InvestIng - HSFPP

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Module04Investing:Money Working for You

About the NEFE High School Financial Planning Program SeriesBy picking up this booklet, you are on your way to making your dreams cometrue and headed down the path to financial independence. This program seriesincludes six topic modules to introduce you to the fundamentals of mindfulmoney management behaviors. Use what you learn in each module todevelop sensible habits to confidently manage your money and adapt tounexpected events.Program Modules1. Money Management: Control Your Cash Flow: goal setting –decision making – spending plan & budget – money management tips2. Borrowing: Use—Don’t Abuse: application process – loans –credit cards – costs – credit score – debt – rights & responsibilities3. Earning Power: More Than a Paycheck: earning potential –career plan – life stages – employee benefits – take-home pay – lifestyle4. Investing: Money Working for You: savings – investing – goals –options – risks & rewards – time value of money – diversification – plan5. Financial Services: Care for Your Cash: account types – fees –service options – transaction tracking – automation – identity protection6. Insurance: Protect What You Have: risk management – costs –claims – insurance types – coverage decisions – insurability factorsFind more money management tips and resources at www.hsfpp.org. 2013, National Endowment for Financial Education (NEFE ). All rights reserved.This publication may only be used for instructional and educational purposes as part of the NEFE High SchoolFinancial Planning Program (HSFPP). No part of this publication may be copied, reproduced, modified, orcombined with other material. This publication may not be used for any commercial purpose, and no separate fee orconsideration may be charged in exchange for this publication or for participation in the NEFE HSFPP.NEFE provides the HSFPP as a public service to enhance the financial literacy of youth. The program does notpromote financial products, financial planning organizations, individuals, or companies. However, to be effectivelytaught, the program often makes use of outside volunteer financial services professionals to add value in a classroomor similar setting. While providing this service, outside financial services professionals are not permitted to sell,advertise, or otherwise in any way promote the particular financial services organizations or products with which theymay be affiliated.

Module04INVESTING:Money Working for You

Table of ContentsMEET JUSTIN AND WHITNEY / page 3UNRAVELING THE ‘MYSTERY’ OF SAVING AND INVESTING / page 5THE 8TH WONDER OF THE WORLD / page 9JUMP-START YOUR FINANCIAL QUEST WITH INVESTING / page 16Risky Business / page 27CHOOSE SMART / page 31Adding it up / page 382INV EST ING : M on ey Wor k i n g f or You

Use the tips and strategies in this guide to do the following:»» Summarize how saving and investing can be used to build wealth.»» Explain how investing works.»» Evaluate the risks and rewards of investment options.»» Outline strategies to achieve investing goals.»» Explore ways to fit saving and investing into your financial planning.MEET JUSTIN AND WHITNEYJustin is an eighth grader who’salready worried about paying forcollege. His older sister, Shelby,won a big basketball scholarship toa state university but lost it after acareer-ending knee injury last year.Their dad isn’t working right nowbecause of a job layoff, so Shelbycouldn’t afford to go back this fall.Justin sees how unhappy she istaking a detour to earn her fouryear degree, and he decides to startsaving his own money for college.Whitney is a senior who spendsmost of the money she earns onclothes, shoes, and going out withher friends. For the past two years, she was supposed to be saving at least10 percent of her paychecks. One day during an argument over Whitney’sspending, her mom asks to see her savings account balance.Both are shocked to see that there’s only a couple hundred dollars in the account.Whitney admits that she skipped saving and withdrew money a couple of times.Her mom shakes her head and walks off in disappointment.To lear n m ore, vis it www.hs fp p .org3

“Poor people see a dollar as a dollar to trade forsomething they want right now. Rich people seeevery dollar as a ‘seed’ that can be planted to earna hundred more dollars then replanted to earn athousand more dollars.” T. Harv Eker, author of Secrets of the Millionaire MindDo you want to be rich? Who doesn’t!But remember: Being wealthy isn’tabout how much you earn—it’s abouthow much you keep. You can findplenty of stories about superstarathletes and big-name singerswho were earning millions butwent broke shortly after theircareers ended.You can have the freedom ofbeing financially set for lifeone day. Anyone can. You do NOThave to be born rich, get straight A’s, have talentworthy of a superstar, or make a huge salary. You just need tostart thinking about and treating money differently. And the sooner youstart, the sooner you may get there.The wealthy think of money as a 24–7 “employee”—expecting it to make moremoney for them while they work, play, and go about their daily lives. They do thatthrough saving and investing.Justin and Whitney will help you get started with saving and investing. In fact,you’ll learn that you already have some of the tools and knowledge to getstarted now.4INV EST ING : M on ey Wor k i n g f or You

