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Five Minutes of

Financial Literacy A guide for college students

Kenneth C. Rakow, Jr., Ph.D., CPA Jessica S. Rakow, CPA

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Five Minutes of Financial Literacy | iii

Five Minutes of Financial Literacy

Table of Contents

I. Introduction

II. Understanding credit scores and credit reports

III. Managing credit cards

IV. Basic budgeting

V. Buying a car

VI. Buying a home

VII. Investing

VIII. Retirement

Note from the Authors

Our primary goal in writing the Five Minutes of Financial Literacy is to provide you with basic financial knowledge that is not often taught in school. We have made some financial mistakes in the past simply because we were not completely informed. We hope you can avoid some of these mistakes. The information we provide is not meant to be all-encompassing, rather it should serve as a foundation to build your financial knowledge set. Some of the topics may seem more obvious to you than others, but we feel the topics covered will allow you to start making sound financial decisions immediately. We hope you enjoy and benefit from the information that follows and can use our guide as a starting point for increasing your level of financial literacy.

Five Minutes of Financial Literacy | 1

Five Minutes of

Financial Literacy A guide for college students

Objectives

Be able to differentiate between a credit report and a credit score as well as understand the composition of a credit score and how credit affects your financial future.

Understand basic credit card terms, interest calculations, and how to manage credit card purchases and debt.

Understand how to create a basic budget. You will also learn some tips for paying off debt and getting control of your expenses.

Understand how financing works and your options related to car purchases. This section will help you take control of your financing and purchasing options before you head to the dealership.

Understand mortgage types, costs, payment schedules, and the benefits of systematic overpayment.

Have a general understanding of some of the different retirement plans that exist, what to do when signing up for a plan, and common mistakes people make in retirement planning.

Have a basic understanding of several different types of investment options, risk associated with each option, the importance of asset allocation and investment horizon, and the power of compound interest.

2 | Five Minutes of Financial Literacy

INTRODUCTION

DID YOU KNOW?

National Financial Literacy Month is recognized every April. It is an effort to highlight the importance of financial literacy and teach Americans how to establish and maintain healthy financial habits.

The Fair and Accurate Credit Transaction Act (FACT Act) established the Financial Literacy and Education Commission. Its purpose is to improve the financial literacy and education of people in the U.S.

WHY IS FINANCIAL LITERACY IMPORTANT?

The average household with debt carries approximately $10,000 to $12,000 in total revolving debt and has nine credit cards. (1)

By the time students reach their senior year of college, 56 percent carry four or more credit cards, with an average balance of $2,864. (2)

People in the 18 to 24 age bracket spend nearly 30% of their monthly income just on debt repayment (10% of net income is a recommended amount for debt obligation). (3)

Teens believe when they get older that they will earn an average salary of $145,000. In reality, adults with a bachelor's degree earned an average of $54,689 in 2005. (4)

The average 21-year-old in the U.S. will spend more than $2.2 million in their lifetime. (5)

The number of 18 to 24-year-olds declaring bankruptcy has increased 96% in 10 years. (6)

About half of adults (49%) say they are concerned they have not paid as much attention to managing their finances as they should have and 48% are concerned they do not know enough about financial planning. (7)

In 2008, 2.3 million homeowners faced foreclosure proceedings. This was an 81% increase from 2007. (8)

In 2005, savings rates dipped to minus 0.5%, something that hasn't happened since the Great Depression in 1932 and 1933. A negative savings rate means Americans spent all their disposable income and dipped into past savings or increased their borrowing. (9)

The 2008 Retirement Confidence Survey (RCS) shows that 36% of all workers have less than $10,000 saved for retirement. This is more startling when you consider that of workers 55 and over, 28% have less than $10,000 saved for retirement. (10) Some of the sources were taken from: http://www.yacenter.org/index.cfm?fuseAction=financialLiteracyStatistics.financialLiteracyStatisticseport.php

(1) Jump$tart Coalition, 2007 (2) Washington Post, 2007 citing student loan

lender Nellie Mae. (3) Generation Broke: The Growth of Debt

Among Young Americans (4) The Denver Post, citing Charles Schwab

Teens and Money, 2007

(5) Share-Save-Spend.com (6) Richmond Credit Abuse Resistant Education

(CARE) Program (7) The Harris Poll #22, 2007 (8) RealtyTrac.com. 2009 (9) U.S. Commerce Department, 2006 (10) Employee Benefit Research Institute, 2008

Five Minutes of Financial Literacy | 3

WHY FIVE MINUTES?

The primary goal of this module is to develop a basic understanding of financial information used in every-day life. Teaching financial literacy topics in addition to a normal curriculum helps mitigate a growing deficiency in the basic financial literacy knowledge of students. The concepts addressed should be learned by every college student, not just business majors.

Five minutes of financial literacy per class period gives students an understanding of the basic concepts. This is not intended to be an all encompassing course but rather a foundation on which future knowledge is built.

MEET JACK AND JILL

Throughout our module, we use an example of two people who illustrate good and poor financial choices. Their background information is as follows:

Jack and Jill are best friends with a lot in common. They both graduated from college a couple of years ago with a degree in engineering. They both accepted a job with Water Pail Inc., making identical salaries. Jill is financially savvy; she is an avid reader of personal finance books and has specific financial goals she plans to accomplish. Jack has never been interested in personal finance; he does not pay much attention to his finances and has had some financial problems in the past.

Jack and Jill have experiences which involve all of our financial literacy topics. Their successes and mistakes help provide a better understanding of the module topics.

UNDERSTANDING CREDIT SCORES AND CREDIT REPORTS

WHAT IS A CREDIT REPORT?

A credit report is a record of your credit activity, which includes all of the necessary information to evaluate your financial health. It lists everything from your address to any arrests you may have. The report will include a detail of past and current debt outstanding (credit cards, car loans, student loans, etc.) and how regularly you make your payments. It also shows if any action has been taken against you because of unpaid bills.

Your credit report may be accessed by creditors, employers, insurers, landlords, government agencies, or any other individual/entity with a legitimate business need for such information.

The three major credit reporting agencies that collect and sell credit information are:

Equifax Information Service TransUnion Corporation Experian (formerly TRW) Attn: Disputes Attn: Disputes Attn: NCAC P.O. Box 740241 P.O. Box 2000 P.O.Box9556 Atlanta, GA. 30374 Chester, PA 19002 Allen, TX 75002 (800) 685-1111 or (800) 888-4213 (888) 397-3742 (800) 985-5000 www.TransUnion.com www.Experian.com www.equifax.com

4 | Five Minutes of Financial Literacy

Credit reports include the following information:

Identifying information: Name, Addresses, Current/Former Employers, Birth date, Social Security #.

Credit Information: Accounts you have with banks, credit card issuers, retailers, and other lenders. These accounts are listed by type, the date you opened them, your credit limit or loan amount, any co-signers, and your payment pattern over the past two years.

Public Record Information: Court records on bankruptcy, tax liens, and monetary judgments.

Recent Inquiries: The names of those who have obtained copies of your credit report during the last two years.

WHAT IS A CREDIT SCORE? It is a number that is calculated based upon financial information in your credit report. The score provides lenders with a simple way to determine whether or not they should lend money to applicants. Each lender has its own strategy, including the level of risk it finds acceptable for different lending tools (i.e. credit card, car loan, home loan). Credit scores are often called "FICO scores" because most credit bureau scores used in the United States are produced from software developed by Fair Isaac and Company (FICO). Credit scores range from 300-850. The score indicates to lenders how "risky" you are. The higher the credit score, the lower the risk of you not paying on time or not paying at all. Scores higher than 720+ are ideal. It is the credit score that makes it possible to get instant credit at places like electronics stores and department stores. If you have never had a credit card or a loan in your name, you will not have a credit score. Because lenders cannot determine your level of risk, you will likely be given the same treatment as someone with a low credit score.

HOW IS YOUR CREDIT SCORE DETERMINED?

35% - Payment History: How often you pay your credit cards (example: Visa), retail accounts (example: Macy’s),

installment loans (example: car loans), mortgage loans, student loans and any other loans you have. Any late or missed payments and the details of those payments will be included here.

Any current or past collection items (i.e. bankruptcy, foreclosures, lawsuits, wage attachments, liens and judgments).

Warning: Accounts that have been “paid off” or closed will still show up on your credit report.

30% - Outstanding Debt: The amount you owe on all accounts (includes loans, credit cards, etc.).

How much credit you have available (example: You have a Visa, Macy’s card and AMEX – how much do you owe on those cards and how much could you charge on them?).

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6 | Five Minutes of Financial Literacy

INFORMATION YOU SHOULD KNOW

Both good and bad credit activity generally remains on your credit report for seven years. Personal bankruptcy stays on your report for ten years. Other items like imprisonment do not have a set time limit.

