COOPERATIVE EXTENSION Bringing the University to You

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1 COOPERATIVE EXTENSION Bringing the University to You Fact Sheet (Replaces 90-54) Getting What You Want: Saving $$$ To Achieve Your Goals Patricia A. Behal Family Resource Management Specialist PURPOSE OF SAVINGS Savings are the cornerstone of building financial security. The reasons for saving vary and are influenced by your age, income, job, stage in the life cycle and number of children. A primary goal of any savings program is to establish a fund to cushion the impact of large recurring expenses. Another is to provide a safetynet for unexpected expenses and emergencies. Saving is also important for reaching short and long-term goals. SOME REASONS TO SAVE Large Recurring Expenses holiday gift buying vacations insurance premiums Unexpected Expenses and Emergencies automobile breakdown family illness unemployment Short- and Long-term Goals appliance or furniture purchase automobile purchase continuing education purchase of a home retirement accumulate funds to invest AMOUNT TO SAVE How much to save will depend on your reasons for saving. It will also depend on your special family circumstances and on how much is needed to reach your specific goals. Just thinking about the lump sum required to reach any one of the goals may be overwhelming. Change your approach! Break the lump sum down into smaller amounts that can realistically be saved each pay period. Separate your money related goals by when you want to achieve them. SAVE OR INVEST? Saving and investing are not interchangeable terms, although many people use them that way. Savings instruments experience virtually no risk for either the principle (the dollar amount placed in the instrument) or the interest (amount earned on the principal of a loan). Typical savings instruments include passbook savings accounts, savings bonds, money market deposit accounts and certificates of deposit. Examples of investments include stocks, bonds, mutual funds or other securities. These types of investments guarantee neither return of the principal nor earnings. For these reasons, investing may be speculative and involve a high degree of risk. But, there is the possibility of a greater return on your money than with savings investments. The main purpose of both saving and investing is to increase your financial assets. Before beginning an investment program, you should have a sound financial base which includes risk protection (insurance) and an emergency savings fund of two to six months take home pay. Ideally, money resources placed in investments with a high degree of risk should not be those needed for your financial base. (Figure 1)

2 THE TIME VALUE OF MONEY One important concept in personal money management is the time value of money. The time value of money is the relationship between time, money, and rate of interest, and their impact on savings growth. These three factors determine how much money will be available to meet your specific financial goals. For example: (1) The more time you have to save, the more money you will have at the end of the time period. (2) The more money you have to save, the more money you will have at the end of the time period. (3) The higher the rate of interest you can earn, the more money you will have at the end of the time period. TRUTH IN SAVINGS Interest is rent paid for the use of money. The money deposited in financial institutions is, in a sense, being borrowed by the institution. For that use, the depositor is paid a rent or interest. Receiving interest is not as straightforward as it may sound. Since each institution has its own method of calculating the amount of interest a depositor is paid, two different accounts claiming to pay the same interest rate don t necessarily yield the same amount of interest. Financial institutions use four variables to determine the amount of interest paid on deposits. These variables include: how much money (principal) is on deposit, the method of determining the account balance, the interest rate applied and how frequently the interest earned is compounded. Account Balance. For savers, the fairest way for financial institutions to determine the account balance on which interest is calculated is the day-ofdeposit to day-of-withdrawal (DDDW) method.

3 Interest Rate. The Truth in Savings Act, which took effect in 1993, was designed to help consumers easily compare various savings options. In the past, yield could be calculated hundreds of different ways. Banks, credit unions and other financial institutions must now use a standard yield calculation called annual percentage yield (APY). APY is the total amount of interest that would be received on a $100 deposit for a 365-day period based on the institution s annual rate of simple interest (APR) and frequency of compounding, expressed as a percentage. APY must be used in advertising and in other disclosures to savers. It gives savers more information on what the money in their account is really earning. The higher the APY, the better the earnings. Banks may still advertise their interest rate. This is usually expressed as an annual percentage rate (APR). The APR is what the account pays without the effect of compounding. Interest Compounding. Interest may be compounded annually, semiannually, quarterly, monthly, daily, or continuously. The more frequent the compounding, the greater the amount of interest earned by the saver. Never underestimate the power of compounding. The longer earnings compound, the faster the growth of your investment. RULE OF 72 This is an easy way to estimate how long it will take for your investment to double. To use it, divide the number 72 by the interest rate (APR). Assuming all interest will be reinvested (compounded), the result will be the number of years it will take for your money to double % = years % = years % = years % = 9.60 years Putting this information to work for you means three things. 1. Select an account that uses the day-ofdeposit to day-of-withdrawal method of determining the balance on which interest is calculated. 2. Select an account that offers the highest annual percentage yield (APY). 3. Select an account that offers the most frequent compounding. Also, avoid accounts that assess costs and penalties such as service charges, maintenance fees, and fees triggered when the saver fails to maintain a certain minimum balance. FINDING THE MONEY TO SAVE First, identify money that is available to save. Do this by adding up your total income, identifying expenses and determining how income will be used to meet the expenses. After you have spent some time working with the facts and figures, you may make some adjustments that will free up some money for savings. The amount need not be large. It will grow quickly as is shown in Table 1. How much you can save will always be a battle between current wants and future needs. By putting money into savings every time you get paid, you increase your chances of success. TABLE 1. MONTHLY AMOUNT TO SAVE IN ORDER TO REACH A SPECIFIC GOAL Savings Goal Years to achieve goal at 6% annual rate of return (APR) $ 5,000 $120 $74 $31 $17 $11 $ 10, $ 15, $ 20, Note: Higher rates of return will shorten the amount of time needed to reach a goal or reduce the amount needed to save each month. TOOLS THAT HELP There are a variety of tools available to help you determine answers to your saving questions such as length of time and amount of money necessary to reach a specific savings goal. One tool that can be especially helpful is a financial calculator. Financial calculators do much more than just add, subtract, multiply and divide. Complex formulas for compound interest, amortization, and others are built-in functions. Special keys on the calculator give you access to these functions. A financial calculator costs about $30.00 and comes with a guidebook. The guidebook explains how to use the calculator and includes real-life examples. No memorizing of complicated formulas is necessary. You just plug in numbers particular to your situation to arrive at answers that help you make informed decisions about financial matters. Other helpful tools include computer software spreadsheets such as Microsoft Excel and Lotus 1-2-3; and sinking fund factor tables and interest tables. The software programs come with user s guides that lead you through examples in a manner similar to the financial calculator guidebooks.

