Chapter 5 Financial Services: Savings Plans and Payment Accounts

Truth in Savings (1 of 2)

Truth in Savings defines Annual Percentage Yield (APY) as the percentage rate a saver should expect to earn - Formula to calculate the APY = (100) × (Interest/Principal) NOTE: Formula is applicable when the number of days in the term is 365 or when the account does not have a stated maturity Example: Interest of $66 on principal of $1,200 =(100) × ($66/$1,200) = 5.5% (APY)

Savings Alternatives (4 of 4)

U.S. Savings Bonds Benefits - Rate varies with interest rates (I-bonds) - Low minimum deposit - Government guaranteed - Exempt from state, local income taxes Drawback - Lower rate when redeemed within first five years

Writing Checks

Before writing a check, record in your check register and deduct amount from your balance Proper check writing steps: 1. Record the date 2. Write the name 3. Record the amount in numbers 4. Write the amount in words 5. Sign the check 6. Note the reason for payment

Savings Alternatives (3 of 4)

Certificates of Deposit (CDs) (less liquidity) Benefits - Guaranteed rate of return for time of CD - Insured (when purchased from bank or comparable financial institution) Drawbacks - Possible penalty (reduced interest) for early withdrawal - Minimum deposit

Other Payment Methods

Certified check - Personal check with guaranteed payment - Amount is deducted from your balance when financial institution certifies the check Cashier's check - Check of a financial institution you get by paying the amount of the check plus a fee Money order - Purchase at financial institution, post office, store Traveler's check - Sign each check twice - Electronic traveler's checks — prepaid travel card used when visiting other nations

Deposit Insurance

Example: Deposit Insurance If you have a $562,000 joint account with a relative in an FDIC insured financial institution, then $31,000 of your savings will not be covered by federal deposit insurance. One-half of the $562,000 (which is $281,000) exceeds the $250,000 limit by $31,000.

After-Tax Savings Rate of Return (2 of 2)

For example, 1. You are in the 28 percent tax bracket. 2. 1.0-0.28 = 0.72. 3. If the yield on your savings account is 6.25 percent, 0.0625 × 0.72 = 0.045. 4. You after-tax rate of return is 4.5 percent. You may use the same procedure to determine the real rate of return on your savings based on inflation. For example, if you are earning 6 percent on savings and inflation is 5 percent, your real rate of return (after inflation) is 5.7 percent: 0.06×(1-0.05)= 0.057.

Inflation and Tax Considerations

INFLATION - Compare your savings rate with inflation rate - If inflation rate is higher than savings rate, then savers will experience loss in buying power TAX CONSIDERATIONS - Taxes reduce interest earned on savings - Taxes are not withheld from savings and investments; you may owe additional taxes at year-end as a result of earnings on saving

Managing Your Checking Account

Opening a Checking Account - Individual or joint account Making Deposits - Deposit ticket - Endorsements Blank endorsement Restrictive endorsement Special endorsement

Payment Methods

Payment Methods - Mobile transfers - Stored-value cards Also called prepaid debit cards - Smart cards "Electronic wallets" with an embedded microchip Stores past purchases, insurance, and medical information

Asset Management Account

- Also called a cash management account or a wealth management account - All-purpose account offered by investment brokers and financial institutions - Provides a complete financial service program for a single fee and includes: Tracking your money in one location Fewer monthly and quarterly statements Lower fees for maintaining a large balance Simplified tax reporting Ease of communicating your financial situation to family members

Mobile Banking Services (1 of 2)

- Banking using text messages, financial institution's website, or banking apps PAYMENTS/TRANSFERS - Access cash at ATM - Balance inquiry - Online payments - Move funds among various accounts - Person-to-person payments (transfer funds to another person's account) - Instant payments for bills you forgot to pay - Tap or wave your phone to make a purchase - Access online images of canceled checks.

Influence the Selection and Use of Financial Services

- Banks, credit unions, and other financial institutions provide payment, savings, and credit services - Today, banking may mean a credit union, an ATM, or a phone app to transfer funds

Online and Mobile Banking

- Benefits of convenience and saving time along with instant information access - Concerns of privacy, security of data, ease of overspending, costly fees, and online scams must also be considered - Traditional Electronic Banking Automatic teller machine (ATM; also called a cash machine) offers various transactions Debit card (or cash card) used to make purchases with your own funds

Managing Daily Money Needs

- Buying groceries, paying the rent, and completing other routine spending activities require a cash management plan - Cash, check, credit card, debit card, and online/mobile transfer are the most common payment choices - When you need more cash than you have available, you either liquidate savings or borrow - Using savings or borrowing reduces your net worth

Changing Interest Rates

- Changing interest rates and decisions related to financial services When interest rates are rising... - Use long-term loans to take advantage of current low rates. - Select short-term savings instruments to take advantage of higher rates when they mature. When interest rates are falling... - Use short-term loans to take advantage of lower rates when you refinance the loans. - Select long-term savings instruments to "lock in" earnings at current high rates.

