# 1Planning Your Financial Future: It Begins Here

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1 This sample chapter is for review purposes only. Copyright The Goodheart-Willcox Co., Inc. All rights reserved. 1Planning Your Financial Future: It Begins Here Terms Financial plan Financial goals Needs Wants Values Wealth Net worth Assets Liabilities Investing Financial independence Growth Average rate of return Interest Compound interest Principal Simple interest Rule of 72 Objectives When you complete Chapter 1, you will be able to: Explain the purpose of a financial plan. Define wealth and calculate net worth. Define investing and calculate average rate of return and compound interest. 7

7 18 Average Rate of Return Becoming Money mart Savings and other investments normally do not earn the same rate of return each year over a long period of time. The rate varies over the years. One year you may earn 2%; the next year you may earn 5%. The average rate of return is the percentage that your savings or other investments earn over a period of time. To find the average rate of return, add the amount of increase or decrease for each year and get a total. Then divide the total by the number of years of the investment to get the average return amount. Divide the average return amount by the number of years to get the average rate of return. Total Amount Earned Number of Years = Average Return Amount Average Return Amount Number of Years = Average Rate of Return There is no guaranteed rate of return on most types of investments. The return on stocks and interest rates go up and down. When investing over a period of 30 to 35 years, an average rate of return of 7% to 9% is not unrealistic. Suppose you are considering an investment in company stock. You should look at the rate of return for the past several years if possible. Doing so will give you a better idea of how your investment is likely to grow than just looking at the rate of return for the previous year or two. Example 1-2 Negative numbers are shown in parentheses and represent losses for those years. Investment 1,500 Year Amount (50.00) 8 (25.00) Total amount 1, Number of years 15 Average return amount Number of years 15 Average rate of return 4.89% Chapter 1 Planning Your Financial Future: It Begins Here 19 You Do the Math 1-2 Investment 1,000 Year Amount (25.00) 9 (50.00) Total amount Number of years Average return amount Number of years Average rate of return Why is average rate of return an important concept for you to understand? Compound Interest You probably already understand the concept of interest. Interest is a fee paid on borrowed money or money earned on deposits with a bank or other financial institution. The longer you keep money on deposit, the more you will earn. To understand how time can make such a difference in your earnings, you need to understand compound interest. Compound interest is earning interest on the principal (amount invested) plus the interest you have already earned. For example, suppose you deposit 1,000 at an interest rate of 5%. In one year you will have 1,050. The next year, you will earn interest on 1,050 instead of 1,000. The interest will be instead of 50. Principal Rate Time = Interest Interest rates are always stated as one-year percentages. To calculate interest, you must first convert the percentage to a decimal. For example, an interest rate of 5% would be converted to.05. A rate of 3.25% would be.0325

9 22 Becoming Money mart Look at the following example to see how quickly your money can grow over a period of three years. Year Quarter Principal 4% Rate Time.25 New Balance Deposit Quarter Balance 1 1 2, , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , Amazing, isn t it? For most savings accounts, the interest is compounded daily, which makes your money grow even faster. You Do the Math 1-4 Now, you try it. Begin with a deposit of 3,500 and deposit an additional 300 each quarter. Your interest rate is 5% compounded quarterly for a period of three years. Chapter 1 Planning Your Financial Future: It Begins Here 23 How does adding to your investment each year (or more often) affect the results of your investment? Current Interest Rates 1. Go to the Internet and find the websites for five savings institutions. What rates are they currently paying on savings accounts? Typically, the interest rate and an APY (annual percentage yield) are shown. Record both rates along with any minimum balance required and related fees. Savings Institution Interest Rate APY Minimum Balance Fees Web Connect Year Quarter Principal 4% Rate Time.25 New Balance Deposit Quarter Balance 1 1 3, What is the purpose of showing an APY? Search the Internet to learn how using this number can help you when comparing investments

12 Wants Apply Your Math Skills 13. Wealth Calculate the answers to the following problems. 21. If your assets total 12,365 and your liabilities total 6,924, what is your net worth? 14. Net w orth 22. The total amount earned on an investment of 3,500 over a period of 10 years is 250. What is the average rate of return? 15. Assets 23. You deposit 1,750 at a rate of 2.5% compounded annually. What amount will you have at the end of 6 years? 16. Liabilities 24. Your initial deposit is 1,500. The interest is compounded quarterly at 5.25%. You add 250 each quarter for three years. What is the ending balance? 17. Financial i ndependence 25. Using the Rule of 72, estimate how long it will take to double the above investment at an annual interest rate of 4%. 18. Interest 19. Compound i nterest 20. Rule of 72

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