Bad credit can keep you from getting a loan, a job, a lease and insurance among other things.

You are actually entitled to receive one free credit report every year from each of the three major credit reporting agencies - Equifax, Experian and TransUnion. This service is provided through the Federal Trade Commission (FTC). Go to their website www.annualcreditreport.com to request all three reports.

Warning: All other offers of "Free Credit Reports" are by companies trying to sell a credit monitoring service.

If there is a mistake on your credit report, contact the credit reporting agency responsible for the error immediately to notify them. The credit reporting agency is then responsible for researching and changing the information. This process could take at least 45 days. You can then request an updated copy to be sent to anyone who has received your report from that agency during the previous six month period and employers from the past two years.

Warning: Companies offering to "improve your credit score" are trying to take your money and can often cause your score to drop.

While you can receive a free credit report each year, you have to pay to receive your credit score. You can order your score from www.annualcreditreport.com or any of the three major credit reporting agencies.

Myth buster: If you request your credit report or credit score it will NOT hurt your score as long as you order your score from one of the authorized places listed above.

TIPS TO IMPROVE YOUR CREDIT AND AVOID IDENTITY THEFT

Pay bills on time and get current on any missed payments.

Go to www.annualcreditreport.com and request your credit report from all three credit reporting agencies at least once per year, and compare them. You should also check your credit report before you apply for any type of loan or credit card.

Keep balances low on credit cards and other "revolving credit." High outstanding debt will lower your score. Maintain balances at or below 50% of the available credit limit.

Do not consolidate debt to a new credit card with a lower interest rate or close unused credit cards if you are going to exceed 50% of your available credit limit. Opening several new accounts over a short period of time can also hurt your score.

Keep interest rate shopping within a two week period. Example: do not start requesting mortgage rates from financing companies until you are ready to buy. If you know your credit score, you should be able to estimate your rate. Do this so the credit agencies know that you are trying to shop for one loan rather than searching for available credit. All auto and mortgage inquiries made within a 14 day period are counted as one inquiry for scoring purposes.

Report a lost or stolen card immediately. Keep a copy of your credit card account number and the financial institution’s name and customer service telephone number in a convenient place.

Five Minutes of Financial Literacy | 7

Protect personal information. You should never give out your credit card number unless making a telephone, mail order, or online purchase. Do not let anyone else use your credit card.

All three credit reporting agencies offer a “credit monitoring” service for a monthly fee. This service will provide you with updates regarding your credit and allow you to review your credit report at anytime. For example you will be notified if a credit card is opened in your name or if a balance on an account increases significantly. You should consider this service if you have had previous problems with errors on your credit report which you are trying to resolve or if you have concerns about identity theft.

Do not listen to the commercials. Most companies advertising “debt consolidation” are actually advertising BANKRUPTCY. Even debt consolidation without bankruptcy will ruin your credit score.

If you need credit counseling, go to a legitimate organization. Find an organization that provides free "in person" credit counseling and sends you free information about their services without asking for any personal information regarding your financial situation. Contact your local consumer protection agency, your banking institution, or your state Attorney General for recommendations of counseling services in your area.

JACK AND JILL

Jack has had a few late payments with his credit cards and student loans and he has "maxed out" one of his three credit cards. He has been thinking about buying a new car and has been rate shopping for the past few months. Jack was shocked to find out that he did not qualify for the interest rate being advertised on TV. Due to his poor credit score of 610, the lowest interest rate he could find was 15.52% (myfico.com estimated rate as of March 2009).

Jill is conscientious with her credit. She always pays her bills on time and she uses good budgeting plans to ensure her outstanding debt is at a minimum. Jill noticed errors on her credit report and has made sure all of the information included on her report is now accurate. Jill has also been thinking of buying a car and has been shopping for the best rate over the last week. She was thrilled to find that, because of her good credit score of 750, she qualified for the lowest interest rate available of 6.19% (myfico.com estimated rate as of March 2009).

PAUSE & DISCUSS

We have explained why lenders look at your credit score. Why do you think potential employers would want to know your credit score and history?

Can you think of five things you can do right now to improve your credit score?

ACTION PLAN

Go to www.annualcreditreport.com and request your credit report from all three reporting agencies. If you agree with the information on all three reports, consider purchasing your credit score. Use the tips above to improve your score. This is the first step to taking control of your finances.

8 | Five Minutes of Financial Literacy

MANAGING CREDIT CARDS

DEFINING THE “FINE PRINT”

Introductory APR (Annual Percentage Rate): The initial amount of interest you will be charged if you do not pay your balance in full. Look for how long the rate will last and what the rate will be once the introductory period is over. For example: 0% APR for 60 days means you will not be charged interest on purchases for the first 60 days you have the card. After the 60 days, interest will be charged on the outstanding balance and you could have to pay interest on the amount owed from the time you originally made the purchase (depends on the terms).

Balance transfer: A balance transfer is when you transfer a balance from one credit card to another. You are often charged a fee for transferring your balance. Some credit cards offer a “no fee” deal and/or low rate on balance transfers, meaning they will charge you a lower rate for only the amount you transfer and only for a set period of time. Look for whether an introductory APR is for purchases or balance transfers.

Other Fees: Fee types and amounts vary widely based on the card you choose. Some common “other fees” are: Late Payment Fee (charged if payment is received past the due date), Over Limit Fee (if you charge over your credit limit), Balance Transfer Fee (see above), Fee for Cash Advances (usually a percentage of the amount of cash advanced), and Dishonored Check Fee (if your payment bounces).

Daily Periodic Rate (DPR): The amount of interest you are charged each day. The APR is divided by 365 to get the daily periodic rate. For example, if your APR is 15.99%, your daily periodic rate is 0.0438%.

Average Daily Balance Method: How finance charges are calculated each day. Multiply the DPR by the beginning balance of your debt each day (including unpaid Finance Charges from previous billing periods) plus any new transactions, debits, or fees, less any payments or credits.

REWARDS – JUST SAY “NO” TO THE FREE T-SHIRT!

Choose a credit card because it has a low APR and no fees, not because of the “rewards” the card offers. Only consider reward offers if you are trying to choose between two cards with identical other terms (i.e., low APRs, no annual fees).

Cash Back: A lot of credit cards will give you back a percentage of each purchase you make. For example, some cards will give you 3% of all gas and grocery purchases and 1% of all other purchases. It is nice to get a check from the credit card company! Cash is much easier to use than airline miles or points.

Points: Points are offered based on how much you spend. Points can be exchanged for anything from flights to gift certificates. Research the difficulty of using points and the cash value of the points before you sign up for this reward.

Miles: Airline miles are also used as a reward on some cards. Like other rewards, miles are awarded based on how much you spend. Check for limitations and difficulty in using miles before applying. Also look for additional fees (i.e., fuel surcharge) which may be applied when miles are redeemed.

Five Minutes of Financial Literacy | 9

TIPS FOR CREDIT CARDS

Stick with one credit card. There is no reason you need more than one card.

Credit cards should only be used to the extent you have the money to pay them each month. If you cannot pay it in full each month, do not charge it!

If you do not have a good credit score, you will probably not qualify for most of the advertised offers from credit card companies. Know your score before you apply!

All credit cards are not created equal. Look for cards with a low interest rate and no annual fee.

Be aware of teaser rates (introductory APR). These rates typically last for only a few months and then jump as high as 20%. Find out what the rate is when the term expires.

Do not pay off one credit card with another.

Pay on time. Be sure to send the credit card payment several days in advance of the due date to allow for mailing time. Late penalties are costly and companies can increase the interest rate after a payment is overdue.

Never get a cash advance. Interest rates for cash advances are much higher than the rates charged on purchases.

Do not exceed the credit limit (i.e. “Max Out” your credit card). In addition to helping your credit score, this helps you avoid penalties and ensures that you have credit available in the event of a true emergency.

Review statements carefully. Immediately inform the credit card company of any discrepancies or errors on the monthly statement.

Eliminate temptation. Sign up with the credit card reporting agencies' opt-out service. This service removes you from the marketing lists they sell to credit card issuers and can be reached at 1-888-5-OPT-OUT or OptOutPrescreen.com.

There are many FREE financial calculators that will help you calculate everything from your daily interest charge to how long it will take you to pay off your credit card on the web. Try typing in "credit card interest calculator" into any search engine and a list of them will pop up.

JACK AND JILL

Jack has three credit cards. One of the cards has an 18.9% interest rate and a balance of $5,000. Jack pays the minimum balance of $200 each month. At this rate, it will take him 12 years and 10 months to pay off the credit card. By the time it is paid off, Jack will have paid the credit card company $8,155!

