1 Why it Matters: Making Saving Decisions Lesson Overview This lesson looks at saving why, how, and when. Students read about why to save, the factors influencing saving, the power of compounding, and the costs and benefits of saving. Then they evaluate several possible savings options (a bank savings account, mutual fund, etc.) to determine which savings option may be best for them now and in other situations. Lesson Introduction Sometimes you have more money than you really want to use for current spending, or you want to make a future purchase that requires more money than you have right now. Saving is simply a way to use your current income for something in the future. You can save for a variety of reasons: for purchasing a new television in a couple of months, a new car next year, college expenses, the down payment on a house, or to support yourself during retirement. Just as there are many reasons to save, there are also many ways to save. The best way to save depends on your future plans, your timeline and your tolerance for risk. Here are some of the key terms about saving: Saving: To keep money for future use; to divert money from current spending to a savings account or another form of investment for future use. Principal: An original amount of money invested or lent (may be in multiple amounts overtime.) Interest: Money paid regularly, at a particular rate, for the use of borrowed money. Rate of Return/Interest Rate: The percentage earned on an investment or savings over some specified period of time.
2 Annual Rate of Return: Income earned on an investment in a year, divided by the amount of the original investment. If you earned $5 dollars on an investment or savings of $100 in one year, your annual rate of return is 5 percent. Compound Interest: Interest that is earned not only on the principal but also on the interest already earned. Financial Risk: The chance of losing money or that the chance that the value of an investment (the principal) will decrease. FDIC: The Federal Deposit Insurance Corporation (FDIC) preserves and promotes public confidence in the U.S. financial system by insuring depositors for at least $250,000 per insured bank; by identifying, monitoring and addressing risks to the deposit insurance funds; and by limiting the effect on the economy and the financial system when a bank or thrift institution fails. [ NOTE: The definitions in this lesson are cited or summarized from the Council for Economic Education s Virtual Economics program. They are consistent with the National Voluntary Content Standards in Economics and the Ohio Academic Content Standards for Social Studies. Lesson Objectives The student will: 1. Identify some reasons for saving. 2. Identify the costs and benefits of saving 3. Calculate the interest earned on savings over a selected period of time. 4. Evaluate several types of savings options. Lesson Materials Article: Why It Matters: Getting Savings Just Right Handout/Visual 1: Why Save? Handout/Visual 2: My Savings Plan Handout/Visual 3: How to Save? Handout/Visual 4: Savings Options
3 Handout/Visual 5: Begin Saving Early The Power of Compounding Handout/Visual 6: Compound Interest Tables Handout/Visual 7: What about Borrowing and Saving at the Same Time? Handout/Visual 8: Costs and Benefits of Savings Options Handout/Visual 9: Savings Scenarios Visual 10: FDIC Sign Compound Interest Calculators BankRate.Com Compound Interest Calculator Smart Money Compound Interest Calculator About.Com Mathematics Compound Interest Calculator Lesson Preparation Make visuals to project or print copies of Handouts 1-8 for each student: Introduction Students should read the Cincinnati Enquirer article, Why It Matters: Getting Savings Just Right, by Dr. Julia Heath Director of the Economics Center at the University of Cincinnati. The point of the article is that saving can be a good choice, but saving has both benefits and costs. Students should be able to summarize the main points of the article. Saving can be good for consumers who want to make big future purchase or be prepared for emergencies. Saving makes more loanable funds available for consumers and businesses to borrow. Saving has a real cost less consumption. When consumers purchase fewer goods and series, it may, in fact, be bad for the overall economy.
