Chapter 5
Money market fund:
A money market fund is a combination of savings-investment plan in which the investment company uses your money to purchase a variety of short-term financial instruments.
Types of Financial Services
Savings Payment services Borrowing Insurance Investments Real estate purchases Tax-assistance Financial planning Trusts
Life insurance companies
The main point of life insurance is to provide financial security for dependents, but many life insurance policies also contain savings and investment features.
Certificates of Deposit (CD):
A certificate of deposit is a savings plan requiring that a certain amount be left on deposit for a stated time period to earn a specified interest rate. These time deposits can be a good and safe savings alternative.
Commercial banks:
A commercial bank is a financial institution that offers a full range of financial services to individuals, businesses, and government agencies. They are organized as corporations, with individual investors contributing the capital needed for the bank to operate.
Credit unions:
A credit union is a user-owned, nonprofit, cooperative financial institution that is organized for the benefit of its members.
Money market account:
A money market account is a savings account offered by banks, savings and loan associations, and credit unions that requires a minimum balance and has earnings based on market interest rates. Money market accounts may allow you to write a limited number of checks to make large payments, or to transfer money into other accounts. Money market accounts also may impose a fee when you go below the required minimum balance. Unlike money market funds, money market accounts are covered by the federal deposit insurance.
Mutual savings banks:
A mutual savings bank is a financial institution that is owned by depositors and specializes in savings accounts and mortgage loans. Unlike the profits of other types of financial institutions, the profits of a mutual savings bank go back to the depositors.
Activity Accounts
Activity accounts charge a fee for each check written, and sometimes a fee for each deposit, in addition to a monthly service fee. However, you do not have to maintain a minimum balance. Activity accounts are most beneficial to people who only write a few checks per month and are unable to maintain the required minimum balance.
Asset management account:
An asset management account, also known as a cash management account, provides a complete financial services program for a single fee. Investment brokers and other financial institutions offer this account as well as a line of credit for obtaining cash loans quickly. These accounts provide access to stock, bond, mutual fund, and other types of investments.
Automatic teller machine (ATM):
An automatic teller machine is a computer terminal used to conduct banking transactions, also called a cash machine. A debit card that activates ATM transactions may also be used to make purchases. A debit card is in contrast to a credit card, because you are spending your own money.
Finance companies
Finance companies make loans to consumers and small businesses. These loans have short and intermediate terms with higher rates than most other lenders charge.
Investment Companies (no deposit insurance)
Investment companies (also known as mutual funds) offer banking-type services, such as the money market fund. Unlike accounts at other institutions, investment company accounts are not covered by federal deposit insurance.
How do payday loans work?
Payday loans are a relatively small portion of money lent at a high rate of interest on the agreement that it will be repaid when the borrower receives their next paycheck.
What does the Truth in Savings law require financial institutions to disclose?
The Truth in Savings law requires financial institutions to disclose: fees on deposit accounts, the interest rate, the annual percentage yield, and other terms and conditions of the savings plan. In addition to setting the formula for APY and requiring the disclosure of fees, Truth in Savings also establishes rules for advertising deposit accounts and restricts the method of calculating the balance on which interest is paid.
Annual percentage yield (APY):
The annual percentage yield (APY) is the percentage rate expressing the total amount of interest that would be received on a $100 deposit based on the annual rate and frequency of compounding for a 365-day period. APY reflects the amount of interest a saver should expect to earn.
What is the tax advantage of these?
The main tax advantages of Series EE bonds are that the interest earned is exempt from state and local taxes, and you do not have to pay federal income tax on earning until the bonds are redeemed. Redeemed bonds can be exempt from federal taxes too, if the funds are used to pay tuition and fees at a college or university.
When interest rates are falling:
When interest rates are falling, use short-term loans to take advantage of lower rates when you refinance the loans, and select long-term savings instruments to "lock in" earnings at current high rates.
How do you manage CDs?
When you save with a CD, you need to assess the earnings with the costs. You should not allow your financial institution to automatically roll over your money into another CD for the same term. Consider the interest rates currently. If they dropped, maybe you want to look into a shorter maturity. Or, if you have a sufficient amount of money, maybe you want to obtain a CD with a longer term. You can create a portfolio to help you manage.
Beware of "free" gifts when opening accounts. Why?
You need to be aware of free gifts when opening an account, because oftentimes you have to leave your money on deposit for a certain time period/you may receive less interest.
Savings and loans:
A savings and loan association is a financial institution that traditionally specialized in savings accounts and mortgage loans. Today, savings and loan associations also offer checking accounts, expanded savings plans, loans to businesses, and other investment/financial planning services.
Interest-Earning Checking Accounts (Now Accounts)
Interest-earning checking accounts usually require a minimum balance. If the balance goes below the limit, you will not earn interest, and most likely have to pay a fee. (A share draft account is an interest-earning checking account at a credit union.)
