Saving and Investing
Saving money is one of the most important things you can do for
your future, along with getting a good education. Saving money takes
discipline, but it enables
you to accumulate money for large or expensive purchases. A good
way to save money is to create a budget.
A budget is a plan for coordinating how you will spend and save
money.
A budget takes into consideration your income
(how much money you make), your expenses
(what you have to spend) and how much you have left over. What's
left over is known as discretionary
income. No doubt some of your discretionary income will be spent
on luxury items that you want now. But you will also want to put
some of that money away for your future. That's called savings.
Some people suggest saving as much as 10 percent of your discretionary
income.
Many kids start out saving money in a piggy bank. Once they have
accumulated a certain amount, they ask an adult to help them open
a savings account at
a bank or credit union. A savings account is a type of investment
account where the money in the account earns interest.
Banks ensure that you will always be able to get your money out
of the bank when you want it. When you put money in a bank account,
the bank may pay you interest on your money. This means that your
money will earn money, and you will eventually have more money than
you originally deposited, just because you deposited it. Piggy banks
don't do that!
How does interest work?
There are two kinds of interest: Simple and compound. Simple
interest is figured only on the amount you deposit (called the
principal). Compound
interest, on the other hand, is figured on the principal and
the interest the principal earns. Stated another way, your interest
earns more interest when it's compounded.
Computing simple interest
To compute simple interest, multiply the principal (the amount
you deposit) by the interest rate by the length of time it will
take you to pay off the loan. The formula for simple interest is
displayed in the box to the right.
Let's say that you deposit $100 at an interest rate of 14 percent,
for three years.
Step 1: Write the formula:
I=prt
Step 2: Substitute $100 for p, .14 for r, and 3 for time.
Step 3: Solve.
I= $100 x .14 x 3
I= $42.00
The interest you will accumulate is $42.00. The total amount in
your account will be $142.00.
Computing compound interest
Your savings account probably will pay compound interest. Figuring
compound interest is slightly more complicated than simple interest.
Using the formula to the right, let's work a problem involving
interest compounded annually. Start with a deposit of $500 and an
interest rate of 6 percent a year. How much money would you have
after five years?
Step 1: Write the formula.
A = P(1 + i)n
Step 2: Substitute 500 for P, 0.06 for i and 5 for n.
A = 500(1 + 0.06)5
Step 3: Solve
A = 500(1.06)(1.06)(1.06)(1.06)(1.06)
A = $669.11
Interest can also be compounded twice a year, four times a year,
or even daily. When interest is compounded daily, interest is added
to your account every day. The formulas for calculating interest
compounded at these intervals is slightly different (see calculation
in the box on the right).
Using the formula on the previous page, let's work a problem involving
interest compounded during the year. Start with a deposit of $1000
and an interest rate of 8 percent that is compounded four times
a year. How much money would you have after two years?
Step 1: Write the formula.
A = P( 1 + i/m) mn
Step 2: Substitute 1000 for P, 0.08 for i, 4 for m, and
2 for n.
A = 1000( 1 + 0.08/4)4 * 2
Step 3: Solve
A = 1000(1.02)8
A = 1000(1.02)(1.02)(1.02)(1.02)(1.02)(1.02)(1.02)(1.02)
A = $1171.66
After you have accumulated savings, you are well on your way to
becoming an investor. Although
investing carriers a certain
amount of risk, it can also be
financially rewarding. You could invest in stocks,
mutual funds, bonds,
and securities. Each type
of investment has its own risks and rewards. Some are riskier than
others. This means that payoffs can be big, but losses can also
be big.
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