4 Like many other economic choices, the level of savings reflects the Goldilocks principle. It shouldn t be too much or too little, it should be just right! Procedures 1. Introduce the lesson by asking students: What can you do with money? [Students will eagerly suggest spend it. Some may suggest saving. Although student may have lots of ideas, there are really only two things you can do with money spend it or save it.] Ask: Why would someone choose to save money? [Again, there will be lots of answers, but they all will be something about using it in the future most likely to spend it.] Summarize the discussion with the statement There are only two things you can do with money spend it to save it. 2. Explain that the decision to save is one that should be made thoughtfully. There are a lot of options and decisions beyond just should I save? Handout or project handout/visual 1, Why Save? After the students read the information, ask them to summarize the important points: Saving can be for short-term, medium-term or long-term goals. Saving can be for planned or unplanned expenses. Saving can be a lot or a little money. Saving can be risky or safe, easy or hard. 3. Using Handout/Visual 2, My Savings Plan, work through the simple math of saving some amount of money over some period of time. [Example: If the person s goal is to save $2,400 over 24 months to purchase a car, he or she must save $100 each month. What will they give up to have an extra $100 per month? It could be anything. How will they be better off? They will have a car.]
5 Summarize by saying that the process of saving for a goal has two real variables: The amount to be saved and the time required. 4. Project or distribute copies of Handout/Visual 3, How to Save? Begin with the three questions: How soon or quickly do I want access to my money? How much interest (return) will I earn on my savings? Is there any possibility that I will lose my money? Define Interest. [Money paid regularly, at a particular rate, for the use of borrowed money.] Clarify the different between interest earned on savings and interest paid for a loan. Although they are essentially the same, the key difference is who pays the interest. Review the key points of the handout. How long do you have to or want to save? How much interest do you want to earn? Do you want to take a risk? Summarize the information by stating: When saving, there is always a trade-off between risk and return. 5. Point out the reference to the FDIC and NCUA in the reading. Explain that this is the Federal Deposit Insurance Corporation. This is an agency, established by the federal government, which provides insurance for deposits in banks, savings and loans, and other financial institutions. Ask students if they have ever seen an FDIC sign on the door of a bank. Even a bank branch in a grocery store will have an FDIC sign prominently displayed.
6 Banks are required to insure their deposits, up to $250,000 per account. If a bank somehow loses its assets, through bad investments, catastrophe, theft, etc., the FDIC will reimburse the depositors. When you go to a bank or credit union, look for one of these signs. Visual 10 can be projected to show the FDIC and NCUA door signs. 6. Using Handout/Visual 4, Saving Options, review the several types of saving options. Each Option is explained briefly. For more details about some savings options, go to: Practical Money Skills for Life Financial Planning Advices Hands on Banking (Wells Fargo Bank) Go to page 44. Family Economics and Financial Education (FEFE)
7 Important Note: Point out that in this sense, even those methods commonly referred to as investments are simply savings. When you purchase a share of stock, it is saving money for some future use. No new real capital is created the economic definition of investment. Investment is usually used when saving is longer term, based on greater expectation of returns and is done with more risk. In a general sense, it is all saving. Ask, what are the important criteria when choosing a savings option? Student should mention: Return/interest rate Risk Transaction Costs Time Convenience 7. Ask students, what it means to compound something. [In this use, it refers to something composed or created by the combination of two or more parts or elements. Referring to savings, it is used with the term compound interest. Compound Interest: Interest that is earned not only on the principal but also on the interest already earned. Explain that one of the benefits of most savings options is that they compound interest. You earn interest on your principal and also on the previously paid interest. Distribute or project Handout/Visual 5, Begin Saving Early The Power of Compounding. Use this handout to explain the concept of compound interest. Handout/Visual 6, Compound Interest Tables, is an example of the power of compounding, comparing two people, one who began saving early and one who waited ten years.
8 Note the information on Handout/Visual 5 about the 10 percent interest rate example used for the compound interest table. 10 percent is used to keep it simple. Summarize: The common advice is Save early and often! 8. Use Handout/Visual 7, Costs and Benefits of Savings Options, to review to common criteria used to compare savings options (tools.) Note that each option (tool) may have certain advantages (benefits) and disadvantages (costs.) Review each criterion defining terms and identifying the examples of savings tools that exemplify each criterion. Bank savings accounts are very safe. Certificates of deposit pay higher interest. Stocks have big potential gains (and potential losses) Government bonds may be tax free. Each option has more or less liquidity. Keeping your cash under your mattress is convenient. Liquidity: The ease with which savings or investments can be turned into cash. 9. Handout/Visual 8, What about Borrowing and Saving at the Same Time? raises the issue of saving and borrowing at the same time a common issue. If appropriate, use this for brief discussion about borrowing and saving.
