Personal Finance: Week 10 - Personal Risk Management PDF

Personal Finance Week 10: Personal Risk Management Learning Objectives A. Risk Assessment and Strategies B. Protecting Income C. Protecting Property A. Risk Assessment and Strategies Risk is the chance of injury, damage or economic loss. Loss refers to some type of...

Personal Finance Week 10: Personal Risk Management Learning Objectives A. Risk Assessment and Strategies B. Protecting Income C. Protecting Property A. Risk Assessment and Strategies Risk is the chance of injury, damage or economic loss. Loss refers to some type of physical injury, damage to property or absence of property or other assets. Probability is the likelihood of a risk actually resulting in a loss. Personal Risk means you could lose something of personal value to you. 1. Risk of Financial Loss - refers to a cost in terms of money. 2. Risk of Financial Resources - refers to a risk that you may lose your ability to earn in the future or assets you acquire in the future. Risk Assessment - identifying what the risks are and deciding how serious they are. Sample Risk Assessment for Sally Edwards Risk Probability of Seriousness Rating Possible Occurrence Consequences Losing my job Medium 10 Payments could be missed. Credit rating suffers. Car accident Unknown 10 Personal injury lawsuit. Physical injury from Medium 3 Missed work time. snowboarding Medical bills. Having bike stolen Low 2 Have to buy a new/used bike. *1 is a Low Risk; 5 is a Medium Risk; 10 is a High Risk Risk Strategies 1. Reducing Risk - means finding ways to change actions or events so that your chance for loss is less. 2. Avoiding Risk - means to stop the behavior or avoid the situation that leads to the risk. 3. Transferring Risk - when you face substantial risk that you cannot or do not wish to reduce or avoid, transferring risk is a good idea. You transfer the risk by buying insurance. The price you pay for insurance is called a premium. 4. Self-insuring - means to set aside money to be used in the event of injury or loss of assets. B. Protecting Income 1. Health Insurance is a plan for sharing the risk of medical costs from injury or illness. 1.1. Types of Plans 1. Fee-For-Service Plans Allows patients to choose doctors and other providers for medical services. The insurance policy has a deductible. The insured pays expenses equal to the deductible amount. Then the insurance company pays a percent, such as 80 percent, for covered services. A fee-for-service plan is often called unmanaged care. This type of coverage is often more expensive than managed care plans that offer fewer choices of doctors and other care providers. 2. Preferred Provider Organization Plans A preferred provider organization (PPO) is a group of health care providers (doctors, hospitals, clinics, and labs) that work together to provide health care services. Patients choose caregivers from approved lists. Lists include doctors, hospitals, clinics, and labs that will bill the PPO for services. A co-pay is an amount you must pay each time you use a medical service. 3. Health Maintenance Organization Plans A health maintenance organization (HMO) is a managed care group plan that has prepaid medical care. HMOs usually have their own facilities (clinics and hospitals) and offer a full range of services. Patients must choose doctors on the HMO staff, including one doctor to be the primary care doctor. 1.2. Types of Health Coverage 1. Basic Health Care Coverage includes medical, hospital, and surgery services. It pays for doctor fees, office visits, and lab work. Approved hospital costs and surgeries are also covered. Cosmetic and elective surgeries are usually not covered. 2. Major Medical Major medical coverage protects against very serious injury or illness. It pays for services beyond basic health care. 3. Dental and Vision Dental plans often have deductibles and co-pays. Vision coverage often provides for an eye exam and part or all of the cost of glasses. 4. Catastrophic Illness  Policies provide protection should you get cancer or some other disease or condition that might cost hundreds of thousands of dollars to treat. 1.3. Managing Costs 1. Deductibles and Co-Pays When deductibles and co-pays are higher, premiums are often lower. Having higher deductibles and co-pays is one way to reduce health insurance premiums. Money must be set aside, however, to pay for expenses up to the deductible amount. 2. Stop-Loss Provisions Provides 100 percent coverage after a certain amount of money has been paid for medical expenses. 3. Health Savings Accounts A health flexible spending arrangement (FSA) allows people to set aside money to pay for qualified medical expenses. A health savings account (HSA) may also be set up individually rather than through an employer. 2. Disability Insurance provides money to replace a portion of normal earnings when the insured is unable to work due to an injury or illness that is not job-related. 2.1. Short-Term Disability Insurance Short-term disability insurance usually begins after a waiting period of 30 days. 2.2. Long-Term Disability Insurance Long-term disability coverage usually begins in 6 months to 2 years. 3. Life Insurance pays money when the insured person dies. The purpose of life insurance is to provide money to a beneficiary, the person designated to receive money. Reasons why people buy life insurance: 1. To pay off a home mortgage and other debts at the time of death 2. To provide money for a spouse and children to maintain their lifestyle 3. To pay for education for children 4. To make charitable bequests at death 5. To accumulate savings 6. To pay inheritance and estate taxes 7. To provide cash value that can be borrowed later  3.1. Term Life Insurance is a policy that provides a death benefit. It is in effect for a specific period of time, such as 20 years. 3.2. Permanent Insurance provides a death benefit and builds cash value. 3.2.1. Whole Life A common type of permanent insurance is called whole life insurance. It is also known as straight life or ordinary life insurance. The insured pays premiums as long as the policy is in effect. 3.2.2. Limited-Pay Life Limited-pay life insurance is a policy on which the insured pays premiums for a limited period of time, such as 20 years. At the end of the period, the policy is paid up. The insured pays no more in premiums, but the life insurance remains in effect until the age limit of the policy. The policy will pay the face value when the insured dies as long as it is in effect. This type of life insurance also builds cash value. 3.2.3. Universal Life Universal life insurance provides a death benefit. However, the premium and death benefit are not fixed. The policyholder can change the death benefit and the premiums during the life of the policy. The advantage of this type of plan is that it allows the policyholder to adjust the death benefit and premiums to fit changing needs. 3.2.4. Variable Life Variable life insurance is a form of permanent insurance that provides a death benefit and builds cash value. The premiums are fixed. Part of the premium is invested in securities chosen by the policyholder. The rest of the premium is used for life insurance. 3.3. Group Life Insurance When a life insurance policy is purchased through an employer or an organization. Group life insurance has much lower premiums than individual policies. Portable insurance can be taken with you when you leave your job. In other words, the group policy becomes an individual policy at the same premiums. Having this feature makes it possible for people who would not otherwise qualify to have life insurance. C. Protecting Property 1. Homeowner’s Insurance protects the policyholder from risk of loss in the home. It covers the building and its contents. This includes personal property, such as furniture, appliances, clothing, and home decorations.  1.1. Types of Coverage 1.1.1. Fire and other hazards The risk of this type of loss is unpredictable, and the consequences can be very serious. Protection extends not just to your home but to a garage or shed, trees, plants, shrubs, and fences. The policy might also cover costs of lodging while your house is being repaired. 