11

Savings

Chapter Objectives

• Define personal savings goals. • Calculate compound interest. • Use the Rule of 72 to determine

savings outcomes. • Compare different types of savings

products.

Creating a Savings Plan

• Saving is setting money aside for future use

• A savings plan is– a vital part of an overall financial

plan– a strategy for using money to reach

important goals and advance your financial security

Budget for Saving

• Strategies for growing your savings:– Pay yourself first– Use direct deposit– Let your savings

grow– Reduce spending;

increase saving

Create an Emergency Fund

• Build an emergency fund, covering 6–8 months of living expenses, to be used in case of job layoff or illness

Set Goals for Saving

• Clearly defined goals make saving easier

• Make a list of what you want to achieve with your money (savings goals)

• Goals should be– realistic– specific and measurable– time related

Maximizing Savings

• Maximize your savings by considering – total amount deposited– interest rate– time span of deposit– interest type: simple interest or

compound interest– frequency of compounding

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Maximizing Savings

Calculating Compound Interest

1. Multiply the deposit amount by the annual interest rate

2. Divide Step 1 answer by rate of compounding

3. Add Step 2 answer to deposit amount to get new balance with interest

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Calculating Compound Interest

Future Value Tables

• Provides an easy way to calculate compound interest earnings at different interest rates and times

• Find the future value of a single $100 deposit after 5 years at a 6% interest rate

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Future Value Tables

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Future Value Tables

• Look along the “5 years” row to the number in the “6%” column

• Multiply 1.3382 by $100• The $100 deposit would be worth

$133.82

Rule of 72

• Use Rule of 72 to estimate the amount of time or interest needed to double savings

• To find the number of years to double savings, divide 72 by interest rate

• To find the annual interest rate needed to double savings, divide 72 by number of years

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Rule of 72

• How long will it take $1000 deposited at a 4% interest rate to double in value?

• Find the annual interest rate you need to double your savings if your savings was in an account for 20 years

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Rule of 72

• 72 divided by 4 is 18; in 18 years your $1,000 will be worth approximately $2,000

• 72 divided by 20 is 3.6; your savings must be in an account paying 3.6% for it to double in 20 years

Consider Inflation and Taxes

• Inflation and taxes reduce the value of savings

• Due to inflation, – goods and services bought with future

savings will cost more than they do today

– you need a savings plan that pays an interest rate higher than today’s rate of inflation

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Consider Inflation and Taxes

• Your earnings and the interest earned on your savings are taxed

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Consider Inflation and Taxes

• By reducing or deferring taxes on savings, you accumulate more money over time

• Minimize taxes by putting money into tax-exempt or tax-deferred savings

Savings Choices

• The Truth in Savings Act – requires financial institutions to

provide information about costs and interest-earning accounts in uniform terms

– helps consumers compare savings products and make informed decisions

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Savings Choices

• Info financial institutions must provide:– minimum required to open an account– interest rate– annual percentage yield (APY) and

effective period– minimum deposit, time requirements,

other terms of APY– description of fees, conditions, and

penalties

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In Your Opinion

• Why do you think the Truth in Savings Act was necessary?

Savings Choices

• Check that the savings product you choose is insured by either– Federal Deposit Insurance Corporation

(FDIC) – National Credit Union Administration

(NCUA)• Liquidity is the ease with which an

asset can be converted into cash without losing value

Savings Accounts

• Regular savings accounts – pay interest– allow you to make

deposits and withdrawals

– usually offer lowest interest earnings, but most liquidity

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Savings Accounts

• Passbook savings—deposits and withdrawals are recorded in a book

• Statement savings—you receive regular statements of account activity; may include a debit/ATM card and online banking

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Savings Accounts

• Special purpose accounts– encourage consumers to set aside

money in separate accounts for specific purposes: holiday gifts, college tuition

– Interest may be tax free or tax-deferred, allowing savings to accumulate faster

Money Market Deposit Accounts

• Pay higher interest rates than savings accounts

• Are liquid• Require higher minimum

balances than savings accounts• Offer limited check-writing and

money-transfer privileges

In Your Opinion

• What has your experience been with savings accounts? What would you do differently if you could?

Online-Only Savings Accounts

• Offered by Internet banks• Customers access bank’s Web

site to check balances and make electronic deposits, withdrawals, fund transfers

• Pay higher interest rates due to lower overhead costs

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Online-Only Savings Accounts

• Disadvantages:– Can have a time lag for deposits and

withdrawals to clear– Can have technical difficulties,

making funds and account info temporarily inaccessible

– May have a different person available each time you call

Certificate of Deposit

• A certificate of deposit (CD)– pays interest rates higher than other

savings– earns more interest the longer you

agree to hold a CD– is not liquid: early withdrawal

penalties

U.S. Savings Bonds

• Buyers of U.S. savings bonds loan money to the government

• On a specified date, the government repays the loan with interest

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U.S. Savings Bonds

• I Bonds pay a fixed interest rate determined by the Secretary of Treasury (plus a semiannual inflation add-on rate)

• EE Bonds earn fixed interest rates based on market yields of Treasury Notes– Tax benefits if used to finance

education; can also defer income tax on interest earnings

Central Ideas of the Chapter

• A savings plan is an essential piece of an overall financial program.

• Compound interest helps your savings grow over time.

Glossary of Key Terms

• annual percentage yield (APY). The rate of yearly earnings from an account, including compound interest.

• certificate of deposit (CD). Money deposited for a set period of time that earns a set annual rate of interest.

• compound interest. Interest figured on money deposited plus interest.

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Glossary of Key Terms

• Rule of 72. A method used to estimate the amount of time or interest it will take for savings to double in value.

• simple interest. Interest computed only on the principal.

• tax deferred. Savings or earnings that are not taxed until the funds are withdrawn.

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Glossary of Key Terms

• tax exempt. Earnings that are free of certain taxes.

• U.S. savings bond. A savings tool that loans money to the U.S. government for a specified period of time. The bondholder is repaid with interest at the time of maturity.

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