Personal Finance Chapter 6: Managing Your Money

Personal Finance - Chapter 6: Managing Your Money

• Chapter Objectives:
  • Provide background on money management
  • Describe popular money market investments
  • Identify risks associated with money market investments
  • Explain how to manage money market investment risk

Background on Money Management

• Money management: A series of decisions regarding cash inflows and outflows over a short timeframe.
• Liquidity: The ability to cover cash shortages. This is related to your personal cash flow statement.
• Using credit cards for liquidity:
  • Interest rates are typically high
  • Maintaining liquid assets helps avoid credit card use and high finance charges
  • Aim for optimal returns on short-term investments

Money Market Investments

• Checking Account:

  • Very liquid investment: Easy to access funds
  • Overdraft protection: Short-term loan from the bank if you write a check for more than your account balance. This avoids fees for overdrafts or bounced checks and results in higher interest rates on borrowed amounts
  • Stop payment: Bank's notice to not honor a check if someone tries to cash it (usually at the check writer's request)
  • Direct deposit: Paychecks are directly deposited into your account.
  • Fees: Vary by institution
  • Interest: Usually no interest

• NOW (Negotiable Order of Withdrawal) account:

  • Checking account that pays interest
  • Requires a minimum balance, lowering liquidity

• Savings account:

  • Pays interest
  • Less liquid than checking accounts
  • Often features automatic transfer to different accounts

• Certificate of Deposit (CD):

  • Retail CDs: Small denomination CDs
  • May pay higher interest rates than savings accounts
  • Penalties for early withdrawal
  • Different terms/maturity options available

• Money Market Deposit Account (MMDA):

  • Requires a minimum balance
  • No maturity date
  • Pays interest
  • Allows a limited number of checks per month
  • Less liquid than checking accounts

• Treasury securities: Government debt securities

• Treasury Bills (T-bills): Treasury securities with maturities of one year or less.

  • Purchased at a discount, resulting in capital gains
  • Secondary market: You can buy and sell existing T-bills.
  • Prices are available online and in financial publications

• Money Market Funds (MMFs):

  • Pool money from investors and invest in short-term securities.
  • Typically less than 90 days in maturity
  • Commercial paper: Short-term debt issued by large corporations (often with slightly higher returns than Treasury bills).

• Asset Management Account: Combines deposit and brokerage accounts.

  • Sweep Account: Any unused balance in brokerage account is automatically transferred into a money market investment at the end of each business day

Money Market Investment Comparison (Advantages & Disadvantages)

• See the details in the provided table.

Risks of Money Market Investments

• Credit risk: Risk that a borrower may not repay on time.
• Interest rate risk: Risk of investment value declining due to changes in interest rates.
• Liquidity risk: Potential loss when converting investments into cash.

Risk Management

• Consider the risk-return tradeoff before making investment decisions.
• Many money market instruments are not subject to credit risk.
• Money Market Funds carry some credit risk because they may hold commercial paper.
• Optimal allocation: Anticipate upcoming bills, estimate future fund needs, invest remaining funds that maximize returns.

Risk Management (Continued)

• Recent lower interest rates: Resist urge to shift money from money market investments to stocks given lower risk.
• Money market investments have a distinct function which is easy access to funds.

Optimal Allocation of Money Market Investments

• Need for much liquidity: Allocate funds to extremely liquid investments.
• Need for little liquidity: Allocate funds to non-liquid investments.

This quiz covers key concepts from Chapter 6 of Personal Finance, focusing on effective money management and popular money market investments. You'll learn about liquidity, risks associated with investments, and strategies to manage investment risks efficiently.