Jill pays her credit card balance in full each month. Her card has a low interest rate and does not charge any fees. In addition, Jill receives cash back, 3% on gas and groceries and 1% on all other purchases, as the reward for her credit card.

PAUSE & DISCUSS

Why do you think credit card companies market so heavily to college students?

Are all of your credit cards necessary? If so, why? If not, which one would you keep and why?

10 | Five Minutes of Financial Literacy

ACTION PLAN

Review the terms of your credit cards. If you have outstanding balances, develop a timeframe for paying off your debt. Credit cards should be paid off in order of the highest interest rate.

BASIC BUDGETING

GOALS FOR BUDGETING

Pay off your debt. Make this your top priority. After you have paid your required monthly payment, pick an additional amount of debt and start repaying it. The debt with the highest interest rate is usually the best place to start. For example, pay off your credit cards in interest rate order first, then move on to other debt (car payment, student loans, etc.)

Create an Emergency Fund. Try to have a minimum amount saved “just in case.” Emergencies can be anything from an unexpected car repair that your insurance does not cover to wages lost from losing your job. Most experts recommend 3 to 6 months of living expense saved for emergency use. Even if you start small, it is critical to have an emergency fund in place.

Save for Retirement. It is never too early to save for retirement. We will discuss more about retirement at the end of the module.

Decide on your financial goals. Everyone’s financial goals will vary depending on personal wants (going to Cancun for Spring Break) and needs (eating something other than cereal for dinner). The important thing is to set your goal and work toward achieving it.

HOW TO MAKE A BUDGET

There are free budget worksheets for setting up your personal budget available online. Websites like Microsoft Office Online have lots of free budgeting templates. Choose the one you like the best!

Once you choose a template you like, start gathering information. Pull out every bank statement you have. If you have thrown them away, contact your bank. You can get online statements and track checking activity for at least six months with most banks. Gather any other financial information you can find. Old utility bills, student loan statements, and credit card statements can all be used to help you figure out where your money is going.

Calculate monthly amounts for income. Include wages, interest earned, and any form of money you receive (even that monthly check from mom).

Break expenses into monthly amounts and categorize them (for example, textbook expenses should be listed under a “school tuition and fees” category). Some expenses will be "fixed" amounts each month (i.e., insurance, rent, cell phone) and some will be "variable" (i.e., groceries, entertainment, clothes).

Start budgeting to reach your goals. Whether it is paying off debt or saving for your vacation, decide how much you are going to spend on achieving your goals and incorporate it into your budget.

Subtract your expenses and goals from your income. If expenses are greater than income, you need to cut some expenses out or earn more income!

Five Minutes of Financial Literacy | 11

BUDGETING TIPS

Pay off debt in interest rate order, not by largest amount owed (this is in addition to making the minimum payment on all debt outstanding).

Keep your receipts. Put an envelope in your purse, car, or where you keep your wallet at home, especially if you pay with cash. This will help you remember where you spent your money when you are ready to record it in your budget. Now you will know what happened to that $20 you took out of the ATM!

Do not include money that you are not sure you will receive. For example, unless you are sure you will receive your scholarship for next semester do not record it.

Budgets are rarely perfect. Your budget will need to be revised and perfected over time.

Do not forget to look for annual payments. (For example, books are purchased at the beginning of each semester, income taxes are due in April, several types of insurances are paid once per year).

Do not forget to estimate car maintenance, household repairs, vet bills, etc. in your monthly budget.

Do not forget about Christmas, birthdays, and other holidays. Budget for any gifts you expect to buy this year.

Use coupons. Why pay full price if you do not have to? The Sunday paper and websites like www.couponmom.com are a great place to find coupons.

Reduce unnecessary expenses. Buy generic, rent videos instead of going to the movies, turn the lights off, take your lunch to work instead of going out to eat, and save money on energy bills by setting the thermostat to a warmer temperature in the summer and a cooler temperature in the winter while you are out.

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JACK AND JILL

Here is an example of the monthly budget Jill uses to plan her finances. Jack does not use a budget; he claims he keeps it "all upstairs."

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PAUSE & DISCUSS

What are your financial goals for the next year? What about for the next five years?

Can you think of five things you can do right now to reduce your unnecessary expenses? Can you think of one way to increase your income?

ACTION PLAN

Get your financial information in order. How much debt do you have outstanding? Do you have anything saved for emergencies? Once you have compiled your debt and reviewed your savings, you are ready to determine your goals. Decide on a financial strategy (i.e., my goal is to pay off my credit card over the next two months and have an emergency fund established by the end of the year). Remember to be aggressive when you set your goal, but be realistic. Once your goals are established, you are ready to budget!

BUYING A CAR

FINANCING TERMS AND SOURCES

Manufacturer’s Suggested Retail Price (MSRP, aka “sticker price”): Like the name states, this is only the suggested price, not the price you HAVE to pay for a vehicle.

Invoice Price: Price the dealer pays to the manufacturer.

Term & Depreciation: A term is the duration of a lease or financing contract, usually expressed in months (e.g., 36 months). Depreciation refers to the decline in value of a vehicle over the term of a financing contract or lease.

Purchase price: The selling price of a vehicle plus any additional charges such as taxes, acquisition fees, official fees and other charges. This is often referred to as the “out the door cost” and is a valuable piece of information to know before even discussing financing. The monthly payment is determined based on the purchase price of the vehicle.

Annual Percentage Rate (APR): The yearly rate you pay in interest. The APR will be compounded monthly and used with your purchase price to determine your monthly payment.

Rebate: An amount of money offered by the manufacturer to help lower your cost. Most rebates have restrictions, and not all buyers will qualify. The dealership should always tell you if an advertised price includes rebates and what type of buyer qualifies for those rebates.

Down payment: An initial payment made when purchasing a vehicle. This payment is negotiable with your dealer, but a substantial down payment (at least 20%) will usually equal a lower interest rate.

Capitalized Cost Reduction: an initial cash payment on a lease of up to 20%, similar to a down payment. The more you pay at the start of the lease, the lower the monthly payments. This could be in the form of cash, or the value of a trade, or a combination of the two.

Residual Value: The projected value of a vehicle at the end of a lease and is not negotiable. Residual value varies according to the lease term, mileage allowance, and the vehicle's make and model. It is considered in the lease payment calculation. High residual value will equal a lower lease payment.

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Credit Union or Bank: Credit unions usually offer the lowest interest rates on auto financing, followed by banks. Simple interest loans where interest is spread evenly throughout the loan term are usually offered.

Dealer or Manufacturer: Dealer or manufacturer financing generally costs higher than that of banks and credit unions unless a special financing rate is being offered. Loans are often front-loaded, meaning payments are made up of a higher interest rate in the beginning of the loan term than towards the end.

LEASE OR BUY?

LEASE BUY

A contract between a car company and you to "borrow" their car. You agree to use the vehicle for a specified amount of time and make a specified monthly payment.

A contract between you and a lender that will result in ownership of a car. Up-front costs include the down payment, taxes and registration as well as other fees and charges.

Pros: You pay less cash up front, because leasing does not usually require a substantial down payment. If you have an excess of disposable income (you are debt free and have met all of your financial goals) and prefer to change cars frequently, you may prefer leasing.

Pros: Buying is more favorable if you plan to keep the vehicle for more than four years, which we recommend. There are no restrictions on mileage when you buy a vehicle. Buying is a better option if you drive more than 12,000 to 15,000 miles per year.

Cons: You may have to pay to have the car reconditioned if the dealer decides there is excess wear and tear on it when you turn it in. You will also pay for every mile (e.g. $0.15 per mile) you drive beyond the per year mileage agreement (usually 12,000 to 15,000 per year) on a lease. If you need to turn in your car before the lease ends, you could be forced to pay a significant penalty. If the book value of the car is less than you owe on the lease, you will pay the difference in addition to any early termination fees that apply. An accident or theft could cause early termination of your lease. Most auto insurance policies pay the average market value of the car, which may be much less than the remaining lease obligation. You will be forced to pay the difference.

Cons: The only con for buying is if you buy a car that you cannot afford.

Tips for Leasing: Look for cars with a low depreciation rate. Avoid leases that extend beyond the factory warranty. Buy extra miles up front if you expect to run over the standard allotment. Make sure your trade-in is deducted from the car's capitalized cost (the vehicle price plus fees and taxes). Make sure the sales tax is included in your monthly payment or you will have to pay the tax when the lease is up.

Tips for Buying: Negotiate as close to the invoice price as possible. A dealer will sometimes negotiate to within $500 of the invoice price, especially if the manufacturer is giving them a special deal if they sell the car. Check for the latest incentives and rebates available for the car you want on websites like Edmunds.com.