Online Payments
Internet companies are serving as a third party to facilitate online bill payments (for example, Venmo, Paypal, Google checkout). When using these, consider fees and security. Some online payment services give you a choice of using a credit or bank account, while others require them. Being linked to your account can make you less credible in a transaction dispute.
Liquidity:
Liquidity refers to how "liquid" your money is. For example, how easy can you convert your assets into cash?
Mortgage companies
Mortgage companies are organized primarily to provide loans to purchase homes.
When interest rates are rising:
When interest rates are rising, use long-term loans to take advantage of current low rates, and select short-term savings instruments to take advantage of higher rates when they mature.
Store-Value Cards
Prepaid, or store-value cards are for telephone services, transit fares, highway tolls, laundry service, and even school lunches. Sometimes they can be disposable, other times they can be reloaded. However, prepaid cards can have activation charges, ATM fees, and inactivity fees.
Compounding:
Compounding is a process that calculates interest based on previously earned interest. (Each time interest is added to your savings, the next interest amount is computed based on the new balance in the account.)
What about joint accounts?
Joint accounts are considered to belong proportionally to each name on the account. (A joint account held by two people would be covered up to $500,000, with each owner being covered up to $250,000.)
Rate of return:
Rate of return refers to the percentage of increase in the value of savings as a result of interest earned; also called yield. (If you had a savings account with $100 in it, and after a year the account earned $5, the rate of return would be five percent, for example. This is calculated by dividing the interest earned by the amount in savings.)
Regular checking accounts
Regular checking accounts usually have a monthly service charge if you do not keep a minimum balance in the account. Some financial institutions will waive the monthly fee if you maintain a certain amount in savings. However, you lose interest on the minimum balance if it is not in an interest-earning account.
Types of CDs
Rising rate or bump-up CD (rising rate CDs can have higher rates at various intervals, such as every six months. However, this rate may be in effect for only the last couple months for an 18-24 month CD.) Indexed CD (indexed CDs have earnings based on the stock market. If the stock market is strong, this type of CD can earn you more money than other CDs would. However, if the stock market is weak, then you may not earn interest, or you could even lose part of your savings.) Callable CD (callable CDs start with higher rates and usually have long-term maturities, as high as 10-15 years. This type of CD has the advantage of the federal deposit insurance. However, the bank may "call" the account after a year or two if interest rates drop.) Promotional CD (promotional CDs attempt to attract savers with gifts or special rates. You need to be sure to balance the value of the gift against the lost interest.)
Regular savings accounts (share accounts):
Share accounts are regular savings accounts at a credit union. Regular savings accounts are a normal account at a bank or savings and loan association. They involve a low or no minimum balance, monthly and quarterly statements with a summary of transactions, and you can withdraw money as needed.
Pawnshops, check-cashing outlets, rent-to-own centers, refund anticipation loans, auto title loans
Pawnshops make loans based on the value of tangible possessions such as jewelry or other valuables. Many low and moderate income families use these organizations to obtain cash quickly. Check-cashing outlets are businesses that cash any kind of check, and you do not need an account to do so. However, they charge between 1 and 20 percent of the face value of the check. The rental-purchase industry is defined as stores that lease products to consumers who can own the item if they complete a certain number of monthly or weekly payments. Refund anticipation loans essentially means, "you are paying to borrow your own money." Many tax preparation services offer the convenience of getting your tax refund immediately, when in fact you are taking out a loan. An auto title loan is a type of secured loan where borrowers can use their vehicle as collateral.
EE Bonds:
Series EE bonds (Patriot Bonds) may be purchased for amounts ranging from $25 to $5,000 (face values of $50 to $10,000, respectively). Electronic EE bonds are purchased at face value. They increase in value every month, as interest builds up monthly. However, if you redeem an EE bond before five years, you forfeit the latest three months of interest.
Smart Cards
Smart cards are similar to other ATM cards, but their microchip stores prepaid amounts and information with account balances, transaction records, insurance information, and medical history.
Define trust:
A trust is a legal agreement that provides for the management and control of assets by one party for the benefit of another. Trusts are usually created through a commercial bank or lawyer. Parents who want to set aside money for their child's future may also use a trust. The bank manages the investments and money in those trusts, and eventually the children are able to use the money for educational purposes.
What are some tax considerations with savings plans?
Taxes can also reduce interest earned on savings. Taxes usually are not withheld from savings and investment income. This means you may owe additional taxes at year-end as a result of earnings (interest) on savings.
I Bonds
The I bond earns a combined rate consisting of a fixed rate for the life of the bond and an inflation rate that changes twice a year. Every six months, a new fixed rate is set for the new bonds. The additional interest payment is recalculated twice a year, based on the current annual inflation rate.