1.1.2. Criminal Activity Your house could be broken into, vandalized, or suffer damage as a result of other criminal acts. You may not be able to prevent these things from happening. 1.1.3. Personal Liability If someone is injured on your property, you are responsible for her or his injuries. 1.1.4. Acts of Nature Some areas of the country can have hurricanes, floods, volcanoes, and earthquakes. These acts of nature can do a great deal of damage. 1.2. Home Inventory When items are stolen from your home or destroyed or damaged, you must file a claim with the insurance company in order to be paid for the items. To be prepared in case you need to file a claim, you should create a home inventory. The inventory should list all the items of value in your home. Ideally, the inventory should include the number of items, when they were purchased, and the original cost. Record as much of this information as you can. Attach any receipts that you have for expensive items. Record serial numbers for items such as appliances and computers. The inventory should include a place to list the replacement cost of the item. 2. Renter’s Insurance protects renters from the risk of losing personal property. Loss could occur from fire, smoke, theft, freezing, water damage, or other hazards. A renter’s policy covers the cost of repairing or replacing personal property. 3. Automobile Insurance protects the owner of a car from losses as a result of accidents. The cost of car insurance depends on many things, such as the model and style of car and the age and driving record of the insured. 3.1. Types of Coverage 3.1.1. Liability protects against loss as a result of injury to another person or damage to that person’s property. It pays nothing for the insured person’s own losses.  3.1.2. Collision coverage protects you from damage from being hit by another car or rolling over. It will pay for damage to your car if you are at fault. Collision coverage usually has a deductible. 3.1.3. Comprehensive - damage to your car from causes other than collision or rolling over is provided by comprehensive coverage. 3.1.4. Personal Injury protection pays for medical, hospital, and funeral costs of the insured, that person’s family, and passengers. Discounts are available if you have airbags and other safety devices to reduce injuries. 3.1.5. Uninsured/Underinsured Motorist - when another person is driving while uninsured or without enough insurance (underinsured) and causes an accident, this insurance pays your costs. 3.1.6. Towing/Rental Car - Full coverage often provides for towing charges when your car is not in running order. While your car is being fixed, your insurance may also cover the cost of a rental car. 4. Umbrella Insurance provides coverage in addition to car and home insurance. It protects you from catastrophic losses. It pays for accidental injuries caused to other persons while you are driving or in your home. It protects you from extraordinary losses. Week 11: Buying Decisions Learning Objectives A. Designing a Buying Plan B. Getting Started with Credit C. Computing Costs of Credit A. Designing a Buying Plan Impulse buying is when you do not think about a purchase ahead of time. You see an item that looks appealing and buy it right away. This type of buying often leaves the buyer feeling dissatisfied and wishing he or she had chosen more wisely. A buying plan is a method for making good buying decisions. List the steps of a buying plan 1. Set Criteria - Once you have decided to buy a good or service, you should set criteria for the item. Criteria are standards or rules by which something can be judged. 2. Set a timeline - For each item you want to buy, decide how soon you want to make the purchase. The timeline may depend on some activity, such as buying a new dress for graduation. Putting a time frame on each planned purchase will help you prioritize. You may choose to drop some items from your list because buying them is not practical. 3. Set a spending limit - A spending limit is the maximum amount you are willing to pay for an item. Based on the need or want that is being met, how much money are you willing and able to spend? By setting an amount, you know the spending limit. You will not be tempted to spend more than you have planned. Set criteria for selecting one item over another to buy 1. Comparison shopping - Comparison shopping leads to better buying decisions. You can make a better choice when you know all of the options available. Check several sources to find data on prices and features of the product or service. You may find that some items are on sale or offer rebates. A rebate is a refund of part of the purchase price of an item. 2. Payment methods - Knowing in advance how you will pay for a product or service puts you in a better position to bargain. B. Getting Started with Credit Sources of Credit Credit is the ability to borrow money with the agreement to pay it back later. The repayment usually includes interest. The purpose of credit is to allow buyers to purchase items at the present time and pay for them in the future. 1. Service Credit - Service credit is the ability to receive services and pay for them later. Examples of service credit include the use of electricity, water, sewer, and other utilities. You may also receive service credit from doctors, dentists, and  others. You may not think of it as credit, but you are receiving services now and paying for them later. Some companies that offer service credit require you to pay a deposit when you begin using the service. After your payment history is known, the deposit may be refunded to you. 2. Bank Credit Cards - Credit cards are available from banks and other companies. These cards are usually issued through a provider such as VISA® or MASTERCARD®. With a credit card, you can buy products or get cash at ATMs around the world. Bank credit cards are a type of revolving credit. With revolving credit, the account holder can charge to the account as often as desired, up to a certain dollar limit. The account holder makes payments, usually each month. The entire debt or part of the debt can be paid each month. This means that the account can have an ongoing balance. However, a minimum monthly payment is usually required. Interest is charged on outstanding balances. Interest on credit cards can be quite high. Bank cards also often charge an annual fee. 3. Store Accounts - Department stores, gas companies, and other retail merchants may offer their own credit accounts. The account holder may receive a credit card to use in making purchases. Unlike bank credit cards, store accounts allow you to charge items or services only at that store or with that merchant. These accounts often have high interest rates and require monthly payments. Using store accounts can lead to less comparison shopping when people simply buy where they have accounts. Store accounts can be revolving credit accounts, or they can be installment plans. With installment credit, an amount is set for the purchase. Payments are made and the balance is paid off in a set period of time. For example, a customer might buy a refrigerator for $800 and agree to pay 18 percent yearly interest on a 3-year payment plan. Figure 7-2.2 shows the payments and interest for this plan. 4. Charge Cards - A charge card is a form of credit card because you buy now and pay later. With charge cards, however, you pay the balance in full each month. Because there is no interest or service fee, these cards often require a large annual fee. 5. Loans - Banks and other companies loan money to consumers. Consumers can get different types of loans. An installment loan is similar to an installment plan for a store purchase. A set amount is borrowed at a certain interest rate for a set period of time. 6. Lines of Credit - is a preapproved amount that a debtor can borrow when needed. It is available through banks, credit card companies, and other lenders. The borrower must fill out a credit application. The maximum amount that can be borrowed is set. No interest is charged until the debtor uses the line of credit. A line of credit is a good thing to have so you know how much you can borrow for something such as a car or a remodeling project. Benefits of Credit 1. Convenience and Rewards  Credit cards and store accounts