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NEW, USED, OR CERTIFIED PRE-OWNED?

NEW USED CERTIFIED PRE-OWNED

Pros: You will be the first owner of the car. There are typically lower financing rates on new cars. You will have the full factory warranty.

Pros: Lower purchase price and cheaper insurance. You do not take the hit for the initial depreciation.

Pros: Lower purchase price and cheaper insurance. You do not take the hit for the initial depreciation. Comes with a factory extended warranty (up to 100,000 miles). Car has been through a specific inspection (100 to 150 points depending on the manufacturer).

Cons: Higher monthly payments and insurance rates. A new car loses 40% of its value within the first three years of ownership (as much as 20% the moment it is driven off the lot), and continues to fall each year. How much it depreciates depends on the make, reputation, popularity, mileage, and condition.

Cons: May have only a few (if any) miles left on factory warranty. Unknown maintenance habits of previous owner. Higher financing rate.

Cons: Usually cost more than used cars.

TIPS FOR CAR BUYING

Before you consider buying or leasing a vehicle, you should determine if you can afford it. Review your monthly budget and your long term goals. Is the car a want or a need?

Leasing should never be considered in order to drive a car you could not otherwise buy (i.e., if you can't afford to buy a Lexus, then you should not lease one either).

Know your credit score before you go to the car dealership. As with any loan agreement, low credit scores equal high interest rates.

Financing is not the only option. You can buy a car with CASH. Then you will not pay any interest!

Buy a car that you can afford to pay off in 48 months or less to avoid owing more on the car than it is worth (aka being "upside down"). Being upside down on your loan can also be avoided by putting 20% down.

Use your budget to determine how much you can afford each month. Do not forget to include fuel, insurance, and maintenance cost in your calculation. Remember that money used on your car payment is money you could be using to reach your financial goals.

Check the Blue Book value for your current car at www.kbb.com before you trade it in. It may be better to sell your car than trade, depending on its value.

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Look up the market value of the car you want to buy. You want to find the average price buyers are paying for cars in your area. This can be done on websites like www.edmunds.com.

Order your car if you do not see what you want on the dealer’s lot. This may cause a delay, but cars on the lot may have options you do not want that will increase the price of the car. If you do decide to buy off the lot, negotiate. If a dealer is trying to get rid of inventory, you may be able to get a good deal.

Do not feel pressured to put down a deposit (some dealers will ask you to put this down to "hold" a car for you). This is typically nothing more than a sales tool. If you give them a deposit, make sure it is refundable and get a receipt that proves it.

It will be more difficult to negotiate the price of high-end luxury cars because the supply is minimal and demand is high for those cars. Dealers are more likely to stay close to the sticker price.

JACK AND JILL

Jack has decided to buy a new car. He goes to the dealership and picks out a 2009 Honda Accord EX. He negotiates with the dealer to pay invoice price of $22,798* because he is buying the car off the lot. He sits down with the car salesman to discuss financing and finds out that the "out the door" cost is $24,565.* Due to his poor credit score of 610, the lowest interest rate he could find was 15.52% (see credit score section for more detail). He decides to finance the car over 48 months, which makes his monthly car payment $690.15. Jill has also decided to buy a 2009 Honda Accord EX, but she has decided to buy a certified pre-owned vehicle. The car she finds has 10,000 miles on it, and the dealer is selling it for $19,000* ($20,495* out the door). Due to her good credit score of 750 she qualified for the lowest interest rate available of 6.19% (see credit score section for more detail). She also decides to finance the car over 48 months, which makes her monthly car payment $483.11. That is an extra $207 per month less than Jack's payment. By the time both Jack and Jill's cars are paid for, Jack will have paid $9,938 more than Jill! *Values and calculations taken from www.edmunds.com using national averages for taxes and fees. PAUSE & DISCUSS

Why do car companies encourage people to lease cars?

Why do car companies advertise the MSRP instead of the invoice price?

Based on what you have learned, will your next car purchase change? Why?

ACTION PLAN

Go to www.kbb.com and find out the value of your car. Compare it to the outstanding amount owed on your car. Do you owe more than the car is worth? If so, start adding an additional amount to your car payment each month to catch up. See "systematic overpayment" discussed in the next section for more reasons why you should pay more than your standard monthly payment on your car.

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BUYING A HOME

WHAT IS A MORTGAGE?

A mortgage is a loan that pledges the purchased property (i.e., your house) as collateral. This means that if the mortgage is not paid, the mortgage company can take the house and sell it. We focus on the pros and cons of two common mortgage types, fixed rate mortgages and adjustable rate mortgages. Other mortgages include interest only mortgages, balloon mortgages, and reverse mortgages.

FIXED RATE MORTGAGES ADJUSTABLE RATE MORTGAGES (ARMS)

A mortgage where the interest rate is fixed for the life of the mortgage; most common are 30-year and 15-year.

A mortgage where the interest rate can change based on some benchmark rate (e.g., prime rate or LIBOR). For example, a 5/1 ARM means that the rate (and payment) is fixed for five years and then adjusts in year six.

Pros: Fixed rate and fixed payment for the entire duration of the mortgage. Generally receive lower interest rates for shorter mortgage terms (i.e., choosing a 15-year mortgage over a 30-year mortgage).

Pros: Typically can receive lower initial rates with ARMs. If rates go down, you could pay less when the rate is adjusted.

Cons: May have higher rates than riskier adjustable mortgages.

Cons: Riskier than fixed rate mortgages. If rates go up, you have to pay more when the rate is adjusted. Many people have been unable to afford their house payments after the payment adjusts.

INFORMATION YOU SHOULD KNOW

A down payment of 20% is recommended for two important reasons. One, a 20% down payment shows the lender that you are serious about the mortgage and can translate into better financing terms. Two, paying 20% down allows you to avoid paying Private Mortgage Insurance (PMI). PMI protects the lender from you defaulting on your mortgage, and can vary depending on the mortgage amount and down payment but is usually around 0.5%.

A lender is required by law to provide you with a Good Faith Estimate (or GFE) within three days of applying for a loan. The GFE includes an estimate of what costs are due at closing. Some fees are controlled by the lender, so it is best to review these to ensure they are legitimate. Other fees are performed by third parties or consist of taxes, so these probably do not change much between lenders.

Some lenders also ask you to pay loan origination points or discount points.

Loan origination points represent a percentage of the loan amount you are paying to the lender. 1% is a common amount, but this amount is negotiable. If you have good credit and the ability to get a loan from somewhere else, then try to have this amount reduced or removed.

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Discount points allow you to pay a percent of the loan amount to lower the rate. Usually, one point reduces your rate between 0.125% - 0.250%, which reduces your payment over the mortgage life.

Other costs include appraisal fees, application fees, title search fees, title insurance fees, and credit report fees. These should all be clearly listed on the GFE. Always question fees that seem unreasonable or ones that you feel should not be included.

Closing costs are typically paid by the buyer, but even who pays what at closing is negotiable. If the seller is eager to sell, then they might agree to pay some or all of the closing costs. It never hurts to ask.

MORTGAGE PAYMENT SCHEDULE

A mortgage payment schedule shows how every payment you make over the life of the mortgage is allocated between interest and principal reduction. You start with a beginning carrying value (i.e., the loan amount) and lower that amount each month based on what portion of the payment goes towards principal. Below is an example of a 30-year $300,000 mortgage at 6%. The $300,000 mortgage is based on a $375,000 home after a 20% ($75,000) down payment. The monthly payment would be $1,798.65. Interest is calculated by multiplying the beginning of the month carrying value times the monthly interest rate, and the rest of the payment is applied to principal. The monthly rate is 0.5% (6% annual rate divided by 12 months), so the first interest amount is $1,500 ($300,000 x 0.005) and the second interest amount is $1,498.51 ($299,701.35 x 0.005).

Month Payment Interest

Principal

Reduction Carrying Value

0 300,000.00

1 1,798.65 1,500.00 298.65 299,701.35

2 1,798.65 1,498.51 300.14 299,401.21

3 1,798.65 1,497.01 301.64 299,099.56

4 1,798.65 1,495.50 303.15 298,796.41

357 1,798.65 35.54 1,763.11 5,344.00

358 1,798.65 26.72 1,771.93 3,572.07

359 1,798.65 17.86 1,780.79 1,791.28

360 1,800.24 8.96 1,791.28 0.00

647,515.58 347,515.58 300,000.00

Notice that even though you have a $300,000 mortgage, you actually pay $647,515.58. You pay more in interest than you do in principal over the life of this mortgage.

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Now, look at the same house using a 15-year fixed-rate mortgage. Assume a rate of 5.75% because you can get lower rates if the mortgage period is shorter. At this rate, your payment would now be $2,491.23.