Activity 4.1: What is Wealthy?In 25 words or less, define what it means to you to be wealthy.UNRAVELING THE ‘MYSTERY’ OF SAVING AND INVESTING“The shortest period of time lies between the minuteyou put some money away for a rainy day and theunexpected arrival of rain.” Jane Bryant Quinn, author of Smart and Simple Financial Strategies for Busy PeopleWhen you receive money, the first thing you should do is to set aside a specificamount for financial goals that you can’t afford on short notice—like prom, buyinga car, or going to college. This “pay yourself first” (PYF) strategy is a way for you toplan ahead to regularly save portions of money over time. Eventually, your PYFfund will grow so you have enough money to later pay for a big-ticket item. (Youcan learn more about planning for a PYF fund in Module 1: Money Management.)Use some of your PYF money to build an emergency fund so you’ll have a financialcushion to fall back on when unexpected things happen. A cushion is especiallyimportant because no one is immune from a sudden loss of income due to a joblayoff or unplanned expenses such as car repair or replacing a lost cellphone.An emergency fund also is important if you choose to work in an industry orprofession where the amount you earn each month may vary a lot—like seasonalwork, farming, selling on commission, or running your own business. Not havingcash on hand when there are shortfalls can add unwanted stress to your life.To lear n m ore, vis it www.hs fp p .org5

Interest is an amount paid to use someone’s money, usually a percentageof the amount deposited (aka principal). The bank or credit union will notactually keep all of your money in the vault. Some of it will be loaned to otherpeople or businesses. Because the financial institution receives interest fromthe borrower, it is able to pay out interest to you for using your depositedmoney.Everyone needs to have some money set aside. But if you stash that money in yourroom, you (or someone else) may be tempted to “borrow” from it. For that reason,keeping your PYF funds “out of sight, out of mind” is a wise route. If you save orinvest it, your money can do a lot more for you than take up space in yourdresser drawer.Many people often use the words “saving” and “investing” interchangeably, buttechnically they’re not the same thing.Saving is setting aside money you don’t spend now so it can be used later.Investing is buying something with the expectation that it will make moneyfor you.The right choice—saving or investing—depends on your situation. Let’s take acloser look at some of the most popular options.THE BIG SCORESavvy people have a strategy in place for windfalls such as work bonuses,inheritances, tax refunds, or other unexpected chunks of money. They usethem to bump up the amount they’re saving and investing. Funneling awindfall in that direction means you get the added boost, with no effect onyour day-to-day living expenses.6INV EST ING : M on ey Wor k i n g f or You

Activity 4.2: My WindfallsHave you received any unexpected increases in cash during the past year?Circle any of the examples below that were windfalls for you:Gift moneyFound moneyIncrease in allowanceIncrease in payTip moneyBonusScholarship or grantInheritanceOther:The next time you have a windfall, decide how much you’ll sock away beforeindulging yourself. You also may need to set aside enough money to pay incometaxes on your windfall.SAVE FOR FUN (AND A RAINY DAY)The first stop for your PYF money probably will be some type of savings option.When you put money into a savings account at a financial institution, you’rebasically lending that bank or credit union your money. Your money is used tomake loans to other customers and businesses. Also, credit unions and banksare required to keep some money on hand so that customers can take out theirmoney whenever they want to.Savings options at banks or credit unions offer these features:»» Safety. No need to worry about impulsive spending or theft. Plus yourmoney is insured, so it will be returned if anything happens to the bank orcredit union.»» Ease of Access. If you put in 100, you can take out 100.»» Interest. The bank or credit union gives you a percentage of the amount thatyou save. The more money in your account, the more interest you receive.»» Easy Tracking. You can check your balance online anytime.To lear n m ore, vis it www.hs fp p .org7

