Personal Finance Unit 5

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Questions and Answers

What is the difference between saving and investing?

Saving is putting money away to keep and use later, while investing is putting money in, hoping that it will increase.

Liquidity is how easy it is to turn your money from the savings account into ______.

cash

Define interest.

The cost of using someone else's money.

What does the phrase 'pay yourself first' mean?

Put away money in savings before you spend any of it. Signup and view all the answers

What percentage of your net pay should be put into savings?

10% Signup and view all the answers

How many months of expenses do the experts recommend saving in an emergency fund?

6-9 months Signup and view all the answers

What are the three factors in the concept of the time value of money?

Money, time, interest rate Signup and view all the answers

List and define the five types of savings tools.

<ol> <li>Checking account: method for withdrawing and depositing money; 2. Savings account: designed to hold money not spent on current consumption; 3. Money market account: usually has minimum balance requirements; 4. Certificate of deposit (CD): used for a fixed period with restricted access.</li> </ol> Signup and view all the answers

Why are savings tools considered secure?

They hold your money in a bank, where it is unlikely to be stolen. Signup and view all the answers

What is the Federal Deposit Insurance Corporation (FDIC)?

It insures deposits in banks and thrift institutions for at least $250,000. Signup and view all the answers

Describe the relationship between liquidity and interest for savings tools.

The more liquid an account is, the less interest there is on it. Signup and view all the answers

What is a tiered interest rate?

It's when the amount of interest earned depends on the account balance. Signup and view all the answers

What is the formula for figuring the rate of return?

Total return / Amount of money invested Signup and view all the answers

Define risk.

Possibility of harm or damage on something that is insured. Signup and view all the answers

List and define the six types of investment tools.

<ol> <li>Bond: lending to a company or government; 2. Stock: share of ownership in a company; 3. Real estate: ownership of property; 4. Speculative investments: high-risk investments; 5. Mutual funds: combined funds of different investors; 6. Index fund: mutual fund designed to reduce fees.</li> </ol> Signup and view all the answers

Where do the six types of investments fall on the financial risk pyramid?

Lowest to highest risk: bonds, mutual and index funds, stock and real estate, speculative investments. Signup and view all the answers

What is the relationship between risk and return in investing?

Higher risk = higher return. Signup and view all the answers

Why would you want to invest in a diversified portfolio?

It reduces risk by spreading money among a wide array of investments. Signup and view all the answers

What is the formula for the Rule of 72?

72 / % = years to double. Signup and view all the answers

Study Notes

Saving vs. Investing

Saving involves setting aside money for future use.
Investing aims to grow money over time.

Financial Terms

Liquidity: Ease of converting savings into cash.
Interest: Cost incurred for using borrowed money.
Compound Interest: Earning interest on previously earned interest.
Opportunity Cost: Potential gains missed when choosing one option over another.
Trade-off: Sacrificing one item for another.

Pay Yourself First

Prioritizing savings by allocating a portion of income to savings before spending.

Savings Percentage

Recommended savings rate is 10% of net pay.

Emergency Fund

Experts recommend saving 6 to 9 months' worth of expenses in an emergency fund.

Time Value of Money

Key factors include money, time, and interest rate.

Savings Tools

Checking Account: Easily accessible account for daily transactions.
Savings Account: Designed to hold money not intended for immediate use.
Money Market Account: Requires minimum balance and offers tiered interest rates.
Certificate of Deposit (CD): Restricted access account for a fixed term.

Security of Savings Tools

Savings in banks are secure and protected against theft, with some tools limiting access to funds.

FDIC

Insures deposits in banks and thrift institutions up to $250,000, fostering public confidence.

Liquidity vs. Interest

As liquidity increases, interest rates typically decrease; checking accounts offer high liquidity but low interest.

Tiered Interest Rate

Interest earned can vary based on account balance; higher balances may yield higher interest.

Rate of Return Formula

Rate of Return = Total Return / Amount Invested.

Investment Terminology

Risk: Chance of loss in investment.
Principal: Initial investment amount.
Inflation: General rise in price levels.
Dividends: Cash distributions to stock shareholders.
Market Price: Selling price of a good in a market.
Financial Risk Pyramid: Hierarchical structure of risk levels in investments.
Portfolio Diversification: Spreading investments to mitigate risk.

Types of Investment Tools

Bond: Loaning money to organizations.
Stock: Ownership share in a company.
Real Estate: Holding property or land.
Speculative Investments: High-risk investments with volatile returns.
Mutual Funds: Investment pooling by companies for diverse asset allocation.
Index Fund: Mutual fund that mimics a specific index to lower fees.

Financial Risk Pyramid

Order of risk levels: Bonds (low), Mutual/Index Funds, Stocks/Real Estate, Speculative Investments (high).

Risk and Return Relationship

Higher investment risk often correlates with the potential for higher returns.

Diversified Portfolio

Investing in diverse assets minimizes overall investment risk.

Rule of 72

Formula: Years to double = 72 / Interest Rate Percentage.

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Description

Test your knowledge of personal finance concepts with this quiz focused on saving, investing, and definitions of key terms. Learn about liquidity, interest, and opportunity cost to enhance your financial literacy. Perfect for students studying personal finance in Unit 5.