Under this scenario you save around $200,000 over the life of the mortgage despite having a higher payment. If you can afford the higher payment (see budget section) then a 15 year mortgage is the best option.

SYSTEMATIC OVERPAYMENT

Systematic overpayment means that you always pay more than your payment amount. This can be done on mortgages, student loans, car notes, etc. and can save you considerable amounts of money over the life of the obligation.

Warning: Before starting a process of systematic overpayment, make sure your emergency fund is fully funded. If you pay down your mortgage faster than your neighbor and you both lose your jobs, the bank is likely to foreclose on you first because they have a better chance of making money on selling your home over your neighbor’s home.

JACK AND JILL

Assume Jack decides on the 30-year mortgage above and does not overpay any over the life of the mortgage. Jill also goes with the 30-year mortgage above because she was not comfortable with the payments on the 15-year mortgage. However, Jill decides she can afford to pay more than the payment for the 30-year mortgage. Instead of paying the monthly payment of $1,798.65, Jill decides to pay an even $2,000. Following is the mortgage payment schedule for Jill using systematic overpayment.

Month Payment Interest

Principal

Reduction Carrying Value

0 300,000.00

1 2,491.23 1,437.50 1,053.73 298,946.27

2 2,491.23 1,432.45 1,058.78 297,887.49

3 2,491.23 1,427.38 1,063.85 296,823.64

4 2,491.23 1,422.28 1,068.95 295,754.69

177 2,491.23 47.18 2,444.05 7,402.71

178 2,491.23 35.47 2,455.76 4,946.95

179 2,491.23 23.70 2,467.53 2,479.42

180 2,491.30 11.88 2,479.42 0.00

448,421.47 148,421.47 300,000.00

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Month Payment Interest

Principal

Reduction Additional Principal

Carrying Value

0 300,000.00

1 2,000.00 1,500.00 298.65 201.35 299,500.00

2 2,000.00 1,497.50 301.15 201.35 298,997.50

3 2,000.00 1,494.99 303.66 201.35 298,492.49

4 2,000.00 1,492.46 306.19 201.35 297,984.95

275 2,000.00 39.03 1,759.62 201.35 5,845.05

276 2,000.00 29.23 1,769.42 201.35 3,874.28

277 2,000.00 19.37 1,779.28 201.35 1,893.65

278 1,903.12 9.47 1,893.65 0.00 (0.00)

555,903.12 255,903.12 244,226.05

In this scenario, Jill will pay off her mortgage in 82 fewer months and save close to $92,000. This example also assumes that Jack would have gotten the same rates as Jill. Based on prior examples, we know that Jack’s credit score is much worse than Jill’s, so he would have had a higher rate, costing him much more over the 30-year mortgage. For example, if Jack’s rate would have been 8%, his monthly payment would be $2,201.29, which is almost as much as the payment Jill would have had if she opted for the 15 year mortgage. Assuming an 8% rate, Jack would have paid a total of $792,470 (interest of $492,470 and principal of $300,000). This is around $150,000 more than Jill’s 30-year mortgage with no overpayments and around $236,000 more than her 30-year mortgage using systematic overpayments.

TIPS FOR AVOIDING MORTGAGE MISTAKES

A common mistake home buyers make is buying a house they cannot afford. Just because you have been approved for a certain dollar amount does not mean that is what you can afford. If you have a strong credit history, then there could be a large difference between what you can afford and what the lender approves. A good rule of thumb is that your mortgage payment should be less than 25% of your monthly take-home income. Other sources will advise this to be higher, but we want you to have a home and save for your future.

Do not forget to estimate the cost of owning a home (i.e. home repairs, appliances, yard maintenance, etc.) when you are trying to determine how much you can afford.

Do your own research on the area of town you want to live. This could be based on such items as school districts, closeness to work, trendiness, new developments, potential for larger appreciation in value, etc.

Avoid becoming “upside down” in your house (or car for that matter). This happens when you owe more than the house is worth. If you finance close to 100% of your house and the

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house drops in value, there is a good chance that you will owe more than the value of the house.

Negotiate for the best price available. Also, negotiate any fees that seem unreasonable before closing on your mortgage and try to get the seller to pay a portion of the closing costs. Remember, the lower the mortgage amount, the less money you will pay in interest over the life of the mortgage.

Shop around for the best rate on the type of mortgage you want. Remember to stay in a two week period when rate shopping so it does not hurt your credit score. Remember that your mortgage rate will be determined using your credit score.

Save for a down payment (at least 20%) and avoid paying PMI.

Become a habitual, systematic over-payer and save thousands! Make sure to notify your mortgage company to let them know that you are going to overpay and that you want every penny of the overpayment applied to principal. Then, check the accuracy of your mortgage statements to ensure the overpayment is correctly applied to principal.

Overpayment in one month does not reduce or eliminate your obligation to pay the next month.

Take advantage of the itemized tax deduction for interest on your mortgage, and do not forget that property taxes are also an itemized deduction.

Review your mortgage statement each month to ensure accuracy.

PAUSE & DISCUSS

Considering the length of most mortgages, why is it important to negotiate the best price possible when purchasing?

What other factors do you think are important when purchasing a home?

ACTION PLAN Find a house listing that interests you and find out the asking price. Estimate what the payment would be for both 30-year and 15-year fixed-rate mortgages. Use your budget and see if this is a house you can afford. If not, what do you need to do to be able to afford this house? This should give you a good idea of what house you can afford and how much you need to save before buying.

INVESTING

WHAT INVESTMENT OPTIONS EXIST?

Several different investment options are discussed below. This discussion is by no means all-inclusive; however, it provides a solid foundation for you to begin to understand the investment environment.

Warning: This overview is intended to provide basic knowledge of some investment options. Further research should be done before deciding which investment is best for you.

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TREASURY BILLS, MONEY MARKET ACCOUNTS, AND CDS

These investment options are generally thought of as the least risky investments. They earn low rates of return, but you probably will not lose your money. These investment options are preferred for money that you will need in the short-term (less than five years).

TREASURY BILLS (T-BILLS)

MONEY MARKET ACCOUNTS (MMAS)

CERTIFICATES OF DEPOSIT (CDS)

U.S. government backed bills usually sold in $100 increments.

Account that is similar to checking accounts. You can open one at most banks. They typically pay a higher interest rate than an interest earning checking account but sometimes require a higher minimum balance.

Account that is similar to savings accounts. You can open one at most banks; however, with CDs, the deposit has a fixed time period (six months, one year, five years, etc.). The longer you are willing to leave it deposited, the higher interest rate it will earn.

Pros: Safe investment backed by the U.S. government. Little to no risk.

Pros: Safe investment. Little to no risk. Easy to open and maintain. Insured by the FDIC.

Pros: Safe investment. Little to no risk. Easy to open and maintain. Insured by the FDIC.

Cons: Rate of return is low and may not outpace inflation.

Cons: Rate of return is low and may not outpace inflation. May not provide check-writing ability.

Cons: Rate of return is low and may not outpace inflation. Can be penalized for early withdrawal of the money.

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BONDS

Bonds are generally less risky than stocks and mutual funds, but they can lose their value if they fall out of favor with investors. Bonds usually pay periodic interest so they can represent a good source of cash flow.

CORPORATE BONDS MUNICIPAL BONDS

Bonds issued by corporate entities. Corporations issue bonds to raise money for a variety of items (e.g., expansion of facilities). Corporate bonds typically pay a higher interest rate than municipalities because there is a greater chance that the corporation will go bankrupt and not be able to fulfill its obligation. Corporate bonds vary widely in terms of risk, from stable bonds in regulated industries (e.g., utilities) to unstable junk bonds.

Bonds issued by local and state governments. Just like corporations, municipalities also issue bonds to borrow money for various projects (e.g., a new library). They pay a lower interest rate than corporate bonds, but the interest revenue you earn is not taxed on your federal tax return.

Pros: Usually lower risk than stocks. Provide steady stream of income through interest payments. Rate of return is usually higher than short-term investments mentioned above.

Pros: Lower risk than stocks and usually lower risk than corporate bonds. Provide steady stream of income through interest payments. Rate of return is usually higher than short-term investments mentioned above. Interest earned is not taxable.

Cons: Risk level can change after you purchase, based on company performance and interest rate fluctuations. Income is taxed as ordinary income.

Cons: Pays lower interest than most corporate bonds. Municipalities can also go bankrupt.

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EXCHANGE TRADED FUNDS, INDEX FUNDS AND MUTUAL FUNDS

Funds are typically riskier than bonds but less risky than owning individual stocks.