Popular Savings OptionsTypeWhereSavingsAccountAny bank orcredit union»» Low minimumbalance requirement»» Able to remove oradd money to theaccount»» Interest is applied tothe account, usuallyeach month orquarter»» Insured»» Low interest rates,which may changeover timeMoneyMarketDepositAccount(MMDA)Any bank orcredit union»» Higher interest ratesthan with regularsavings accounts»» Able to remove oradd money to theaccount»» Interest is applied tothe account, usuallyeach month»» Insured»» May limit howmany times moneycan be removedeach month»» Required firstdeposits are higherthan for regularsavings accounts»» May require aminimum balanceto avoid feesCertificateof Deposit(CD)Any bank orcredit union»» Higher interest ratesthan for regularsavings accounts andMMDAs»» Interest rate staysthe same for specificlength of time»» Interest might beapplied more oftenthan with savingsaccounts or MMDAs»» Insured»» Low interest rates»» Money isn’tavailable until aspecific date»» Penalties forcashing in CDearlyU.S.SavingsBondBonds are soldonline by theU.S. Treasuryat www.treasurydirect.gov»» Buy in amounts of aslittle as 25»» Fixed interest rate forup to 30 years»» Interest adds upbut isn’t paid untilyou cash in thebond»» Low interest rate»» Penalty if cashedin within the firstfive years8ProsINV EST ING : M on ey Wor k i n g f or YouCons

THE 8TH WONDER OF THE WORLDWhitney’s surprised to hear that her45-year-old uncle is leaving his jobto backpack around the world for ayear. He never really seemed like hewas rich, so she asks her mom howhe can afford to do it.“Compound interestis the eighth wonderof the world. He whounderstands it, earnsit . [and] he whodoesn’t . pays it.”Her mom says that he has a lot moremoney than people think. It’s notbecause he earns a lot—he really Physicist and theorist Albert Einsteindoesn’t. It’s because he startedsaving and investing everything hecould when he was a teen. Insteadof spending money on big houses,fancy cars, or expensive clothes, he continued to save it for things that are moreimportant to him—like this trip he’s been dreaming about for years.Whitney questions how he could have put that much money away when he washer age. It must have been mostly later, once he was climbing the career ladder.Her mom says no, for years it was just 25 here and 10 there. But all the while,his investments and earnings were compounding over time—trickling a littlemore money into his account at first and then building to a waterfall the longer heleft it untouched.To lear n m ore, vis it www.hs fp p .org9

Investment gurus may have lots of expertise, but you have one HUGE advantagethey can only wish for: more time. That’s because when it comes to buildingwealth, time is much more powerful than the amount you invest and even thereturn you earn.The more often your money is earning interest, the fasterand bigger your account will grow—thanks to the mightypower of compounding.Simply leave your savings in your account. As interest is addedto the account balance, you earn interest on the original balanceplus the previously earned interest. The more frequently interest iscompounded, the more the balance increases.Justin has been saving up hisbirthday money and some cashhe’s earned from odd jobs in hisneighborhood. He now has 500 inhis savings account with an annualinterest rate of 0.55 percent.Simple Interest Rate Formula:I P x R x T whereI interestP principal (the originalinvested amount)R interest rate (decimal number)He crunches some numbers to seehow much his account will growin a year. Using the simple interestformula, Justin calculates that he willhave 502.75 ( 500 2.75 interest)at the end of a year.T time (number of years)Example: 2.75interest 500principalx .0055 xrate1timeWhen interest is compounded, the amount paid in a year is actually morethan when the simple interest formula is used to calculate the interest. That’swhy financial institutions show the return as the annual percentage yield(APY), the actual return on an investment when compound interest is takeninto account.10INV EST ING : M on ey Wor k i n g f or You

Justin’s dad suggests puttingthe 500 into a CD thatearns more interest, morefrequently. Their credit unioncurrently offers 2.5 percentAPY on a 12-month CD andinterest is compounded daily.Justin uses the compoundinterest formula to see thedifference it makes to havehis money earn interest at ahigher rate every day ratherthan just once a year. Hediscovers that he will havealmost 513 after one year ifhe goes with the CD option.Compound Interest Formula:A P (1 r/n)ntA final amount including interest aftert yearsP principal (original invested amount)r annual interest rate (decimal number)n number of times interest is compoundedeach yeart number of years the amount is investedExample: 512.66 500 (1 .025 /365)365final amountprincipalratex 1how often yearcompoundedActivity 4.3: More MoneyJustin can increase his savings by compounding interest more often. What are atleast two other ways he can grow his savings?Before you decide where to stash your cash, always shoparound for the best interest rates. Every little bit ofadded interest can make a big difference over time.Comparison shop to compare rates at local and nationalbanks and credit unions.To lear n m ore, vis it www.hs fp p .org11

