, it is often understood as the
quantifiable likelihood of a loss or less-than-expected returns.
There are different kinds of risk.
For example, a certificate of deposit (CD) requires that money stay deposited for a
specific period of time. If a person with a CD needs his/her money prior to the end of
the term, she is likely to lose all earnings from interest through the payment of
penalties. Not being able to access the money when it may be needed is a risk.
If you are a shareholder of McDonalds Corporation, you are subjecting yourself to
certain risks. The value of your shares of stock in McDonald’s Corporation could
decline due to changes in the economy. For example, people may eat out less often
because they have less disposable income, or people could have increased concern
about the negative health effects of consuming fast food. These trends could impact
McDonalds’ sales, profits, public image and ultimately, the value of the stock.
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In finance, there are generally two main categories of risk: unsystematic and
systematic risk.
Unsystematic risk is company or industry specific risk that is inherent in each
investment. If people stop eating hamburgers, then McDonald’s and its shareholders
will suffer because of declining revenues. However, other companies (Home Depot)
will not be affected at all by the decline in burger consumption. An individual investor
can reduce exposure to unsystematic risk through diversification among different
companies and industries, which will be discussed later.
Systematic risk describes the risk of simply being ―in the market‖ where the chance
of loss or economic disturbances affect a financial system as a whole. Recession and
wars all represent sources of systematic risk because they affect the entire market
and cannot be avoided through diversification among different companies and
industries. The recent recession is a prime example of systematic risk. Virtually all
industries and companies experienced a decline in business revenue, and investors
experienced losses.
This risk can only be mitigated by something called ―hedging,‖ which essentially is a
way of insuring a portfolio of stocks or bonds against negative events. Hedging does
not prevent the negative event from occurring but it makes the impact less severe.
For a small investor, the easiest way to hedge against systematic risk is to have a
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portfolio of stocks and bonds that are negatively correlated. When two securities are
negatively correlated it means that they move in opposite direction of each other. For
example. gold is often used as a hedge for the stock market because when gold is up,
stocks are usually down and vice versa. Other methods of hedging include
derivatives such as options and futures. The majority of investors will never trade a
derivative contract in their life. In fact, most small investors practice a buy-and-hold
strategy and ignore short-term fluctuations altogether.
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Systematic risk can never be completely eliminated, but can be mitigated by finding
negatively correlated investments.
In other words, if the market as a whole goes down, there is nowhere to hide.
However, when it comes to unsystematic risk, that is, risk that is particular to a
specific company or industry, an investor can take specific actions to lessen that risk.
When addressing unsystematic risk, investors apply two tools: asset allocation and
diversification.
Asset allocations means that an individual investor must determine how much of the
money he invests should be in cash (for example, checking accounts, savings
accounts, CDs and money market deposit accounts), bonds and notes (for example,
treasury notes, savings bonds, municipal bonds, corporate bonds, mortgage-backed
bonds, TIPS and zero-coupon bonds), stocks (for example, common stocks and
preferred stocks), real estate (for example, a primary residence, vacation home, rental
units or REITs) and commodities (for example, gold, wheat, cocoa, pork bellies and
orange juice).
While there is no simple formula for the right asset allocation for each individual, the
consensus among most financial professionals is that asset allocation is one of the
most important decisions that investors make. In other words, the selection of
individual securities is secondary to the way an individual allocates his investment in
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stocks, bonds, and cash and equivalents, which will be the principal determinants of
the investment results.
An asset allocation plan should consider savings and spending patterns, tax situation,
economic outlook, return expectations and risk tolerance. What naturally follows from
the asset allocation plan is different from person to person. A person who invests in a
college savings plan for his infant child will have a different asset allocation plan than
the person who is five years from retirement.
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The simplest example of diversification is provided by the idiom "don't put all your
eggs in one basket.‖ Dropping the basket will break all the eggs. Placing each egg in
a different basket is more diversified. There is more risk of losing one egg, but less
risk of losing all of them.
In finance, an example having all of the eggs in one basket is an undiversified
portfolio –all assets are invested in only one stock. A one-stock portfolio is associated
with a number of risks, such as business risk (that is, the risk that the business model
becomes unprofitable), financial risk (or the risk that the company fails due to debt
obligations), liquidity risk (that is, the risk that the stock cannot be sold readily at a
reasonable price) and event risk (or the risk that an unforeseen event, beyond
financial and business risk, harms the company such as a product recall).