MUTUAL FUNDS INDEX FUNDS EXCHANGE TRADED FUNDS (ETFS)

Mutual funds represent a portfolio of stocks. They can be classified as balanced, domestic only, international only, emerging markets, large cap, mid cap, small cap, growth stocks, value stocks, etc. Actively managed means that there is a person (or team) responsible for deciding what stocks to buy, hold and sell from the fund holdings. Because it is actively managed, the fees are typically higher to compensate the fund managers. That is not always a bad thing as some managers consistently beat their benchmarks. However, many do not, so be careful.

Index funds are mutual funds that track an index like the Dow Jones Industrial Average or S&P 500. For example, if the S&P 500 goes up by 1% in a day, then a fund that tracks the S&P 500 should also go up by 1%. In other words, the portfolio of stocks in an index fund are the same as the stocks in the index it is tracking. Because the fund tracks an index, it is not actively managed. This allows expense ratios to remain low.

Like mutual funds, ETFs are also a portfolio of stocks or bonds. They are similar to an index fund in that you can buy ETFs that track a certain index (e.g., S&P 500). One main difference is that ETFs trade daily on an exchange. That simply means that prices can fluctuate during the day. ETFs can also track industries and international stocks. If there is an area in which you are interested in investing, then there is probably an ETF that covers it.

Pros: Actively managed funds always have someone looking over the fund holdings to hopefully prevent major losses. Broader exposure than simply owning one stock. Many types to choose from. Most dividends are reinvested at no additional charge.

Pros: Broader exposure than simply owning one stock. Usually more tax efficient than other mutual funds because relatively little turnover in an index. Expense ratios are typically lower than other funds. Most dividends are reinvested at no additional charge.

Pros: Broader exposure than simply owning one stock. Usually more tax efficient than other funds because taxes go into affect only when the ETF is sold. Expense ratios are typically lower than mutual funds. Easy to buy and sell.

Cons: Turnover within a fund’s assets is typically high, so the capital gains taxes are passed through to you. Many fund managers do not outperform their benchmarks. Expense ratios are typically higher than ETFs or index funds.

Cons: Not actively traded on an exchange, so not as flexible as ETFs. When markets are declining, managers must stick to the index.

Cons: Dividends are usually not automatically reinvested. Going through brokerage accounts to buy and sell may cause higher commissions.

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STOCKS Stocks represent ownership in a company. Stocks are traded on exchanges with the three most common being the New York Stock Exchange (NYSE), NASDAQ, and the American Stock Exchange (AMEX). Typically, all that is needed to buy and sell stock is an account with a brokerage company. Several on- line brokers are available today. They all offer varying services and charge varying commissions. Stocks are typically viewed as riskier than funds because the probability of any one stock losing value is higher than an entire portfolio of stocks. However, within the category of stocks, there are still varying levels of risk, from stable blue-chip companies to risky start-ups with little cash flow.

Before investing in stocks, familiarize yourself with the following:

Brokerage accounts – full service company (Merrill Lynch, Charles Schwab, etc.) or on- line discount company (Scottrade, Etrade, etc.);

Market jargon used when valuing a company – P/E ratios, PEG ratios, dividend yields, forward P/E ratios, free cash flow, etc.;

Types of stocks you are interested in buying – specific companies (e.g., Apple or Best Buy), types (e.g., value, growth, or large cap), certain industries (e.g., energy or financials), or regions (e.g., domestic or international);

Risk tolerance – see discussion below.

INFORMATION YOU SHOULD KNOW

RISK TOLERANCE, ASSET ALLOCATION, AND INVESTMENT HORIZON Investing, in a sense, is like gambling. There exists the risk that you can lose all your investment, but there is also the potential for extremely large gains. There is an investment option for everyone based on their risk tolerance. Your risk tolerance and investment horizon often determines asset allocation.

Because you are young, your risk tolerance for all long-term investments should be high because you can afford to wait out the ups and downs of the market. A couple of bad months or even a bad year will probably not affect your long-term earning potential. This does not mean choosing crazy investments that you are not sure about, but it does mean you have time on your side.

If you are a short-term investor (you plan to use the money in less than five years), then your risk tolerance is low. For example if you are saving for a down payment on a car, a relatively risk-free investment like a MMA might be a good choice. A MMA is easy to access, you can continue adding to it, and its rate of return will hopefully keep up with or outpace inflation. You will not get rich, but your down payment will be secure and your purchasing power should not be diminished.

As you get older and move closer to retirement, your risk tolerance should gradually get lower and you should start shifting your riskier assets into less risky funds or bonds.

WHEN IS THE RIGHT TIME TO INVEST? The time to start is now, but different approaches exist for investing. You can try to pick and choose the time of your investments or you can set up an automatic system that consistently deducts money from your checking account to invest.

Pick and Choose: There is no way to perfectly forecast peaks and valleys in the stock market. If you can then you do not need to read any more because you are already rich. Waiting for a stock to dip in price may become an expensive past-time if the stock

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continues to go up. If you know what you want to buy and feel it is a reasonable price, then buy it. It may go up some or down some, but do not panic. Remember you purchased it for long-term potential.

Systematic: This method is easier for funds than for individual stocks. Most mutual fund companies wave certain fees or loads if you agree to have a certain amount of money deducted from your checking account and invested every month. This is often referred to as Dollar Cost Averaging. By investing smaller amounts over a longer period of time, you reduce the risk of investing a large lump-sum at the wrong time. There are pros and cons to this approach, but at least it makes you continue to invest instead of saving money to invest and then spending it on something else.

THE POWER OF COMPOUND INTEREST Compound interest simply means that interest earned gets added to the existing principal, which means the next period’s interest (assuming a constant rate) will be higher. For example, if you invest $100 earning an annual rate of 8%, then you would have $108 ($100 + ($100 * .08)) after one year. After two years you would have $116.64, and after three years you would have $125.97. Now, this might not seem like a big deal, but with larger sums of money over long periods, the returns are substantial.

JACK AND JILL

Assume Jack and Jill both have children at the same time. Jill starts investing in her child's college fund immediately. She starts by investing $2,000 at the beginning of each year. She plans on doing this until her child is eighteen. Jack decides to wait until his child is eight to start putting $2,000 a year away into a similar college fund. Assume both funds earn an average of 10% per year (ignore taxes for this example). Below is a chart of Jill’s investment side-by-side with Jack’s investment.

Jill's Investment Jack's Investment

Age Deposit Beg. Value Earnings

End. Value Deposit

Beg. Value Earnings

End. Value

0 2,000.00 0.00 200.00 2,200.00 0.00 0.00 0.00 0.00

1 2,000.00 2,200.00 420.00 4,620.00 0.00 0.00 0.00 0.00

2 2,000.00 4,620.00 662.00 7,282.00 0.00 0.00 0.00 0.00

3 2,000.00 7,282.00 928.20 10,210.20 0.00 0.00 0.00 0.00

4 2,000.00 10,210.20 1,221.02 13,431.22 0.00 0.00 0.00 0.00

5 2,000.00 13,431.22 1,543.12 16,974.34 0.00 0.00 0.00 0.00

6 2,000.00 16,974.34 1,897.43 20,871.78 0.00 0.00 0.00 0.00

7 2,000.00 20,871.78 2,287.18 25,158.95 0.00 0.00 0.00 0.00

8 2,000.00 25,158.95 2,715.90 29,874.85 2,000.00 0.00 200.00 2,200.00

9 2,000.00 29,874.85 3,187.48 35,062.33 2,000.00 2,200.00 420.00 4,620.00

10 2,000.00 35,062.33 3,706.23 40,768.57 2,000.00 4,620.00 662.00 7,282.00

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11 2,000.00 40,768.57 4,276.86 47,045.42 2,000.00 7,282.00 928.20 10,210.20

12 2,000.00 47,045.42 4,904.54 53,949.97 2,000.00 10,210.20 1,221.02 13,431.22

13 2,000.00 53,949.97 5,595.00 61,544.96 2,000.00 13,431.22 1,543.12 16,974.34

14 2,000.00 61,544.96 6,354.50 69,899.46 2,000.00 16,974.34 1,897.43 20,871.78

15 2,000.00 69,899.46 7,189.95 79,089.41 2,000.00 20,871.78 2,287.18 25,158.95

16 2,000.00 79,089.41 8,108.94 89,198.35 2,000.00 25,158.95 2,715.90 29,874.85

17 2,000.00 89,198.35 9,119.83 100,318.18 2,000.00 29,874.85 3,187.48 35,062.33

18 2,000.00 100,318.18 10,231.82 112,550.00 2,000.00 35,062.33 3,706.23 40,768.57

38,000.00 74,550.00 22,000.00 18,768.57

As you can see, the quicker you get started, the better off you will be when you need the money. This example shows around a $72,000 difference with only a $16,000 greater investment. This is all because of the power of compounding interest. It is not surprising that Albert Einstein once referred to compound interest as the most powerful force in the universe. Time is on your side, so use that to your advantage.