offer convenience to consumers. Many people prefer to use credit cards for purchases instead of carrying large amounts of cash. Some companies to which consumers make regular payments accept credit cards. The account can be set up to be billed to a credit card each month. Utility companies and Internet service providers are examples of businesses that offer this option. Paying one credit card bill each month is easier than paying several bills to different companies. Consumers can get cash advances with so 2. Increased Spending Power Without credit, many people would have lower standards of living. They would have to wait to buy things that can save them time and money. For example, a consumer might have to save money for a year to have the purchase price of a washer and dryer. By using credit, the consumer can purchase the washer and dryer when needed. A small down payment might be required. The remaining cost, along with interest, can be repaid over the course of a year or two. During this time, the consumer is able to use the washer and dryer. Using credit allows some people to buy expensive items that they might never save enough to pay for at once. For example, many people do not have enough money to pay the full purchase price of a house. Having a home loan 3. Records and Protection Credit card receipts provide you with records of what you have bought using the card. You can use receipts for returning goods, as well as getting adjustments. Having the receipts also allows you to verify your purchases against the credit card statement. Using credit gives you advantages when resolving some disputes with merchants. For example, suppose you purchased an item on the Internet. The seller says you can expect delivery within two weeks. Five weeks go by, however, and you have not received the item. When your credit card bill arrives, you find you have been charged for the item. Because you have used a credit card as payment, you can dispute the charge with your credit card company. C. Computing Costs of Credit Explain the difference between fixed and variable interest rates 1. Fixed rate - the interest rate is set and does not change each month or year. 2. Variable rate of interest - the lender or credit card company can change the rate often. Variable rates tend to rise fast when interest rates in general go up. Use three different methods for computing finance charges 1. Adjusted Balance Method - the balance at the beginning of the period is added to charges made during the period. The payment received is subtracted from this amount to find the adjusted balance. The adjusted balance is multiplied by the interest rate and the time to find the interest amount. The interest amount is added to the adjusted balance to find the new balance (amount owed). 2. Previous Balance Method - interest is calculated using the outstanding balance at the end of the previous billing period. Charges in the current billing period are not included. Interest is calculated by multiplying the previous balance times the interest rate times the time. The new balance is the previous balance plus interest plus charges minus any payments made. 3. Average Daily Balance Method - an adjusted balance is computed for each day of the month. The adjusted balance is the balance from the previous day plus charges and minus payments received on that day. The adjusted balances for all days are added and then divided by the number of days. This amount is the  average daily balance. The amount is multiplied by the interest rate and the time to find the interest amount. The interest is added to the balance on the last day of the billing period to find the new balance (amount owed). Describe penalties and fees imposed by credit card companies Minimum Payments - The minimum payment is how much you must pay each month on a credit account. If you pay only the minimum, it could take many years to pay off a balance. The interest charges could cost you more than the purchase itself. This payment includes both principal and interest. Higher minimum payments help you pay off debt sooner. However, higher payments also give you less flexibility in managing your budget. The minimum payment can be changed at any time. The creditor may decide to increase the minimum, and you will have to pay that amount. This could be difficult if your budget is already tight. Penalties - is a fee charged for violating the credit agreement. Late payments can also cause your interest rate to rise. Many credit agreements state that if you are late with a payment or miss a payment, your interest rate will increase. Over the limit fee - Many credit card accounts have a set limit to the amount you can charge at any one time. If you try to charge more than your limit, the charge may be refused. In other words, your purchase is not approved at the time you check out and try to pay using the credit card. The credit card company may approve the charge even though it is over your limit. Week 12: Preserving your Credit A. Identifying Financial Issues B. Long-term Debt Repayment C. Credit Management Paying for Credit 1. Payment Methods a. Manual Payment i. Cash - Cash is a traditional payment option. Many people prefer to deliver cash to local stores and banks rather than mail a check. An advantage to using cash is that cash is accepted everywhere for payments. Be sure to get a receipt for any payment you make in cash. The receipt serves as proof of payment and is another advantage to this payment method. A disadvantage to paying with cash is that carrying large amounts of cash can be unsafe. You may be robbed, or you may lose the money. Another disadvantage is that the cash must be delivered in person. Never send cash through the mail. ii. Personal Check - is another traditional payment option. The check can be mailed or delivered in person. Before you write the check, compare the bill with your receipts to be sure everything is correct. iii. Money Order - is a type of check that directs payment of a sum of cash to a payee (a person or company). iv. Bank Check - You can purchase a cashier’s check at a bank or credit union. You can pay for the check in cash or have the money taken from your account with the bank. An advantage to using a cashier’s check is that it is prepaid. The payee is guaranteed payment. A certified check is a personal check for which payment is guaranteed by the bank on which it is drawn. To use this payment option, you write a check and have the bank certify it. The bank sets aside from your account the amount of the check. This amount will be used only for payment of the certified check. When the check is presented for payment, the money is waiting. An advantage to using a certified check is that it is prepaid. The payee is guaranteed payment. b. Electronic Payments i. Online and Telephone Payments - You may be able to make payments online at the creditor’s Web site. At the Web site, you access your account with a username and password. Then you enter your bank account information. This includes the bank routing number and checking account number. ii. Online Banking - allows you to make payments and manage your account using the bank’s or credit union’s Web site. Convenience is the main advantage to online banking. iii. Automatic Payments - occur when you ask the bank to transfer money electronically from your checking account to some other account.  