It is not unusual for a single stock to go down 50% in one year. It is much less
common for a portfolio with 20 stocks to go down that much, even if they are selected
at random. If the stocks are selected from a variety of industries, company sizes and
types (such as growth stocks and value stocks) it is even less likely to see the value
of the portfolio decline dramatically.
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Most small investors have a limited investment budget and may find it difficult to
create an adequately diversified portfolio.
Moreover, to maintain a well-diversified portfolio requires significant on-going
research and evaluation of the market and the individual securities. To address the
costs of research and the need for diversification, investment companies have
developed a vast range of products that are both affordable and risk-appropriate for
small-scale investors.
One such product is the mutual fund. When an investor buys a share in a mutual
fund, she essentially owns a share of a widely diversified portfolio of securities. In
other words, a mutual fund consists of a large number of different securities, which
makes the mutual fund well-diversified. Most mutual funds are actively managed –
meaning that most mutual funds are overseen by an investment manager that makes
regular adjustments and changes to the mutual fund portfolio to meet the objectives of
the mutual fund prospectus. However, to have a manager actively keeping track of a
mutual fund is expensive and the cost has to be passed on to mutual fund
shareholders through annual operating fees, which can be as high as 3-4%.
A prospectus contains information required by the SEC, such as investment
objectives and policies, risks, services and fees. It provides a potential investor with
information about investment style and risk profile.
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An alternative to mutual funds is called Exchange Traded Funds (ETF). ETFs were
first introduced in 1993 and have since grown in terms of availability and popularity.
ETFs are very similar to mutual funds with a few exceptions, which will not be
covered here except for one significant difference; the price of operating a mutual
fund vis-à-vis ETF. Just as a mutual fund, an ETF is a portfolio of many different
securities which means it has diversification built in, but where mutual funds are
actively managed, ETFs are usually passive instruments with very little ongoing
maintenance by a manager. This feature makes ETFs cheaper to own compared to
mutual funds.
Buying shares in a mutual fund or buying ETFs can provide investors with
an inexpensive source of diversification.
You may be intimidated by this complex world of investments and rightly so, many
things can go wrong if you don’t know what you are doing. That being said, there are
ample help to get through advisory services. But as always, you need to know what to
look for in an advisor and make sure that the advisor fits you.
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Saving and investing in this new economy may feel like an uncertain prospect for
many of the people in AFI Projects.
Understanding and addressing both external and internal barriers to saving and
investing may be a place to start. Equally important is providing participants with
factual information about savings and investment vehicles. Information for
participants about how they can ensure their principal remains intact using federallyinsured financial institutions for short-term savings goals can help participants fearful
about saving increase their confidence. Explain the tradeoff between risk—including
the different kinds of risk—and return can help participants make better decisions for
themselves and their families.
Helping participants understand that figuring out where to put their savings is based
on the goal for the money, the timeframe by which the money will be needed and their
tolerance for risk. This will ensure risk and return is properly aligned with participants’
goals, time frame and risk tolerance.
Finally, as mentioned in the beginning of this training, you should not give investment,
tax or legal advice unless you have the proper education, certifications and/or
licenses. Investment and tax advice is under strict regulatory oversight by state and
federal authorities. However, most communities have professional networks or
associations that provide pro bono education and/or individual assistance. Check the
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list of resources at the end of this training for more details.
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What is an investment adviser? An investment adviser is an individual or a firm that
is in the business of giving advice about securities to clients. For instance, individuals
or firms that receive compensation for giving advice on investing in stocks, bonds,
mutual funds, or exchange traded funds are investment advisers. Some investment
advisers manage portfolios of securities.
What is the difference between an investment adviser and a financial planner?
Most financial planners are investment advisers, but not all investment advisers are
financial planners. Some financial planners assess every aspect of your financial
life—including saving, investments, insurance, taxes, retirement, and estate
planning—and help you develop a detailed strategy or financial plan for meeting all
your financial goals. Others call themselves financial planners, but they may only be
able to recommend that you invest in a narrow range of products, and sometimes
products that aren't securities. Before you hire any financial professional, you should
know exactly what services you need, what services the professional can deliver, any
limitations on what they can recommend, what services you're paying for, how much
those services cost, and how the adviser or planner gets paid.
How do investment advisers get paid? Before you hire any financial professional—
whether it's a stockbroker, a financial planner, or an investment adviser—you should
always find out and make sure you understand how that person gets paid. Investment
advisers generally are paid in any of the following ways: A percentage of the value of
the assets they manage for you; an hourly fee for the time they spend working for
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you; a fixed fee; a commission on the securities they sell (if the adviser is also a
broker-dealer); or some combination of the above.