Warning: There are different types of college funds (e.g., 529 plans, Education Savings Accounts (ESAs)). There are different rules and tax benefits for each, so make sure to do the proper research before opening one for your children.

TIPS FOR INVESTING SUCCESSFULLY

Think about your financial goals, risk tolerance, and investment horizon before investing.

Because of the multitude of investment options, it is easy to get overwhelmed and not do anything. Pick investments that you are comfortable with but will still push you towards your financial goals.

Do not be afraid to ask for help from a professional financial advisor.

Do lots of research and always strive to continue your financial literacy education.

Start Now! Time is on your side. Invest money that you will not need and forget about it until you are older and need it. The power of compound interest is not something to take lightly.

If you take anything away from this section, we hope you take away the desire to start investing right now. It will change your life.

PAUSE & DISCUSS

Why is understanding your investment time horizon (long vs. short term) so important when deciding where to put your money?

What do you think it means to be diversified in your investments? How would you go about making your investment portfolio diversified?

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ACTION PLAN

Learn more about investing. Go to the Motley Fool's website (www.fool.com) and read the information provided in their Investment section. Many websites provide investment sections that you can take advantage of to further your financial literacy education.

RETIREMENT PLANNING

WHAT RETIREMENT PLANS ARE AVAILABLE?

INDIVIDUAL RETIREMENT ACCOUNTS (IRAS) An individual retirement account is a common way to save for retirement. Several types exist, but the two most common are Traditional IRAs and Roth IRAs.

TRADITIONAL IRA ROTH IRA

An IRA that can be opened by anyone and contributions can be made to the IRA in any year you have earned income.

An IRA only available to individuals with an Adjusted Gross Income (AGI) less than $95,000 ($150,000 for joint filers) and must come from earned income.

Taxes: Provides tax-deferred savings in that you can deduct up to $5,000 in contributions made in 2008 ($6,000 if you are 50 or older) on your income tax return.

Warning: there are some restrictions on the deduction amount when you earn above certain income levels so always check before making contributions. Also, contribution limits change over time, so check the current year’s contribution limit before making a contribution.

Taxes: You cannot use the contribution amount to reduce your income taxes. However, the principal and earnings within the Roth IRA are not taxed when withdrawn (assuming all rules are followed) because your contributions come from after-tax earnings.

Withdrawals: You can begin withdrawing money at age 59 ½ and the earnings are taxed at this time (and contributions if you originally took a deduction). It is mandatory to start withdrawing at age 70 ½. Remember that the IRS is waiting to tax your earnings, so they make you start withdrawing money even if you do not need it. If money is withdrawn before age 59 ½, you pay a 10% penalty and the earnings are taxed. There exist a few exceptions to the 10% penalty, such as paying for qualified higher education expenses.

Withdrawals: You can begin withdrawing money when you are 59 ½, but there is no mandatory distribution age. This means you can keep the money invested as long as you want. You can also withdraw your actual contributions (but not the earnings) from a Roth IRA at any age without penalty. A 10% penalty exists if you withdrawal earnings before you reach 59 ½. Exceptions exist to this penalty as well.

Control: You control how the money is invested depending on the options provided by the bank or brokerage house holding the account.

Control: You control how the money is invested depending on the options provided by the bank or brokerage house holding the account.

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COMPANY SPONSORED RETIREMENT PLANS This section focuses on the most common company sponsored retirement plan, the 401k, the newer Roth 401k, and defined benefit plans (pension plans).

401K ROTH 401K DEFINED BENEFIT (PENSION) PLANS

A 401k plan is a defined contribution plan, which means the amount (contribution) going in to the plan is known (defined) but the amount available at retirement is not known. The amount available at retirement is a function of how much is contributed, how long it is invested, how smartly it is invested, etc. The name (401k) comes from the part of the tax code governing this retirement plan.

A Roth 401k is basically a company sponsored Roth IRA. This is a relatively new plan and some employers may not have sponsored one yet. It is also a defined contribution plan. As such, the amount available at retirement is a function of how much is contributed, how long it is invested, how smartly it is invested, etc.

Pension plans are defined benefit plans because the amount you receive at retirement is defined based on a formula including salary levels and years of service.

Taxes: Similar to a Traditional IRA in that it is a tax deferred plan. Your employer withholds a certain percent of your income (up to 15% or a pre-determined threshold of $15,500 if you are under age 50) from each of your paychecks pre-tax and forwards your money to the trustee of the plan (usually a brokerage company — Charles Schwab, ING, TIAA-CREF, etc.) to invest the money.

Taxes: Similar to a Roth IRA, the principal and earnings are not taxed when withdrawn at retirement because the money was put into the plan after taxes. You can contribute up to $15,500 and there are no income limits on a Roth 401k, unlike the income limits on a Roth IRA.

Taxes: Pension Plans are also tax deferred. Generally, employers make all contributions to the plan, but some allow employees to contribute.

Control: You control how the money is invested depending on the options provided by the trustee of the plan. Several 401k plans provide more than one trustee to choose from so you can see which one provides the investment options that best meet your needs.

Control: You control how the money is invested depending on the options provided by the trustee of the plan. Several provide more than one trustee to choose from so you can see which one provides the investment options that best meet your needs.

Control: Because the employer generally makes all contributions to the plan, employees typically have no control over how the money is invested.

Matching: Most 401k plans come with a company match so you are getting free money to participate.

Matching: There is probably not a match with a Roth 401k plan.

Matching: No matching because the company is making the contributions.

Changing Jobs: When you leave one employer, you can roll your 401k into another 401k or Traditional IRA without being penalized.

Changing Jobs: When you leave one employer, you can roll your Roth 401k into another Roth 401k or Roth IRA without being penalized.

Changing Jobs: Many require you to work a certain number of years before you have any right to the money (vesting period).

INFORMATION YOU SHOULD KNOW

WHICH PLAN TO CHOOSE? It is important to realize that this is a brief overview of each of these plans, so it is important to fully understand how each one works before committing to one.

If your employer provides a 401k plan with a company match, participate in this plan to at least get the company match. If they also offer a Roth 401k plan, participate in this plan at

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the highest level you can. If they do not offer a Roth 401k plan, open a Roth IRA and contribute the maximum amount allowable each year based on your income level. This method means you are contributing what you need in order to get the company match and putting everything else into either a Roth 401k or Roth IRA.

If you are self-employed or work for someone who does not sponsor retirement plans, use the same approach above using the Roth IRA and Traditional IRA. This requires more work on your part, but you cannot afford not to save for retirement.

Start on day one of your job. If you wait, you will get used to the extra money and find it hard to go back and have some of it put into a retirement account. If you have it withdrawn from your paycheck on day one, you will never know the difference. If you find that it is too hard to get by on what you are taking home, you can always go back and reduce your contribution amounts.

Remember the importance of compounding interest. If you start early and put as much as possible into retirement savings, you will put yourself in a position to enjoy the type of retirement that you want.

WHAT DO I DO ONCE I HAVE SIGNED UP FOR A PLAN? Once you sign up, you then need to choose the trustee (if more than one is offered) and decide how you want your contributions (and the company matching contributions if applicable) invested. Now is the time to rely on what you learned in the previous section on investing. Remember that you should not plan on touching this money until you are at least 59 ½ so it is definitely a long-term investment. As such, you can afford to be a little riskier with your choices. Most trustees offer several different investment choices ranging from money market accounts to global mutual funds, so choose funds with good track records. Then monitor the performance of each fund periodically (at least once a year) to make sure each one is still pushing you toward your retirement goals.

TIPS TO PLAN FOR YOUR RETIREMENT

Many people never estimate how much money they will need during retirement. A general rule of thumb is between 60 and 70 percent of your pre-retirement income, but this can vary greatly for different individuals. You may want to keep your same home and your same expenses associated with that home, or you may want to downsize and decrease your monthly home expenses. You may want to travel extensively, or you may want to spend your time relaxing. These are all considerations you need to think about when preparing your estimate.

Do not forget to incorporate inflation into your calculation. For example, if you need $5,000 a month to live on today, you will need considerably more to live at the same level when you retire. Failure to account for inflation could result in not having enough money at retirement.

Many people do not actively monitor their retirement savings. You should give yourself a financial physical at least once a year to make sure that your investment choices are still the right ones for you. For example, as you near retirement age, you may want to start shifting more of your savings to less risky investment choices within your retirement plan.