iv. Wire Transfers - is the process of sending money electronically rather than using paper checks. This service is available from companies such as Western Union. Banks and other financial institutions also do wire transfers for their customers. The sender pays the amount of the money transferred plus a fee. The money is delivered to a designated location where the recipient can collect it. c. Prepayment Penalty - is a fee charged when you repay a loan before the agreed-upon time. 2. Consumer Loans Types of Loans a. Personal Loans - Loans that are based on personal creditworthiness. The borrower submits a loan application asking for a fixed amount of cash. The amount of the loan that a creditor will approve is based on factors such as the following: i. The purpose for which the money will be used ii. The borrower’s credit payment history iii. The borrower’s existing debts and current payments to other creditors iv. The borrower’s monthly and yearly income v. The borrower’s job security (whether the job is likely to continue) b. Secured Loan - is a debt agreement in which the borrower pledges property of value as security. This property is called collateral. Some borrowers do not have property that can be used as collateral. In this case, another person may agree to serve as a cosigner on the loan. A cosigner is a person who agrees to repay the loan if the borrower does not repay the loan. The cosigner typically must have property that can be used as security for the loan or a very good credit rating. i. Car Loan - The car itself serves as collateral. The creditor holds the title to the car until the loan is paid in full. If the borrower cannot make the payments as agreed, then the car is repossessed and sold by the creditor to pay off the debt. ii. House Loan - A mortgage is a loan that is used to secure financing for the purchase of a house or other real estate. The mortgage usually requires 10 to 30 years of monthly payments. A mortgage is a form of secured loan. If you do not make payments as agreed, you can lose the house. Some mortgages have prepayment penalties. The borrower must pay an extra fee if the loan is repaid before a set period of time, such as 5 years. Adjustable Rate Mortgage (ARM), the interest rate on the loan can change over time. As interest rates go up or down in the economy, the mortgage rate can change as well. If the rate goes up, the payment amount increases. The term of the loan may also increase. A balloon payment is a large sum that must be paid at a set time. The balloon payment is typically the last loan payment.  Closing Costs are expenses you must pay in order to get a loan. They include charges for items such as appraisal fees, credit report fees, loan origination fees, recording costs, and inspection fees. Closing costs can be hundreds or even thousands of dollars. iii. Amortization - repaying a debt by making regular payments of principal and interest over a period of time. c. Student Loan - is debt that is used to finance education costs. Student loans can be secured from banks and other financial institutions. Lease/Rent-To-Own - Another way of buying is by leasing or renting to own. You select an item, such as a television. You take the item home and use it just as if you had purchased the item. 3. Credit Tips a. Using Credit Wisely i. Consider the economy - When the economy is doing well and people can get jobs easily, consumers may feel optimistic about the future. This optimism often leads to increased buying. When credit is used to buy more items, future income may be tied up as well. During good economic times, interest rates are usually rising. Thus, rather than buying on credit, this could be a good time to save money. ii. Study Credit Offers 1. Interest Rates - Are they fixed or variable? How often can they change? What will cause them to change? Fixed rates often do not stay fixed and can be changed with some notice from the creditor. 2. The grace period - the amount of time you have before a credit card company starts charging you interest on your new purchases. Most credit offers allow for a grace period of at least 20 days. The longer the grace period, the longer you have to pay without being charged interest on the purchase amount. 3. Method of computing interest - Many creditors use the two-cycle average daily balance method. This means if you have a balance any time during the two-cycle billing period, you will be charged a finance charge. A billing cycle is typically about 1 month. This method is not good for consumers. 4. Annual Fee - Some credit cards charge an annual fee or a membership fee. 5. Minimum finance charge - Some credit cards require a minimum charge of $1 or more for each billing period. 6. Transaction fees - If you transfer balances from other credit accounts, you may be charged a transaction fee. 7. Cash Advances Fee - Some credit cards allow you to take cash advances at ATM machines and at banks. There is often a fee for this type of transaction.  8. Late Fees and Over-The-Limit Fees - The fee may depend on the balance on your card. Having late fees or over-the-limit fees can cause the interest rate you are charged to rise. b. Reduce and Avoid Costs i. Keep the number of credit cards and accounts you have to a mini mum. Avoid having an account at every store in town and with every bank card available. Only carry with you the cards you will be using. ii. Comparison-shop when getting a loan. Compare the costs of credit from at least three different sources. iii. Consider financing and special deals arranged by the seller. A sales finance company is a type of lender that makes loans for the purchase of consumer goods, such as cars or household appliances. The finance company may also purchase time-sales contracts from merchants. The finance company often works closely with the seller. This makes it easy for customers to arrange financing at favorable terms. iv. Use credit to take advantage of sale prices. With the help of credit, you can buy things on sale that you would not buy if cash were your only option. Thus, you can avoid higher prices and save money. v. Time your credit purchases. If you buy right after the closing date of your billing cycle, you may be able to delay payment for 2 months after the purchase. vi. Take advantage of cash rebates and rewards. Many credit cards offer rebate programs. A rebate is a partial refund of the purchase price of an item. Week 13-14: Investment Concept and Strategy Learning Objectives: 1. Meaning and Concept of Investment 2. Characteristics of Investment 3. Investment Environment and Investment Management Process 4. Sources and Investment of Risk 5. Investment Strategies Understanding Saving and Investing 1. Reason for Saving and Investing The purpose of saving is to accumulate money for future use. Saving money is important because it means you are planning for future needs and wants. When you are saving money, the emphasis is on safety. Investing money is another way to plan for future needs. The purpose of investing is to make your money grow. Investing is sometimes explained as using money to make more money. Stocks - which are shares of ownership in a corporation. Money in a savings account or money market account that you plan to leave there for a long time can be considered a type of investment. a. Short-Term Needs Saving is a good way to have money to handle short-term needs or wants that are not part of your regular spending. For example, you may want to save money to pay for a trip or to purchase a home theater system. Savings can also be used to handle unexpected expenses, such as repairs to a roof that is damaged by a storm. Savings accounts are considered liquid assets. Liquidity is a measure of the ability to turn an asset into cash quickly. i. Contingency Planning Contingencies are emergencies or other unplanned or possible events. An emergency fund is an amount of money you set aside for unplanned expenses. ii. Vacations Taking vacations is a healthy thing to do. Many people want a break from time to time—to get away from the usual stresses in life. A vacation also helps refresh tired minds and bodies so that people are ready to go back to school or work. Vacations can be simple and inexpensive, such as going camping or hiking. Vacations can be elaborate and expensive, such as flying to Europe for a 2-week stay in a resort. Setting aside money for vacations allows you to plan for the kind of vacations you would like to take. b. Long-Term Needs i. Education College expenses can be met with a plan that includes loans, scholarships, spending savings or money from investments, and working.  