Each compensation method has potential benefits and possible drawbacks,
depending on your individual needs. Ask the investment advisers you interview to
explain the differences to you before you do business with them, and get several
opinions before making your decision. Also, ask if the fee is negotiable.
Are investment advisers required to have credentials? While some investment
advisers and financial planners have credentials -- such as Certified Financial
Planner (CFP) or Chartered Financial Analyst (CFA) -- no state or federal law
requires these credentials. Many states require advisers to pass a proficiency exam
or meet other requirements. Investment advisers and financial planners may come
from many different educational and professional backgrounds. Before you hire a
financial professional, be sure to ask about their background. If they have a
credential, ask them what it means and what they had to do to earn it. Also, find out
what organization issued the credential, and then contact the organization to verify
whether the professional you're considering did, in fact, earn the credential and
whether the professional remains in good standing with the organization. For
information on various financial professional credentials and the entities that issue
them, you can visit FINRA’s website. FINRA’s information is available on the resource
page at the end of this training.
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What questions should I ask when choosing an investment adviser or financial
planner? Here are some of the questions you should always ask when hiring any
financial professional:
• What experience do you have, especially with people in my circumstances?
• Where did you go to school? What is your recent employment history?
• What licenses do you hold?
• Are you registered with the SEC, a state, or the Financial Industry Regulatory
Authority (FINRA )?
• What products and services do you offer?
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• Can you only recommend a limited number of products or services to me? If so,
why?
• How are you paid for your services? What is your usual hourly rate, flat fee, or
commission?
• Have you ever been disciplined by any government regulator for unethical or
improper conduct or been sued by a client who was not happy with the work you
did?
• For registered investment advisers, will you send me a copy of both parts of your
Form ADV?
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What are good options for saving money?
A. Savings Accounts at Banks.
B. Share Accounts at Credit Unions.
C. Money Market Accounts.
D. Certificates of Deposit.
E. All of the Above.
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What are good options for saving money?
A. Savings Accounts at Banks.
B. Share Accounts at Credit Unions.
C. Money Market Accounts.
D. Certificates of Deposit.
E. All of the Above -- is the Answer
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True or False?
The Federal Deposit Insurance Corporation (FDIC) and the National Credit Union
Administration (NCUA) insure against losses up to $250,000 per account owner at
banks and credit unions in the United States.
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TRUE!
The Federal Deposit Insurance Corporation (FDIC) and the National Credit Union
Administration (NCUA) insure against losses up to $250,000 per account owner at
banks and credit unions in the United States.
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What is NOT a good strategy for mitigating risk with investments?
A. Diversifying your investments
B. Buying mutual funds.
C. Investing all your money in commodities like gold.
D. Investing in different assets such as stocks, bonds or real estate.
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What is NOT a good strategy for mitigating risk with investments?
A. Diversifying your investments
B. Buying mutual funds.
C. Investing all your money in commodities like gold.
D. Investing in different assets such as stocks, bonds or real estate.
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What are some key questions you would ask a financial adviser before
engaging them?
A.
What experience do you have?
B.
What licenses or certifications do you hold?
C.
What products and services do you offer?
D.
How are you compensated?
E.
All of the above.
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What are some key questions you would ask a financial adviser before
engaging them?
A.
What experience do you have?
B.
What licenses or certifications do you hold?
C.
What products and services do you offer?
D.
How are you compensated?
E.
All of the above.
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AFI Resource Center Home Page – http://www.idaresources.org/
Certified Financial Planner Board of Standards (CFP) - http://www.cfp.net/
Federal Deposit Insurance Corporation (FDIC) – http://www.fdic.gov
Financial Industry Regulatory Authority (FINRA) – http://www.finra.org/
Financial Planning Association (FPA) – http://www.fpanet.org/
National Association of Personal Financial Advisors – http://www.napfa.org/
National Credit Union Association (NCUA) http://www.ncua.gov/
SMART Goals -
U.S. Securities and Exchange Commission (SEC) – http://www.sec.gov/index.htm
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There are many other resources at the AFI Resource Center Website located at
www.idaresources.org.
From that page, you can access many other presentations and useful tools
If you have specific questions, the AFI Resource Center is available to provide oneon-one technical assistance regarding all your project implementation needs. To
reach us, call 1-866-778-6037 or email [email protected].
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