9 Handout/Visual 8 also provides some helpful suggestions about saving. These are things students can do to learn more about saving on their own or with their families. Conclusion/Assessment Using handout/visual 9, Saving Scenarios, students should offer their advice for each situation. This can be done as a whole class discussion or each scenario can be assigned to individuals or pairs. When suggesting what each individual or family should do, the students should explain why, using the criteria from Handout/Visual 7. Summarize by asking students to suggest which criteria will be more important to them when they begin to save for their futures.
10 Why It Matters: Making Savings Decisions A penny saved is a penny earned. Save your money for a rainy day. You have probably heard many people use these expressions to talk about how important it is to save your money. We even have National Teach Children to Save Day (It was April 24, in case you missed it). With all this attention paid to how much people save, you have probably concluded that saving is a good thing. Well, yes and no. Saving money (as opposed to spending it) can be a good thing. For individuals, saving money allows them to purchase high-priced items sometime in the future. For example, people save money to send their children to college, to make a down payment on a house or a car, or to save for retirement. People also save money for emergencies, so they can fix the car if it needs repair. In each case, money that could have been spent today is, instead, put aside for some future use. In the United States, the savings rate (the percentage of their personal income that people put aside into savings) was 3.4% in April, 2012, down from 3.5% in March. The personal savings rate has been falling since the early 1980 s when it was 12.2 percent in 1982, reaching a low of 0.9 percent in The rate for the United States is much lower than other developed countries. It turns out that personal saving can be a good thing for the economy, too. When people save, it builds up what are called loanable funds. This is the money banks and other financial institutions have available to loan out to businesses that want to invest in the growth of their companies, or start new ones. With the money they have borrowed, businesses can then hire more employees, buy more capital equipment or develop new products. So, the more businesses invest, the more the economy as a whole grows. The more people save, the larger the pool of loanable funds, leading to more business investment and economic growth. If that s the result of personal saving, we should want people to save as much as possible from their incomes, right? Maybe not. Remember that when people save for something they will want in the future, they are giving something up the opportunity to spend their money now. The amount of money that consumers spend on goods and services is the largest portion (about two-thirds) of our country s total spending much greater than what businesses and governments spend. That means that if you and I, and the rest of the country s consumers suddenly started saving our money at a much higher rate than we do now, we would have less money to spend on the goods and services that the economy produces. If consumers are not buying as many of these goods and services, businesses would stop producing them, and people would lose their jobs since the demand fell for the products they produce. Therefore, if individuals started saving more, it could push the economy into a recession in the short-run. The bottom line is that how much people should save like many other economic concepts can best be described by the Goldilocks model. If people save too little, we run the risk of not having enough loanable funds for business investment in the long run. If people save too much, we run the risk of not having enough current spending in the economy in the short run. We need just the right amount of saving enough that there is sufficient demand for current goods and services, and sufficient loanable funds to generate goods and services in the future.
11 Handout/Visual 1 Why Save? You may want to save for a variety of reasons. Either you want to feel a little more secure, you want something big but don t want to borrow, or you may just like the idea that you are accumulating wealth for the future. You may, in fact, be saving some amount of your income for several different reasons and saving in different ways. A saving plan should fit your lifestyle and your short-term and long-term goals. Reasons to Save For very short term saving - a night out next Friday or for a short-term purchase - maybe dropping a few dollars and change in a jar each day will work. For very long-term goals - a home purchase or college tuition - putting your money somewhere will it will grow safely is important. For emergencies - a new water heater or an unexpected medical bill you may want quick access to your savings.