You could start saving now to have money for this need. Parents of young children can invest money that will grow while the children grow. Money from the investment can be used to pay for education when the children reach college age. ii. Buying a House A house can be a good investment that grows in value over several years. Buying a house may require using savings. Savings may be used to buy a home or to make a down payment on a home. iii. Providing for a Family Many people plan to have children in the future. These people need to plan for the expenses involved in raising children. Housing, food, clothing, medical care, and child care are examples of expenses parents must meet for at least 18 years. iv. Financial Security Financial security is the ability to prepare for future needs and meet current expenses to live comfortably. For most people, financial security is built on saving and investing. It means having enough resources so that you will have enough to eat, proper clothing, a safe and comfortable place to live, medical care, and other items that you need. v. Retirement Planning Retirement planning should begin the day you start working. You can begin thinking about retirement even earlier, as you choose a career. Think about what you would like to do and how you would like to live when you retire. 2. Saving and Investing Principles a. Growth of Principal When money is set aside for savings, it should be growing. That is, the principal amount on which interest is computed should get larger over time. The principal grows when you deposit more money into the account. The principal can also grow through compounding interest. With compound interest, the interest amount is calculated for the first period. b. Return on Investment When you put money into savings or an investment, you expect the value of the savings or investment to grow. The amount that the savings or investment grows is called the return. Return on investment (ROI) is a measurement of return given as a percentage. ROI tells how much you will receive, either in cash (such as interest on a savings account) or in increased value (such as with real estate). c. Risk and Return When selecting an investment, the buyer must weigh the risk involved against the possible return expected. The higher the risk you are willing to take, the greater your possible return may be. If you are not willing to take much risk, then you cannot expect high returns. i. Investment Risk - is the potential for change in the value of an investment. For example, when you buy stock in a company, you risk having the stock price fall. If the company goes out of business, the stock may become worthless. In this case, you may lose the money you invested. ii. Inflation Risk - is the chance that the rate of inflation will be higher than the rate of return on an investment. When this occurs, your investment loses value. A bond is a debt instrument that is issued by a corporation or government. The issuer must pay the bondholder the principal (the original amount of the loan) plus interest when the bond matures. iii. Industry Risk - is the chance that factors that affect an industry as a whole will change the value of an investment. iv. Political Risk - is the chance that an event in politics (laws, policies, wars, or elections) will affect the value of an investment. v. Stock Risk - Stock in a company can go up or down in value. Stock risk is the chance that activities or events that affect a company will change the value of an investment. d. Tax Advantages When you set aside money for future retirement, such as in an IRA (individual retirement arrangement), the money may be tax-deferred. Tax-deferred means that there are no taxes on gains until the money is taken from the account. Also, you may not have to pay taxes on the amounts placed in the account until later.  This tax advantage allows your investment to grow for years without being taxed. When you retire and take money from the account, you may be in a lower tax bracket. You are taxed only on the portion you take out of the account. 3. Saving and Investing Strategies a. Systematic Saving and Investing Systematic means regular, orderly, or done according to a plan. Systematic saving is a strategy that involves regularly setting aside cash that can be used to achieve goals. Once money is set aside in savings, ideally it should remain there until used to meet a planned goal. The amount should be the most you can comfortably afford to save each pay period. Systematic investing is a strategy that involves a planned approach to making investments. Systematic saving and investing is important for building financial security in the long term. i. Long-Term Focus A saving and investing plan is designed for growth in the long run, not for short-term results. Investors may need to hold investments for 20 or more years to get the returns they want. In any given year, investments may actually lose money. Over time, however, gains exceed losses on sound investments. ii. Dollar-Cost Averaging A person invests the same amount of money on a regular basis, such as monthly. The amount is invested regardless of whether prices are high or low. Sometimes the investor pays more and gets fewer shares. Sometimes the price is low and more shares are purchased. Overall, the dollar cost per share may be less than the average price. Using this strategy, investors do not have to study the stock market and try to determine the best time to buy stocks. b. Diversification Diversifying is a very important saving and investing principle. Diversification is holding a variety of investments for the purpose of reducing risk. When one type of investment goes down in value, there may be others that go up. Thus the losses of one area are offset by the gains in others. It is important for investors to choose more than one type of investment. All of a person’s savings and investments make up that person’s invest ment portfolio. An investment portfolio is a collection of assets, such as certificates of deposit, stocks, bonds, real estate, and other holdings. In order to lower risk over time, the portfolio should be diversified. A portfolio should have a strong foundation of safe investments. c. Understanding the Market The market refers to any place where investments are bought and sold. There are stock markets and bond markets. There are real estate markets and markets for precious metals such as gold and silver. For most things that an investor may want to buy or sell, a market exists. The term market is also used to refer to price levels or other market conditions. i. Bull Market A bull market exists when stock prices are steadily increasing. A bull market may last a few months to a few years. During a bull market, price advances are often followed by profit-taking. Profit-taking occurs when people who own stocks that have increased in price sell those stocks. This selling activity may cause prices to drop for a while. The bull market does not end, however, because a few stocks drop in price. As long as the general trend is toward increasing stock prices, it is still considered a bull market. ii. Bear Market A bear market exists in the stock market when prices are steadily decreasing. Bear markets may last from a few months to a year or more. This is a good time to buy stocks that are sound investments because prices are lower. At times in a bear market, there is a lot of buying activity. This can cause a temporary rise in stock prices. The bear market does  not end, however. As long as the general trend is toward declining stock prices, it is still considered a bear market. Savings and Investing Options 1. Low-Risk Investment Options a. Savings Saving is setting aside money to meet future needs. Having savings to handle short-term needs is especially important. A checking account or savings account in a bank that has no restrictions on withdrawals is an example of a safe, liquid savings option. Interest earned on the account may be very low. Low return is acceptable because the purpose of the account is to have funds available when needed. Keeping a certain minimum balance in a checking or savings account may have other advantages. i. Savings Accounts A savings account in a bank, credit union, or other insured financial institution is a good option to choose for meeting short-term needs. Savings accounts in banks are low-risk. Savings accounts are liquid. ii. Money Market Accounts A money market account is another good option to choose for liquid savings. This type of account pays the market rate of interest on the money deposited. A money market account is liquid. You can withdraw some or all of the money at any time. Money market accounts may have some restrictions. iii. Certificates of Deposit A certificate of deposit, also called a CD, is a time deposit. This means that the money you deposit is set aside for a fixed amount of time at a set interest rate. A typical CD is not a liquid investment. You must pay a penalty if you withdraw the money before the stated time. CDs purchased at banks and credit unions are safe because they are insured by the FDIC. 1. Withdrawal Penalties If you redeem a CD early, you will typically pay a penalty. Be sure to ask about the penalty if you buy a CD. Early withdrawal penalties are meant to discourage depositors from withdrawing the money before the stated time period. 