Financial Services and Economic Conditions

- Changing interest rates, rising consumer prices, and other economic factors influence financial services - Be aware of current trends and future prospects for interest rates - Read The Wall Street Journal, business periodicals such as Bloomberg Businessweek, Forbes, Fortune, and other online finance sources

Opportunity Costs of Financial Services

- Higher returns for long-term savings may be obtained at the cost of low liquidity (inability to obtain your money quickly) - Convenience of nearby ATMs should be considered against service fees - The "no-fee" checking account with a $500 non-interest-earning minimum balance means lost interest earnings

Mistakes Made Frequently

- Mistakes made frequently in managing current cash needs include... 1. Overspending from impulse buying and using credit 2. Not having enough liquid assets to pay current bills 3. Using savings or borrowing to pay for current living expenses 4. Failing to put unneeded funds in an interest-earning savings account or investment program

Prepaid Debit Cards

- Popular alternative to checking accounts - Issued by many financial service providers including banks, credit card companies, retailers (such as Walmart), and nonbank companies - Major concern is extensive number of fees a user can encounter due to few current regulations for these cards - Benefits include lowering consumer debt by helping to control spending and buying on credit

Trust

- Trust is a legal agreement that provides for the management and control of assets by one party for the benefit of another - Commonly created through a commercial bank or a lawyer - Parents who want to set aside certain funds for their children's education may use a trust

Certificates of Deposit

1. A CD is a savings plan that requires you to leave your money on deposit for a set time period, otherwise you incur early withdrawal penalties - Several types to chose from - Consider all the earnings and all the costs before saving with a CD or rolling over a CD (automatically buying a new one at maturity) - Consider creating a CD portfolio with CDs maturing at different times (3-month, 6-month, 1-year, 2-year) - Review current information about CD rates at various institutions at Bankrate

Other Financial Institution (2 of 2)

1. Brokerage Firms - Employ investment advisers and financial planners which serve as agents between the buyer and seller for stocks and bonds 2. Finance Companies - Make short and intermediate term loans to consumers and small businesses but at higher rates 3. Credit Card Companies - Fund short-term retail lending 4. Mortgage Companies - Provide loans to customers to purchase homes

Compare the Types of Financial Institutions

1. DEPOSIT INSTITUTIONS - Commercial Banks Offers a full range of services including checking, savings, lending, and other services Organized as corporations - Savings and Loan Associations Traditionally, specialized in savings accounts and home mortgages Today, offer services comparable to banks

Mobile Banking Services (2 of 2)

1. DEPOSITS - Direct deposit of paycheck and government payment - Online transfer from other account - Take photo of check to deposit (remote deposit) 2. OTHER SERVICES - Direct deposit, transfers to savings accounts - Text alerts for balances, payments, deposits - Apply and receive approval for loans - Compare current interest rates for loans - Check rates, apply for insurance - Buy, sell, monitor investments - Locate ATM and bank branches using GPS - Access or shoot photo of store, online coupons.

Other Financial Institutions (1 of 2)

1. Life Insurance Companies - Provides financial security for dependents - Offers insurance plus savings and investment features; recently expanded to offer investment and retirement planning 2. Investment Companies - Are also referred to as Mutual Funds - Offer a money market fund, which is a combination savings-investment plan, on which you can write a limited number of checks - Accounts are not covered by federal deposit insurance

Other Financial Institutions (1 of 2)

1. Life Insurance Companies - Provides financial security for dependents - Offers insurance plus savings and investment features; recently expanded to offer investment and retirement planning 2. Investment Companies - Are also referred to as Mutual Funds - Offer a money market fund, which is a combination savings-investment plan, on which you can write a limited number of checks Accounts are not covered by federal deposit insurance

Deposit Institutions

1. Mutual Savings Banks - Specialize in savings and mortgages - They are owned by their depositors - Mainly located in northeastern United States 2. Credit Unions - Are user-owned, nonprofit, cooperative financial institutions - Annual banking studies report lower fees and lower loan rates with higher satisfaction levels compared to other financial institutions