12 Think about your savings goals and be as specific as possible. How much do you want to save? What is your capacity to save? What is your saving time line or saving deadline? How much risk do you want (or can afford) to take?
13 Handout/Visual 2 My Savings Plan 1. My goal for saving is to 2. I want to achieve my goal by this date 3. To achieve my goal, I must save a total of $ 4. To save $ by (date) I must save $ per (day, week, month) 5. I will save $ by (how will you do it?)
14 6. To save and achieve my goal, I will give up 7. If I save and achieve my goal, I will be better off because Do the savings math $ X = $
15 Handout/Visual 3 How to Save? Factors Influencing How You Save Ask yourself these questions: The first question most directly relates to the reason for saving. If you are saving for a relatively short term or for an emergency, you may want an account that will give you easy access to your account, such as a passbook savings account or a money market account. Keeping money in a checking account is another way to save for a very short term. You can get your money very quickly, but possibly at some additional cost. Sometimes, when the goal is years away, it is better to save your money in a way that you will not want to use it for other things and earn a better return on your principle. If you want to earn a higher interest rate, you may be interested in a certificate of deposit (CD). A CD is an account where you promise to keep your money in the account for a specified length of time. Usually, the longer the time you are willing to tie up your money, the higher the interest rate you will receive. CD s can mature in as little as a couple of months to as long as years later. If, for some reason, you want the money from your CD prior to the set time, you will give up some of the interest you earned. Even more gain is possible if you invest in stocks, mutual funds or bonds. You may get more, but there is more risk that you can lose some or all of your money. If you want a simple checking or savings account or a certificate of deposit, choosing the right bank, savings and loan, or credit union is an important decision. They have different types of accounts, different fees, or they may be open different hours. A small bank in your neighborhood may give you more personal service. A large bank with offices in grocery stores or with many ATM machines is very convenient. Credit unions
16 sometimes loan funds at slightly lower interest rates. A key thing to consider is that your account is protected by deposit insurance. Again, look for the FDIC sign. Note: Credit Union savings deposits are insured by the National Credit Union Administration (NCUA), an organization similar to the FDIC. Risky investments can pay much bigger dividends, but with a greater possibility that you may lose money. Traditionally, savings that are safe and gain a guaranteed rate of interest are referred to as just savings. Methods that are riskier and that may gain or lose more are more often called investments. The key is deciding why you are saving and how much you can afford to save.
17 Handout/Visual 4 Savings Options Here are some of the basic savings options. Keep your cash at home in a box, under your mattress, or in a safe. You can get your money quickly whenever you want it. It is probably safe, but you never know. You do not receive interest. Cash and coins maintain their face value, but may lose purchasing power with inflation. Open a passbook savings account at a bank, savings and loan, or credit union. You can get your money whenever the bank or its ATM is open. Your balance is insured by the FDIC or NCUA, so you will not lose your funds. You will earn interest, but not much. Open a checking account that pays interest. You can write a check to make payments. You may have to pay check processing fees. You can earn interest, but you may have to have a minimum balance. Your balance is insured by the FDIC, so you will not lose your funds. Purchase a certificate of deposit (CDs) from a bank, S&L, or credit union. You must commit your funds for some period of time (6 months, a year, 2 years, etc.). Your interest rate will be determined by the time required for the certificate. An early withdrawal will reduce your interest earned and may have a fee. Your balance is insured, so you will not lose your funds. Open a money market account (MMA) with a financial institution. A financial account that pays interest based on current interest rates in the money markets. The interest rate may change daily. They typically have relatively higher interest rates, but require a higher minimum balance to earn that interest rate or to avoid fees. A money market account at a bank will be insured by the FDIC. You may be able to write checks on this account.