2. Special Features CDs pay higher interest when money is set aside for a long period of time. They also pay higher interest for large amounts. b. Investments Investments vary in term, risk, rate of return, and relative liquidity. Options that are low-risk typically pay a lower rate of return than those with higher risk. Options that are long-term typically pay higher rates than those that are short-term. i. Saving Bonds  A bond is basically a loan that a buyer makes to a bond issuer. The bond issuer may be a government or a corporation. The bond is designed to be a long-term investment. ii. Corporate and Government Bonds 1. Corporate Bonds - Corporate bonds are issued by corporations to raise money. Bonds are a form of borrowing for the company. The money is used for various purposes, such as building new factories or buying equipment. Corporate bonds pay a fixed coupon rate. The interest is subject to income tax. Any amount you gain when you redeem the bond is also taxed. 2. Government Bonds - These bonds are low-risk when held to maturity. You do not have to pay state and local taxes on the income from some government bonds. These bonds make a good tax shelter. A tax shelter is an investment that allows you to legally avoid or reduce income taxes. iii. Brokerage Accounts - You can open an account at an investment company. This account may pay interest like a savings account, or it may be a clearing account. A clearing account is an account used to buy and sell investments. Money is taken from the account to buy them. When they are sold, money is put back into the account. Brokerage accounts are not insured. However, they are considered low-risk when placed with a reputable investment company. The accounts work a lot like a checking account. iv. Annuities - an annuity is a contract purchased from an insurance company. It guarantees a series of regular payments for a set time. To buy an annuity, you would pay a monthly payment into the account for a set number of years. You could also invest a lump sum. Then, at the end of the set number of years, the annuity would start paying you monthly payments. Many people who buy annuities use them as a source of retirement income. v. Life Insurance Plans Life insurance provides a low rate of return on your money. However, it also provides death benefits. Many life insurance policies allow you to borrow money. If the loan is not repaid, the life insurance death benefit is reduced by the amount of the loan. 2. Medium-Risk Investment Options a. Retirement Accounts Retirement accounts are a good way to save for the future. This means you must also manage them, or make choices about how to save or invest the money. i. Individual Plans 1. IRA Accounts  An IRA (individual retirement arrangement) allows individuals to deposit money into an account during their working years. The money deposited may be tax-deductible. Taxes are paid on the money and interest earned when the money is withdrawn during retirement. Money set aside for a traditional IRA can be deducted from gross income if you meet certain requirements. This lowers your income tax. IRAs are tax-deferred, which means you will not pay taxes on the money earned until it is withdrawn. IRA accounts can be set up at banks and other financial companies. You can choose the types of investments. If you choose a Certificate of Deposit rather than stocks, you will take less risk, but you will also have lower returns. IRA accounts are managed by the investor. They are a good long term plan for providing retirement income. 2. SEP Accounts The SEP (simplified employer plan) is similar to an IRA. It is for self employed small business owners and their employees. SEPs work like IRAs, except that the amount of money that can be set aside is higher. SEP contributions are deducted from gross earnings. This money is not taxed until it is withdrawn. As with an IRA, the investor chooses how the money is invested. 3. Keogh Accounts A Keogh account is similar to a SEP, but it has more complex filing rules. It also has higher limits and is available to self-employed professionals and their employees. ii. Employer-Sponsored Plans Many employers provide some type of retirement plan for their employees. Often it is part of the employee’s benefits package. These plans are sometimes very good options for workers. You can set aside money pretax. In some cases, the money you set aside may be matched by money contributed by the employer. Although you will pay taxes when you withdraw the money, the plan is a good option for providing retirement income. 1. 401(k) Accounts A 401(k) plan is a tax-deferred plan for employees. The employee sets aside money each month with a pretax payroll deduction. There is a limit to the amount the employee can contribute. These accounts and their earnings are not taxed until the money is withdrawn. At retirement, they are taxed as ordinary income. Employer contributions are optional. Sometimes companies match a certain percentage of employee deposits. 2. 403(b) Accounts A 403(b) account is a retirement plan for employees of nonprofit organizations or educational institutions. Teachers, school staff, nurses, doctors, professors, librarians, and ministers are examples  of people who may qualify for a 403(b) plan. Some employers offer tax-sheltered annuities for their 403(b) retirement plans. Money is set aside by workers through payroll deduction. It is not matched by employers. The employee is allowed to choose investments for the money deposited. As in other retirement accounts, earnings and contributions are not taxed until the money is withdrawn. 3. Pension Plans Some employers offer retirement accounts that are paid for entirely by the employer. These accounts are called defined benefit plans or simply pension plans. Pension plans provide payments to retired workers. Typically, employees must work for the company for a certain number of years to qualify. The payment amounts vary depending on the number of years worked, the worker’s salary, and other factors. b. Portability Many retirement accounts are portable. This means you can take the account with you when you leave a job. Rollover is the process of moving an investment balance to another qualified account. Once the account is vested, you can also take with you money your employer contributed to the account. An account is vested when the employee has met certain requirements, such as time of employment. When you are vested, you have rights to the account. Vesting often occurs after 3 to 6 years of continuous employment. c. Investments with Medium Risk Medium-risk investments will increase your return without raising the risk beyond reason. With many medium-risk choices, the investor can choose how much risk he or she is willing to take. i. Mutual Funds - is operated by a professional investment firm. The firm sells shares in the mutual fund and invests the money in a variety of stocks, bonds, and other investments. Mutual funds are focused on a chosen investment strategy. Mutual fund companies manage many different types of mutual funds. If you invest with one of these companies, you can pick the type of investment strategy that appeals to you. Mutual fund companies sell shares to many investors. These investors are pooling their money with that of other investors to reduce risk. The mutual fund company is in the business of buying and selling. Its advisors are watching companies and markets. When you invest your money with a mutual fund company, you are paying for the firm’s expertise. This allows you to spend your time doing other things. It also lowers your risk because your investment is diversified. Indirect Investing - is buying mutual funds. With this indirect investment, you invest in the mutual fund company. The company makes the investment purchases and sales. You are investing indirectly in the choices of your mutual fund company. In other words, you own shares of the mutual fund company, not shares of stock in the companies in which it invests. Asset Allocation - with mutual funds, the investor can also choose a combination of funds. The investor could pick investments that have a variety of risks.  