Many people forget to roll over their accounts when they switch employers. This can result in a distribution being made to you causing a 10% penalty or the money could be moved into the least risky investments causing a large loss in potential earnings.

Never pass up a company match. It is free money.

Five Minutes of Financial Literacy | 31

The biggest mistake is not doing anything at all. Do Not Wait! Get started as soon as you can. Think about what you want to do when you retire and then make it happen. You do not have to do anything flashy because time is on your side. START NOW!!!!

JACK AND JILL Jill’s starting salary is $50,000, and she elects to put 5% into her company sponsored 401k plan in order to receive the company match of 5%. She also elects to open a Roth IRA on her own and contributes the maximum amount of $5,000 each year. Jack does nothing because he has plenty of time to save. At age 35, Jack and Jill quit work and start a consulting practice. Jill rolls her 401k into a Traditional IRA and continues to contribute to her Roth IRA. Jack decides to open a Roth IRA similar to Jill’s. At age 45, Jill’s and her husband’s AGI is above the limit for contributions to a Roth, so she no longer contributes to that account anymore. But, she leaves the money in the account. Jack continues to contribute to his Roth IRA until he is 52 at which point his wife’s and his AGI exceeds the limit. Assume the 401k, Traditional IRA, and Roth IRA all earn 10% on average and Jill receives a 7% pay raise each year while she is working. If they both want to make withdrawals at age 62, how much money will each have? Jill's 401k Retirement Account

Age Annual Salary

Contri- bution Percent

Contribution Amount

Company Match (5%)

Total Contribution

Beg. of Year Value

10 % Growth

End of Year Value

23 50,000 5% 2,500 2,500 5,000 0 500 5,500

24 53,500 5% 2,675 2,675 5,350 5,500 1,085 11,935

25 57,245 5% 2,862 2,862 5,725 11,935 1,766 19,425

26 61,252 5% 3,063 3,063 6,125 19,425 2,555 28,106

27 65,540 5% 3,277 3,277 6,554 28,106 3,466 38,126

28 70,128 5% 3,506 3,506 7,013 38,126 4,514 49,652

29 75,037 5% 3,752 3,752 7,504 49,652 5,716 62,872

30 80,289 5% 4,014 4,014 8,029 62,872 7,090 77,990

31 85,909 5% 4,295 4,295 8,591 77,990 8,658 95,240

32 91,923 5% 4,596 4,596 9,192 95,240 10,443 114,875

33 98,358 5% 4,918 4,918 9,836 114,875 12,471 137,182

34 105,243 5% 5,262 5,262 10,524 137,182 14,771 162,477

35 112,610 5% 5,630 5,630 11,261 162,477 17,374 191,111

50,352

The 401k grows to $191,111 on her contributions of $50,352 (an additional employer contribution of $50,352 was made as well) when she rolls it over to a Traditional IRA where it grows until she is 62. The Traditional IRA grows to $2,505,470 (see below). Notice that there are no contributions to the Traditional IRA.

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Jill's Traditional IRA

Age

Beg. of Year Value

10 % Growth

End of Year Value Age

Beg. of Year Value

10 % Growth

End of Year Value

36 191,111 19,111 210,223 50 725,746 72,575 798,320

37 210,223 21,022 231,245 51 798,320 79,832 878,152

38 231,245 23,124 254,369 52 878,152 87,815 965,967

39 254,369 25,437 279,806 53 965,967 96,597 1,062,564

40 279,806 27,981 307,787 54 1,062,564 106,256 1,168,820

41 307,787 30,779 338,566 55 1,168,820 116,882 1,285,702

42 338,566 33,857 372,422 56 1,285,702 128,570 1,414,273

43 372,422 37,242 409,664 57 1,414,273 141,427 1,555,700

44 409,664 40,966 450,631 58 1,555,700 155,570 1,711,270

45 450,631 45,063 495,694 59 1,711,270 171,127 1,882,397

46 495,694 49,569 545,263 60 1,882,397 188,240 2,070,637

47 545,263 54,526 599,790 61 2,070,637 207,064 2,277,700

48 599,790 59,979 659,769 62 2,277,700 227,770 2,505,470

49 659,769 65,977 725,746

Below are the charts for Jack and Jill’s Roth IRAs. Jill continues contributing until she is 45 and Jack contributes from the age of 35 until he reaches 52.

Jill's Roth IRA Jack's Roth IRA

Age

Contri- bution Amount

Beginning of Year Value

10 % Growth

End of Year Value

Contri- bution Amount

Beginning of Year Value

10 % Growth

End of Year Value

23 5,000 0 500 5,500 0 0 0 0

24 5,000 5,500 1,050 11,550 0 0 0 0

25 5,000 11,550 1,655 18,205 0 0 0 0

26 5,000 18,205 2,321 25,526 0 0 0 0

27 5,000 25,526 3,053 33,578 0 0 0 0

28 5,000 33,578 3,858 42,436 0 0 0 0

29 5,000 42,436 4,744 52,179 0 0 0 0

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30 5,000 52,179 5,718 62,897 0 0 0 0

31 5,000 62,897 6,790 74,687 0 0 0 0

32 5,000 74,687 7,969 87,656 0 0 0 0

33 5,000 87,656 9,266 101,921 0 0 0 0

34 5,000 101,921 10,692 117,614 0 0 0 0

35 5,000 117,614 12,261 134,875 5,000 0 500 5,500

36 5,000 134,875 13,987 153,862 5,000 5,500 1,050 11,550

37 5,000 153,862 15,886 174,749 5,000 11,550 1,655 18,205

38 5,000 174,749 17,975 197,724 5,000 18,205 2,321 25,526

39 5,000 197,724 20,272 222,996 5,000 25,526 3,053 33,578

40 5,000 222,996 22,800 250,795 5,000 33,578 3,858 42,436

41 5,000 250,795 25,580 281,375 5,000 42,436 4,744 52,179

42 5,000 281,375 28,638 315,013 5,000 52,179 5,718 62,897

43 5,000 315,013 32,001 352,014 5,000 62,897 6,790 74,687

44 5,000 352,014 35,701 392,715 5,000 74,687 7,969 87,656

45 5,000 392,715 39,772 437,487 5,000 87,656 9,266 101,921

46 0 437,487 43,749 481,235 5,000 101,921 10,692 117,614

47 0 481,235 48,124 529,359 5,000 117,614 12,261 134,875

48 0 529,359 52,936 582,295 5,000 134,875 13,987 153,862

49 0 582,295 58,229 640,524 5,000 153,862 15,886 174,749

50 0 640,524 64,052 704,577 5,000 174,749 17,975 197,724

51 0 704,577 70,458 775,034 5,000 197,724 20,272 222,996

52 0 775,034 77,503 852,538 5,000 222,996 22,800 250,795

53 0 852,538 85,254 937,791 0 250,795 25,080 275,875

54 0 937,791 93,779 1,031,571 0 275,875 27,588 303,463

55 0 1,031,571 103,157 1,134,728 0 303,463 30,346 333,809

56 0 1,134,728 113,473 1,248,200 0 333,809 33,381 367,190

57 0 1,248,200 124,820 1,373,020 0 367,190 36,719 403,909

58 0 1,373,020 137,302 1,510,323 0 403,909 40,391 444,299

59 0 1,510,323 151,032 1,661,355 0 444,299 44,430 488,729

60 0 1,661,355 166,135 1,827,490 0 488,729 48,873 537,602

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61 0 1,827,490 182,749 2,010,239 0 537,602 53,760 591,363

62 0 2,010,239 201,024 2,211,263 0 591,363 59,136 650,499

Jill’s total contribution of $165,352 ($50,352 contributed to her 401k plus $115,000 contributed to her Roth IRA) spread over 23 years grows to a retirement nest egg of $4,716,733 ($2,505,470 + $2,211,263). That’s not too shabby. Keep in mind this excludes her husband’s retirement accounts, the equity they have in their home, and other investments they might have. Also, the $2.2 million from the Roth IRA is tax free.

Jack’s contribution of $90,000 grows to $650,499. That is still not too bad. It is actually way better than what most Americans have going into retirement, but it pales in comparison to what Jill has for retirement. If he would have just started when he was 30, he would have $1,134,728. That is close to twice the money for an additional investment of $25,000.

PAUSE & DISCUSS

Have you considered what retirement benefits are offered by the companies you are interested in working for?

Do you have to graduate before you start a retirement account? If so, why? If not, when do you plan to start?

ACTION PLAN

Get online and investigate different retirement plans. Look locally and through large, reputable institutions. Compare the minimum to open a balance, fees, investment options within the plan, and the possibility of waiving fees if you agree to have an automatic contribution to the plan each month or sign up for online statements. Consider opening a retirement account. You will be glad you did.