chapter 11 saving and investing options. slide 2 what are low-risk savings options? 11-1 low-risk...

Chapter 11

Saving and Investing Options

What Are Low-Risk Savings Options?

11-1 Low-Risk Choices

• 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.



• 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 fundo 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.



• 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



• 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.



• 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

1 Low-Risk Choices

Early Withdrawal PenaltyEarly Withdrawal Penalty

Certificate of DepositAmount deposited: $5,000Interest rate: 5% yearlyTerm: 5 years

Penalty for Early WithdrawalIf the money is withdrawn before 5 years, the penalty imposed will equal 365 days’ interest, whether earned or not.

Sample ScenarioThe money is withdrawn after 180 days.

$5,000 x 0.05 x 180/365 = $123.29 interest earned$5,000 x 0.05 x 365/365 = $250.00 penalty

$5,000.00 amount deposited+ 123.29 interest earned$5,123.29- 250.00 early withdrawal penalty$4,873.29 amount received at early withdrawal



• Life insurance savings planso Borrow against the policy’s cash valueo 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



• Brokerage accountso An account at an investment companyo 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.

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.



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.

1 Low-Risk Choices

Return on a Corporate BondCorporate Bond

Face value: $5,000Discount 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



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.



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.



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



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



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



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.



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

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

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

Mutual Funds• Balanced Funds: Diversified portfolio that includes some low-risk, 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.


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.


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

5% New venture fund To invest in emerging, young businesses that could become highly profitable and provide a high return

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

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 self-

employed professionals.– Used more by higher income business owners because it

can have higher contribution limits

What Retirement Plans Are Available through Employers?


• Defined-contribution planso 401(k) plans: tax-deferred plans for employees of

profit-seeking businesseso There is a limit to the amount a employee can contributeo Not taxed until money is withdrawno Early withdrawal penalties

o 403 (b) plans: tax-deferred plans for government and nonprofit organization employeeso Operates the same as a 401k except employers cannot

contribute to this account

What Retirement Plans Are Available through Employers?


• Defined-benefit planso 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.

Success Skills


• 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.

Tracking Investments Using a Spreadsheet

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

How Can You Invest Directly in Financial Markets?


• Buying stockso You become a stockholder and own

shares in a company.o Make money in two ways

oReceiving dividendsoSelling stock at a higher price than bought

o Purchased through a stockbroker



• 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.



• Futures contracts and commoditieso 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 producerso Meat, soybeans, cattle, coffee, etc.

o Buying and selling futures does not transfer ownershipo Used as a way to hedge or reduce the likelihood of losing money

in the futureo 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.



• Investment clubso You pool your money with other people

and invest together.o Examples:

oMay buy a timeshareoPool money to buy stocks

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

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.

What Are Other High-Risk Investment Choices?


• Real estateo Land or vacant lotso Real estate investment

trusts (REIT): a corporation that pools money of many individuals to invest in real estate.

o Rental property

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.

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


chapter 11 saving and investing options. slide 2 what are low-risk savings options? 11-1 low-risk...

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