The "Unbanked" and High-Cost Alternative Financial Services (1 of 2)

1. Pawnshops - Make loans on tangible items but charge higher fees than other financial institutions; used for quick cash; charge can range from 3% to over 100% interest 2. Check-cashing outlets - Charge from 1% to 20% of the face value of a check; the average cost is 2% to 3% - Sometimes called currency exchanges

The "Unbanked" and High-Cost Alternative Financial Services (2 of 2)

1. Payday Loans - Referred to as cash advances, check advance loans, postdated check loans, and delayed deposit loans; interest rates charged can be 780% or more 2. Rent-To-Own Centers - Lease products to consumers who can own the item if they complete a certain number of payments; interest rates can be over 300% 3. Car Title Loans - Provide loans with automobile title as security for a high-interest charge often over 200%

Costs and Benefits of Various Savings Plans

1. REGULAR SAVINGS ACCOUNTS - Usually involve a low or no minimum balance - Credit unions call them share accounts

Types of Checking Accounts

1. Regular Checking Accounts - Monthly fee unless minimum balance maintained 2. Activity Accounts - Fee on each check and deposit 3. Interest-Earning Checking Accounts - Sometimes called NOW accounts - Usually require a minimum balance - Known as share draft account at credit unions

Savings Alternatives (1 of 4)

1. Regular Savings Accounts Benefits - Low minimum balance - Ease of withdrawal - Insured Drawback - Low rate of return

Types of Financial Services

1. Savings - Time deposits, savings accounts and CD's 2. Cash Availability and Payment Services - Demand deposits, checking accounts and other payment methods 3. Borrowing for the short-term or long-term 4. Investments and Other Financial Services - Insurance, investment, real estate purchases, tax assistance, and financial planning

Reconciling Your Checking Account

1. Used to compare the bank's balance and your checkbook balance 2. Reasons for differences - Interest earned - Checks that have not cleared - Deposits not yet received by bank

After-Tax Savings Rate of Return (1 of 2)

AFTER-TAX SAVINGS RATE OF RETURN The taxability of interest on your saving reduces your real rate of return. In other words, you lose some portion of your interest to taxes. This calculation consists of the following steps: 1. Determine your top tax bracket for federal income taxes. 2. Subtract this rate, express as a decimal, from 1.0. 3. Multiply the result by the yield on your savings account. 4. This number, expressed as a percentage, is your after-tax rate of return

Debit Card Transactions

Debit card transactions result in the amount of the purchase deducted from your checking or other bank account - Can be used with your signature - Can be used with your personal identification number (PIN) - Can be used to check into a hotel or rent a car; merchant may freeze an amount in your bank account

Liquidity and Safety

LIQUIDITY - Allows you to withdraw your money on short notice without a loss of principal or fees - With certain types of savings accounts, early withdrawal penalty may be loss of interest or lower earnings rate SAFETY - FDIC coverage prevents a loss of money due to the failure of the insured institution up to $250,000 per depositor per insured financial institution - NCUA provides similar insurance for credit unions

Savings Alternatives (2 of 4)

Money Market Account/Funds (more liquidity) 1. Benefits - Favorable rate of return (based on current interest rates) - Allows checks to be written Insured (money market accounts) 2. Drawbacks - Higher minimum balance than regular savings accounts - Service charge and/or lower rate if below certain balance - Not insured (money market funds)

Evaluating Checking Accounts

Need to be evaluated based on: - Restrictions The Expedited Funds Availability Act - Fees and charges - Interest Interest rate, compounding method, and interest computation Minimum deposit to earn interest or avoid a service charge - Special services such as overdraft protection and online access to view and print checks that have been paid

Evaluating Savings Plans

RATE OF RETURN - Percentage or yield is the increase in value of your savings from earned interest - Example: a $100 savings account that earned $3 has a yield of 3 percent ($3/$100) - Compounding refers to interest that is earned on "previously earned interest" More frequent compounding means the higher your rate of return

Choosing a Financial Institution

Step 1: List your important features Step 2: Rank the top 3 or 4 features on "importance" Step 3: Prepare a list of financial institutions Step 4: Conduct research - Talk to others who have used their services - Research online the services and fees - Visit the financial institution to meet staff Step 5: Decide where you will do business based on your needs

Truth in Savings (2 of 2)

The Truth In Savings law - Purpose is to provide consistency when comparing different savings options at different institutions - Requires Disclosure of... Fees on deposit accounts The interest rate The annual percentage yield (APY) Other terms and conditions of the savings plan