Chapter 2: SavingThis chapter emphasizes the importance of saving and explains the

three reasons to save: emergencies, large purchases, and wealth building.

Key Terms: Get to know the language of money.

• » Compound interest: Interest paid on interest previously earned; credited daily, monthly, quarterly or semiannually.• » Emergency fund: Five hundred dollars in readily available cash to be

used only in the event of an emergency; the goal of the First Foundation.• » Interest rate: Percentage paid to a lender for the use of borrowed

money (in debt); percentage earned on invested principal (in investing).• » Five Foundations: The five steps to financial success.• » Sinking fund: Saving money over time for a large purchase.

Before watching the video, read each statement below and mark whether you agree or disagree in the “Before” column. Then, after watching the video, do it again using the “After” column to see if you changed your mind on any statement.

Before Before After AfterAgree Disagree Agree Disagree

The amount of money you save depends on how much money you earn. Simply put, you will save more when you earn more.

A savings account at your bank is the best place to put your emergency fund.

The two biggest factors in compound interest and building wealth are time and the initial amount of the investment.

It is okay to use your emergency fund to pay cash for big purchases such as a TV or a cell phone.

You should pay yourself first before you pay bills.

Section 1Saving: An Exercise of Character

The Five Foundations: Video

1) Save a $500 __________________Fund2) Get out of _______________3) Pay ________________ for Your Car4) Pay Cash for ___________________5) Build _________________ and ______________

Emergency

Debt

Cash

College

Wealth Give

Video: Continued• » The First Foundation is $ 500 in an emergency fund. You should do this as quickly as possible.

• » When you’re in high school, you won’t have the same emergency expenses as your parents (like needing to put a new roof on the house). For you, a surprise expense might be fixing a flat tire or replacing a broken cell phone.

• » An emergency fund allows you to have money available for any surprise expenses.

• » If you don’t have money saved to pay for these things, then debt will start looking like an easy answer.

• » Debt never solves problems. At best, it just delays one problem while creating another one!

• » When you’re older and out of school, you’ll need to grow your emergency fund into a full three to six months’ worth of expenses.

• » Make sure this money is kept in the bank and that you ONLY use it for emergencies. You can’t keep the money handy, because it will get spent.

• » Keep your emergency fund in a separate savings account away from your spending money.

Section 2Three Basic Reasons to Save Money

Three Basic Reasons to Save Money: VideoSave Money for Three Basic Reasons:• 1._______________________________ Fund• 2. _______________________________• 3. _______________________________ Building

Emergency Fund• ____________________________________ are going to happen. Count of it. The First

Foundation, a beginner fund, is _____________.• It’s a good idea to open a _______________________ savings account for your emergency fund.

Then, leave it _________________!• Your emergency fund is NOT an _______________________________. It is insurance for when

unexpected things happen.• The emergency fund is your _______________ savings priority. Do it quickly!

Emergency

Purchases

Wealth

Emergencies$500

separatealone

investment

first

Savings by Nation: Take a Peek in the World’s Piggy BankThe Household Saving Ratio: Household saving divided by household disposable income. Dispensable income is the amount of money that households have available for saving and spending after income taxes have been taken out.

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Savings by Nation1. How much less does the United States save compared to the

highest saving nation? 2. What is the average saving rate in Europe as compared to the

average saving rate in North America? 3. Find the mean and median for the list of values in the Savings by

Nation chart. 4. Based on an annual disposable income of $40,000, calculate the

average amount of money a person would save in Japan; in the United States; in France.

5. What are some possible explanations for the low saving rate in the United States?

11.8%

Europe 10.6%; North America 3.5%

Mean (82.9/10) = 8.29%; Median (average of two middle numbers) 5.4 + 10.6 = 16, 16 ½ = 8%

Japan ($40,000 x 1.9%) =$760; U.S. = $1,600; France = $6,320

High prevalence of credit card debt; aggressive marketing our culture tends to equate stuff with happiness; saving is not a priority.

Sinking Fund Savings: Using a sinking fund savings approach for large purchases means that, when the time comes, you’ll have the cash on hand for large purchases and can avoid going into debt.

• Step 1: The item column (A) lists common big expense that you might need to plan for. If you have an upcoming expense that is not listed, fill it in as “other”.• Step 2: For the items that apply to you, write how much money you’ll need

for that expense in the Needed column (B). Then figure out how many months you have to save up for that item, and write that in the Months column (C). • For example, let’s say it’s January and you want to have $120 spending money saved

for your family vacation in July. You have six months to save.

• Step 3: Now, for each item, divide the “Needed” amount by the “Months” you have. Write that in the Budget column (D).• $120/6 months = $20 a month

Section 3The Power of Compound Interest

What is interest?

It is the money the principal (original amount invested) earns. It is typically a percentage of the principal, paid on a monthly, quarterly or annual basis.

Compound interest is interest paidon interest previously earned.

Here’s an example.Take a one-time investment of $1,000 and earn 10% on it. Your interest earned at the end of the year is $100.Add that to your original $1,000, and you have $1,100.At the end of the next year, your $1,100 is compounded at 10% interest, so your return on investment is $110. Add that to the $1,100, and you now have $1,210.Your interest on $1,210 is $121.

• Inflation: Inflation is a persistent rise in the price of goods and services over a period of time.

• Time Value of Money: This principle suggests that a certain amount of money today has different buying power than the same amount of money in the future. This notion exists both because there is an opportunity to earn interest on the money and because inflation will drive prices up, thereby changing the “value” of the money.

Video 3.1The Power of Compound Interest

How to Calculate Compound Interest

FV=PV (1+r/m)mt* REMEMBER: When calculating this formula, use the mathematical order of operations.FV: The future valuePV: The present valuer: The annual rate of interest as a decimal (5% is expressed as the decimal 0.05)m: The number of times per year the interest is compounded (monthly, annually, etc.)t: The number of years you leave it invested

Rate of Return* Use the online calculator at foundationsU.com

Investment 1: $1000Interest Rate: 5%Time: 40 yearsCompound: once a year

Investment 2: $500Interest Rate: 10%Time: 40 yearsCompound: once a year

Investment 3: $100Interest Rate: 15%Time: 40 yearsCompound: once a year

Review: 3 Reasons to Save

SAVE FOR:_______________________

IMPORTANT BECAUSE:_______________________________________________________________________________________________________________________________________________________________________________________________________________

Emergency Fund

An emergency fund allows you to have money available for any surprise expenses.

Large Purchases

Instead of borrowing to purchase, pay case by using a sinking fund approach.

Wealth Building

Investing allows your money to work for you.

The Five Foundations Activity

The Five Foundations

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23

4

5

What is the foundations?What does this look like?

Draw picture.