Challenge 4-A: It Pays to Shop AroundGo online to compare options for saving your money. Find out the followingabout savings accounts, money market accounts, and CDs at one or two banks orcredit unions:»» any minimum balance requirements»» current APY»» compounding»» interest frequencyUse the DECIDE steps to assess the saving option(s) that might be best foryour current situation. (You can learn more about the DECIDE Steps in Module 1:Money Management. The steps are also listed in the Appendix.)BEWARE SAVINGS ENEMY NO. 1Everyone should have savings for short-term and unexpected needs. Forlong-term goals, however, you need to amp up your earnings because of theinflation bandit.The inflation bandit silentlysteals your spending power bydriving up prices of food, gas,clothes—everything—over time.As it costs more to provide goodsand services, those costs areoften passed on to consumers. Ifyou use the inflation calculatorprovided on the U.S. Bureau ofLabor Statistics website (www.bls.gov/bls/inflation.htm), you will see that thesame items you bought for 20 in 2005 would cost you 23.95 to buy in 2013.12INV EST ING : M on ey Wor k i n g f or You

The increase in the cost for the same items is expressed as a percentage(aka inflation rate). The historical long-term annual average for inflation is about3 percent. Even at that growth rate, inflation would slash the value of your dollarnearly in half every 20 years. If you stashed 1,000 in your drawer today, in 20years it would buy only 554 worth of stuff (at today’s prices)!When the rate of inflation is greater than the interest rate on your savings, yourmoney may be growing, but it’s losing spending power. That means you cannotbuy as much with the same dollar later. That’s not good over a long period of time.Is the historical annual average for inflation more or less than thesavings APYs you found for Challenge 4-A?WHEN A DOLLAR IS NOT A DOLLARWould you rather get 100 today or a month from now? Today, of course! Fortwo reasons:»» You’ll save money buying an item now, in case inflation drives up the priceover the next month.»» Waiting a month to save or invest deprives you of a month’s worth ofreturns—which has the potential to help your money grow faster than therate of inflation over time.Both reasons reflect the time value of money (TVM), which basically meansthat a dollar today is worth more than a dollar tomorrow. The shrinking dollaris why investing is a possible way to help you reach your long-term goals.It makes sense to start sooner rather than later to save and invest, so yourmoney can potentially earn more than the rate of inflation.To lear n m ore, vis it www.hs fp p .org13

THE POWER OF NOWWhitney’s intrigued by the factthat her uncle got rich—thanksprimarily to compounding interest.She finds a compound interestcalculator online and starts playingaround with it.She decides to see what wouldhappen if she invested 2,000 ayear starting now, at age 18, thenstopped after 10 years. Using thecalculator’s suggested annualreturn of 7 percent, she tells it tocalculate what the total would bewhen she is age 65.She’s shocked at the results, which she shares with her mom. Her mom chucklesand says, “I know. That’s why I keep trying to get you to save more money now.”Her mom tells Whitney to see what the total would be if Whitney invests the sameamount— 2,000 a year—but doesn’t start until she’s 31 years old. How muchmoney will she have 35 years later?Again, Whitney is blown away. Although she contributed 30 percent less money inthe first scenario, she ended up having a much higher total amount, thanks to themagic of compounding.Activity 4.4: Getting a Late StartAs you can see in the chart, after a late start you have to invest more to catch up tothe amount in an account started earlier. In Whitney’s scenario, what is the cost ofstarting later to invest at age 31 rather than earlier at age 18?14INV EST ING : M on ey Wor k i n g f or You

The Advantage of Starting Early: The Impact of Time on the Value of MoneyWhitney Starting to Invest at Age 18Total Amount Whitney Invested: 20,0007% APRYear-End Balance 2,000 2,140 2,000 4,430 2,000 6,880 2,000 9,502 2,000 12,307 2,000 15,308 2,000 18,520 2,000 21,956 2,000 25,633 2,000 29,567 31,637 33,852 36,221 38,757 41,470 44,372 47,479 50,802 54,358 58,163 62,235 66,591 71,252 76,240 81,577 87,287 93,397Stopping early 99,935after investing 106,931 2,000 annually 114,416for 10 years. 122,425 130,995 140,164 149,976 160,474 171,707 183,727 196,588 210,349 225,073 240,828 257,686 275,724 295,025 315,677 337,774 361,418 636465Whitney Starting to Invest at Age 31Total Amount Whitney Invested: 70,0007% APRYear-End BalanceStarti

4. investing: Money working for you: savings – investing – goals – options – risks & rewards – time value of money – diversification – plan 5. FinanCial serviCes: Care for your Cash: account types – fees – service options – transaction tracking – automation – identity protection 6.