ii. Family Home Most financial experts believe that buying your own home is the best investment you will ever make. They also agree that home ownership is not always liquid. You must be willing to wait to sell when the market is rising. Because the costs of buying are so high, it usually takes several years to make a profit. When you own your own home, you should take good care of it to protect your investment. Over the long run, home ownership is a fairly safe investment, with value that often grows faster than the rate of inflation. 3. High-Risk Investment Options a. Stocks When you buy stock in a corporation, you become a stockholder. A stockholder owns shares of the company. Stockholders make money in two ways. One way is by receiving dividends. The other way is by selling the stock at a price that is higher than the price paid for the stock. This increase in selling price is referred to as growth (in value). A stock that pays annual dividends is attractive to an investor who needs the income (such as at retirement). Buying stocks and holding them for growth is a long-term strategy. You are betting that the value of the stock will go up over time. i. Common Stock Owners of common stock may share in the profits of the company through dividends. They have voting rights in decisions made by shareholders, such as who the company directors will be. They take a higher risk than owners of preferred stock. Common stock has no guaranteed dividends. If the company does well, the stockholder shares in the profit in the form of dividends. The directors of the corporation decide if a dividend payment is to be made. Stock dividends are taxable. There is no guarantee that the value of the stock will go up. ii. Preferred Stock Owners of preferred stock have a guaranteed dividend rate. This rate is paid before common stockholders get paid a dividend. Because there is less risk, preferred stock costs more than common stock. Preferred  stockholders do not have voting rights. If the company goes bankrupt, they get paid before common stockholders. iii. Direct Investing Buying investments directly from companies and holding them individually is known as direct investing. If you buy the stock of a company and hold that stock, you are taking a high risk. That is because you have a lot of money in one place. This plan does not spread risk. You can, however, lower your risk by buying many different types of stocks and other direct investment options. b. Business Ventures You may decide to start a small business. You could also loan money to someone so that person can start a business. More than half of all small businesses fail each year, making this a very risky investment. If the business succeeds, however, it can be a profitable investment. A business plan is a document that outlines how a business plans to succeed. It includes the company mission, the financing needs, the marketing plan, the management plan, and the operating plans for the company. The plan attempts to show how the business will make a profit. Before you invest in a business venture, be sure to read and understand the business plan. You could make a lot of money, or you could lose your investment. c. Collectibles Collectibles are art objects, coins, decorative plates, books, baseball cards, or other items bought for their investment value. Some collectible items will go up in value over time. Others will not. The investor must decide which items she or he thinks will go up in value. Coins are a commonly collected item. When coins are rare, they gain in value. Buying collectibles is a very risky investment choice. When collecting, have a clear goal in mind. Decide whether you are collecting items as an investment or whether you are simply buying items that you like for your own enjoyment. If you are buying items as an investment, do market research to learn which items may increase in value. d. Rental Property Individuals can buy real estate beyond a family home. If you buy a house and rent it to tenants, you will receive rent for income. Buying rental real estate has risks and responsibilities. The tenant (renter) takes possession of a valuable piece of property. The tenant must take reasonable care of it. You, the owner, are responsible for repairs and maintenance. This may mean fixing or replacing the roof, painting, and other upkeep. The property may increase in value over time. Thus, an investment in rental property can provide current income and long-term growth. Other forms of rental property besides a single-family home include duplexes, apartment complexes, and vacation property. e. Futures Contracts and Commodities Futures contract is an agreement to buy or sell a specific commodity or currency at a set price on a set date in the future.  Commodity is a specific item of value that is bought and sold in a marketplace. It could be soybeans, silver, live cattle, coffee, or other items. f. Real Estate Investment Trusts REITs (real estate investment trusts) are also known as real estate stocks. A REIT is a corporation. It may own and operate income-producing property. An apartment building that rents to families and a factory building that rents to a business are examples of income-producing properties. A REIT may lend money to real estate developers. It may also invest in securities backed by real estate mortgages. g. Investment Clubs An investment club is a group of people who pool their money together to buy and sell investments. The group may be small—just a few people who work together to buy something they could not afford as individuals. Week 15-17: Investment Planning Learning Objectives: 1. Investment Planning 2. Buying and Selling of Stocks 3. Real Estate and High Risk Investment Buying and Selling Investment 1. Researching Investments a. Sources of Information Some people hire a stockbroker or financial planner to help them choose investments. Other people do research and make choices on their own. Either way, investors need a basic knowledge of financial markets. Keeping informed about current market conditions helps investors make better choices. i. Magazines Business magazines, such as BusinessWeek, Fortune, and Forbes, contain information that can be helpful to investors. In these magazines, you can read business articles and get experts’ opinions on various topics related to investing and the economy. ii. Newspapers One of the best sources for current information is the financial sections of newspapers. You will find articles about business triumphs and failures. You can read about new products and services. You will also see articles about the latest business scandals and frauds. Price quotes for securities are provided in many newspapers. Securities refers to stocks, bonds, mutual funds, and other investments. iii. Investor Newsletters Investors can subscribe to newsletters that give financial advice. iv. Company Reports All companies that sell stock to the public must publish yearly annual reports. An annual report is a company’s report to shareholders about the financial position of the company. It also tells about profits or losses and plans for the future. These reports are free, and many are available online as well as in print. v. The Internet Investors can find information about companies, products, and market trends on the Internet. vi. Using Research Data A great deal of information about investing is available in print and online. Investors need to know about the economy and current market trends. They also need to learn about specific companies or funds in which they may want to invest. News articles are a good source of information on the economy and markets. Annual reports and online profiles are good sources of data about specific companies or mutual funds. b. Advice from professionals  Many investors seek advice from experts in the investing field. A fee is typically charged for investment advice or for making a sale or purchase for an investor. Choose advisors that you can trust to help you make the right choices. Be sure that they have proper licenses, bonds, and certifications. Ask how long they have been working for the bank or investment company. i. A stockbroker is a person who buys and sells securities on behalf of others. Stockbrokers may also provide advice on which products to buy. The broker will make commissions on the items the investor buys. ii. A financial planner is an advisor who helps people make investment decisions to meet stated goals. 