4 Sinking fund factor tables and interest tables have limited use, but can help you determine how much money you need to set aside (or sink) into savings in order to have a specified amount of money saved, including interest, at the end of a specified time period. The term sinking fund factor comes from the language of bond investing. Investors in bonds want the interest payments made on time and want the principle repaid on schedule. The bond trustee is in charge of setting aside money to repay the bond s principle. The term used for this setting aside of money is sinking fund. SAVINGS STRATEGIES It is often difficult to save because all sorts of expenses seem to keep popping up. Here are some simple strategies to help establish a savings habit: Pay yourself first think of savings as just another bill and not as something you do only if you have leftover money at the end of the month. Deposit money into savings each payday before paying any bills. This is most easily accomplished through a payroll deduction plan where you make arrangements with your employer to deduct a fixed amount from each paycheck to go to savings. Or, arrange with your bank to have the amount transferred from your checking to your savings. Debt to credit switch once an installment payment is paid in full, continue making the payments, but add them to a savings account instead. Crash savings go on a money diet where for a fixed period of time say two months you spend only what is absolutely necessary and save the remainder. Bank your surprises deposit tax refunds, gift money, bonuses, rebates and refunds in a savings account. Collect loose change empty pockets or purse of loose change each day and deposit the accumulation on a regular basis. Kick a habit give up that morning donut or pass by the soda machine. Adjust your withholding to use all of your qualifying exemptions and deductions. Add the extra money in your pay check to savings now rather than waiting for a tax refund. FINDING HELP The financial marketplace undergoes constant change which requires you to continually seek updated information. In addition to asking questions of reputable people in the financial industry, there are numerous references available. Magazines such as Kiplinger s Personal Finance Magazine, Money, Consumer Reports, Forbes, Fortune and others have information on a wide range of topics. The business section in the daily newspaper as well as newspapers such as the Wall Street Journal will provide you with information on the current status of the financial world. Your task is to digest the information, then utilize it in a manner best suited to your financial goals. START NOW! Successful savers know that one of the keys to acquiring wealth is to make your money work for you. Setting aside a portion of your earnings on a regular basis and placing it in interest bearing accounts will help you accumulate cash much faster than you might think possible. Regardless of your financial goals, good savings habits help you get what you want. References Financial planning program instructor s manual. (1992). Denver, CO: National Endowment for Financial Education. Garman, E. T. & Forgue, R. E. (1994). Personal finance (4th ed.). Boston: Houghton Mifflin Co. Hogarth, J., Swanson, J., Davey, A., & Robinson, J. (1985). Savings basics (CHE Topics), Ithaca, NY: Cornell University, Department of Consumer Economics and Housing. The information given herein is supplied with the understanding that no discrimination is intended and no endorsement by Cooperative Extension is implied. The University of Nevada, Reno is an equal opportunity/affirmative action employer and does not discriminate on the basis of race, color, religion, sex, age, creed, national origin, veteran status, physical and mental disability and in accordance with university policy, sexual orientation, in any program or activity it operates. The University of Nevada employs only United States citizens and aliens lawfully authorized to work in the United States.

5 MONTHLY SAVINGS PLAN This worksheet is designed to help you estimate the monthly savings you will need to reach the financial goals you and your household have set. 1. Write down your goals, the estimated amount you ll need (Column A), and when you d like to have this amount (Column B). 2, Use Table 2 Sinking Fund Factor (SFF). Find the approximate interest rate (APR) your savings instrument pays. Go across the appropriate interest rate column and down the appropriate number of years row. The SFF is at the intersection of this row and column (In the example, the SFF for 3 years at 6% is.3141.) Enter this number in Column C. 3. Multiply the amount needed (Column A) by the Sinking Fund Factor (Column C). Enter the answer in Column D. 4. Divide the annual savings goal in Column D by 12. This is the monthly savings needed for the goal you ve listed. Enter this amount in Column E. (Note: Since we are using Annual SFF figures and saving monthly, the figure in Column E will result in slightly higher savings due to more frequent compounding. The $91.61 monthly savings will compound to $3,603 in 3 years. In our example, to save $3,500 you would need to save $88.97 monthly instead of $91.61.) 5. Add up Column E, the monthly savings for each goal. The total figure is the amount you ll need to save monthly to reach the goals you have set. A B C D E Goal Amount Needed When Needed Sinking Fund Factor example: Emergency Fund Annual Savings Needed (A X C) Monthly Savings Needed (D/12) $3,500 in 3 years.3141 $1, $91.61 Total $ Source: Consumer Economics and Housing Topics Savings Basics, Cornell University Cooperative Extension

6 TABLE 2 Sinking Fund Factor (annual) Years 4% 5% 6% 7% 8% 9% 10% Years 11% 12% 13% 14% 15% 16% 17%