18 Purchase shares in a money market mutual fund. A money market mutual fund through a brokerage is similar to a money market account, but it will not be insured by the FDIC. You will be more restricted as to how and when you can withdraw your funds. There may be fees for deposits, maintenance and withdrawals. Purchase shares of corporate stock through a broker. You can purchase shares of stocks through brokers or directly from companies. Typically, there are fees to buy and sell your shares. These transactions may take several days to clear and for you to receive your money. Purchase corporate bonds or government bonds. You can purchase bonds through brokers or directly from companies or governments. Typically, there are fees to buy and sell your bonds. These transactions may take several days to clear and for you to receive your money. Government bonds are often tax free. Bonds will pay a specified interest rate, but may lose some of their asset value. Government bonds keep their face value to maturity. Note: Income from savings and investment is usually taxable at the federal, state, and local levels. Some government bond income is not taxable. Account maintenance fees may be tax-deductible.
19 Handout/Visual 5 Begin Saving Early The Power of Compounding There are real advantages to beginning saving early in life. Your benefit from savings depends upon two things: the amount you save and the interest rate or return that you receive. When interest compounds, interest is paid on interest. IMPORTANT NOTE: The compound interest table below assumes a 10 percent interest rate or rate of return. Few investments, except the most risky, will earn a return of 10 percent. How Does Compound Interest Work? Mary put $1000 in a savings account at 5% interest. After one year, the account balance was $1050. $50 interest was paid to her account. After another year, her balance was $ In the second year, her interest was $50 on the original $1,000 and another $2.50 interest on the $50 interest from the first year. In the next One sure thing is that the earlier you start saving, the more you will accumulate over time. For example, compare the savings plans of Frank and Margaret, who graduated from high school together and both decided to save for their retirement. Frank decided when he was twenty-five years old to save $2,000 each year. Margaret waited until she was thirty-two years old to begin saving $2,000 per year. For simplicity, let s assume that they each receive a 10% interest rate on their account balances, compounded daily. Let s see how their savings plans compare. It pays to begin saving early. As interest is paid on your previous deposits and the accumulated interest, the total grows even more. This is called compound interest. Margaret will not reach Frank s total unless she deposits more each year. Frank, on the other hand, stopped saving after eight years and uses the extra $2,000 for a great vacation each summer. By continuing his saving for more years, Frank will greatly increase his total. Margaret had more money to spend for the first eight years, but will end up far behind.
20 IMPORTANT NOTE: The compound interest table below assumes a 10 percent interest rate or rate of return. Few investments, except the most risky, will earn a return of 10 percent. For this example, 10 percent is used because the math is easier to understand. To determine how much you can expect to gain on your savings over any period of time, go to one of many compound interest rate calculators that can be found online. The three calculators listed below are just examples. BankRate.Com Compound Interest Calculator Smart Money Compound Interest Calculator About.Com Mathematics Compound Interest Calculator
21 Handout/Visual 6 Compound The Benefits of Compound Interest Interest Tables Year Frank s Frank s Margaret s Margaret s Deposits Balance Deposits Balance Handout/Visual 7 1 $2,000 $2, $2,000 $4, $2,000 $7, Costs and Benefits of Savings Options 4 $2,000 $10, $2,000 $13, There are many factors that influence your ability and willingness to save or to use various 6 methods $2,000 to save. Think $17,251 about these factors: $2,000 $21, $2,000 $25, $28,394 $2,000 $2, $31,368 $2,000 $4, $34,652 $2,000 $7, $38,281 $2,000 $10, $42,289 $2,000 $13,616
22 Handout/Visual 7 Costs and Benefits of Saving Capacity: How much of your current income can you save? What do you give-up when you choose not to spend your current income? If you choose to save, your opportunity cost is what you could have purchased with that current income. Risk: Some savings methods are very safe. Saving accounts in banks are insured by an agency of the federal government. When insured, the chance of losing some of your savings is very small. Shares of stock may rapidly gain or lose value on an open market. There are no guarantees. Are you a risk taker? Return: Some savings methods pay interest or dividends, thus, increasing the value of the savings. Stock purchases may greatly increase in value over the years. Bonds will pay a set interest rate. The interest paid on municipal bonds is usually tax-free. Your real gain increases by the amount of the tax savings. Liquidity: Some types of saving allow you very quick access to your money. Others make it more difficult. A bank savings account can be accessed whenever the bank is open or through using an ATM. Stocks and bonds are sometimes difficult to sell unless you are willing to take a loss. Plus, you may have to pay a fee for a transaction. Transaction Costs: Will you have to pay a fee to deposit or to withdraw your funds? Sometimes, you pay for convenience, such as using ATMs, receiving your money more quickly, or using technology. Some banks require minimum balances and may charge a fee if you go under that level or make too many transactions. Convenience: Do you want to use Internet banking services or ATMs? How easy will it be to deposit or withdraw your funds? How many branches or ATMs does your bank have? Can you access your funds if you are travelling?