2. Buying and Selling Securities Securities are stocks, bonds, and other financial investments. When securities are bought or sold, they are said to be traded. Investors can trade directly or use the services of a broker. Investors can trust a professional to manage the investments, or they can be involved in all the decisions. a. Trading Securities i. Primary Market The primary market is one in which new issues of securities are sold. Proceeds of sales go to the issuer of the securities sold. New security issues (stocks and bonds) are issued through investment banks. An investment bank is a company that helps corporations raise money by selling stocks and bonds. A fee is charged for this service. The process takes many months to complete. New security offers are often in the form of initial public offerings. An initial public offering (IPO) is a company’s first sale of its stock to the public. IPOs are often made by small or young companies seeking to expand their business. They can do this with the money raised by selling stock. ii. Secondary Market The secondary market is one in which securities are bought from current investors. A buyer is trading with someone who already owns the stock. After stock is sold in the primary market, it can be resold many times in the secondary market. Many securities are listed on securities exchanges. Some can also be found in the over-the-counter market. 1. Securities Exchanges A securities exchange is a place where brokers buy and sell securities for their clients. Securities listed on the exchange have been accepted for trading at that exchange. An auction market is one in which a stock is sold to the highest bidder. Both buyers and sellers compete with others for the best price. 2. The Over-The-Counter Market  The over-the-counter market is a network of dealers who buy and sell stocks and other securities. These stocks are not listed with a securities exchange. b. Direct Investing Many companies have direct investing plans. Direct investing allows you to buy stock directly from a corporation. You do not use a brokerage company. Direct investing allows you to reinvest dividends as well. With this option, cash dividends are used to buy more shares of stock. A stock dividend is a dividend paid in the form of new shares of stock instead of cash. Stockholders have more shares of stock for future growth. A stock split occurs when a company issues more stock to current stockholders in some proportion. c. Broker Services When you use the services of a stock agent or broker, you pay this person to buy or sell securities on your behalf. From some brokers, you also get advice about what and when to buy and sell. Although these services cost money, they can help you invest wisely. i. Full-Service Brokers If you buy securities through a full-service stockbroker, you will receive advice about what to buy. A stockbroker is a licensed professional who buys and sells securities for her or his clients. Stocks, bonds, mutual funds, and commodity futures contracts are examples of securities traded through stockbrokers. The broker will consider your investment goals. He or she will try to help you achieve those goals through your investment choices. You will be charged a commission or fee for the services provided. You will receive regular reports of activity and account balances. The stockbroker will consider the information you provide. You should clearly state your financial goals. Be honest about your tolerance for risk. Be realistic in what you expect for returns on the money you invest. This information, along with her or his knowledge about the market and securities, will be used to select stocks or other investments for you. The broker will recommend securities to buy and sell and the timing of those trades. ii. Discount Broker A discount broker works for a firm that buys or sells securities on behalf of investors. The term discount broker is also used to refer to the brokerage firm. The fees or commissions charged by a discount broker are much lower than those charged by a full-service broker. The firm may charge a flat fee for its services of buying and selling. iii. Online Broker Many brokerage firms offer their services online. Online brokers charge low fees. They also give the least amount of service. They do not provide investment advice or manage assets. Some firms do offer free research  reports. You must make your own decisions about buying and selling. Once you decide, you set up an account with an online broker. iv. Commissions and Fees Stockbrokers make money when stocks are bought and sold for clients. Some brokerage firms have minimum commissions. d. Stock Transactions Once you have decided to buy or sell a stock, there are four types of transactions, called orders, that you can request. i. Market Order is a request to buy (or sell) a stock at the current market value. In an auction market, the broker will try to get you the best price as soon as possible. There is no guarantee of what you will pay or receive. The stock will be auctioned to the highest bidder, and you may or may not buy or sell the stock at the price you hoped to get. ii. Limit Order is a request to buy (or sell) a stock at a specific price. When you are buying, a limit order ensures that you will not pay more than a set dollar amount. When you are selling, the order ensures that you will not get less than a specific dollar amount if the stock is sold. iii. Stop Order is a request to sell at the next available time after the price reaches a certain amount. This type of order protects an investor from a sudden drop in price. iv. Discretionary Order is an order to buy (or sell) a stock that lets the broker get the best possible price. The broker also determines the best time to buy. This type of order may involve a range of shares, such as buying odd numbers of shares if they are available. Discretionary orders give the broker the power to use her or his experience and judgment to make good decisions. e. Market Timing A market timing plan is a strategy used to increase profits and reduce costs. There are several timing plans you can use, regardless of the type of securities you buy and sell. i. Selling Short - is selling stock that has been “borrowed” from a brokerage firm and must be replaced at a later date. You are hoping to make a sell agreement today for more money than you will have to pay for the stock at a later time. This is a lawful thing to do (if the brokerage firm allows it), but it is highly risky. You are hoping that prices will drop. If prices for the stock do not drop, you will lose money. ii. Buying on Margin - is a transaction in which you borrow part of the money to buy stock. The cash you use to pay for the rest of the purchase is called the margin. The margin amount is set by the Fed. This is a form of leverage, or borrowing money to make a profit on a stock transaction. You may make less than if you paid for the stock yourself. However, you can buy more stocks with less money and thus possibly make more profits. iii. Buy and Hold - is a long-term plan in which investors make money in three ways. First, they will receive dividends over the years. Second, the  price of the stock will go up (giving them long-term capital gains). Third, the stock may split. When a stock splits, they gain additional shares of stock. They do not have to pay commissions on the stock gained, and there is no tax to be paid on the added shares. Week 18: Final Examination