23 Handout/Visual 8 What About Borrowing and Saving at the Same Time? Many people have savings accounts and also owe large balances on credit cards. Often, a good solution for this problem is to use some of the savings to pay off the balance. If you owe $1000 on a credit card account at 15% interest for one year, you will pay $1,150. If you have $1000 in a savings account for one year with 5% interest, your balance after one year will be approximately $1050. By using the $1,000 to pay the balance of the credit card bill, you will gain $100. Of course, you may want to have some or all of the $1,000 in savings for an emergency. This decision requires you to compare and make some important decisions about your borrowing and saving goals. What can you do next? Visit your bank, savings and loan or credit union. Compare interest rates on savings and checking account charges with other institutions. If you do not have your own account, open one in your own name. Opening a checking account that you may only use a limited number of times will, at least, help to establish an account as part of your credit history. If you do not have a credit card, consider applying for a secured credit card. A secured card is guaranteed by a minimum deposit in your savings or checking account. After several months of successful use of the card and prompt repayment, you may be able to receive a credit card with a larger limit. Review your budget and decide what kind of money is most appropriate to use for each item. Remember that some forms of money provide automatic receipts to prove you made the payment. Getting a receipt is always a good idea. Start saving now for a long-term goal. Find two ways to save a little money each week and regularly put it into your account. Take advantage of compound interest.
24 Handout/Visual 9 Saving Scenarios For each scenario below, suggest what method the person (or the parents) should use to save. Provide a rationale for your suggestion. What characteristic about the person will influence their best savings choice? See Handout/Visual 4. Cash, savings account, checking account, certificate of deposit, money market account, money market mutual fund, corporate stock, corporate or government bonds, 1. Bill is fourteen years old and a high school freshman. He wants to save for his college education. He plans to work during the summers and already has $2,000 he received from his grandparents. 2. Mary and John want to build up an emergency fund to cover any unexpected large expenses medical bills, car repairs, home repairs, unexpected travel, etc. They have a little income left over each month and want to make sure it is available for an emergency. 3. Susan is a single mother. She wants to start savings accounts for her two young children. They are just 2 and 3 years old. She knows there will be things like cars, proms, etc., that they will want when they are older not to mention college. 4. James has a plan to start his own business in two years, after he has learned all about the business by working for someone else. He can save a few hundred dollars each month, but he occasionally makes impulse purchases if he has cash in his pockets. 5. Kate will be able to drive in one year. Her parents told her that if she saves enough for a half of the price, they will loan her the balance to buy a new car. She plans to get a summer job and work a little during the school year. Right now, she has just over $1, Fred wants the newest and best ipod. It will cost almost $300. As soon as he has enough money he wants to buy one. He is willing to go without lunch, dates, concerts, and whatever it takes to save enough. 7. Tom and Margaret are in their early 50s. They are now starting to think about their retirement. They both have modest retirement plans with their employers, but they want to make sure they can do some fun things. Together, they can put about $400 more in savings each month. They started saving last year and now have about $4,000 more than they need each month in their checking account.
25 Visual 10 When you go to a bank, look for this sign: At a credit union, you should see this sign