Money and You: Course Notes

Savings Accounts - These are accounts in which you deposit your money. In a sense, you loan your money to the bank that they use for their primary business purposes. In return, you earn a small amount of interest each month. Savings accounts are considered low-risk, low-reward options. You generally can withdraw your money fairly easily, making them quite liquid.

Certificates of Deposit (CDs) - CD’s are essentially savings accounts with the added rule that once you deposit your money, you cannot withdraw it for a pre-specified amount of time (usually 6 months to 2 years). It is usually still possible to withdraw your money before the allowed date, but it comes with a reduction in your interest earnings. Because you take on more personal risk by guaranteeing the bank access to your money for a longer period of time, CDs come with higher interest rates than basic savings accounts. CDs are still considered low-risk, low-reward opportunities.

Health Savings Accounts (HSAs) - An HSA is account in which you can deposit money to use for medical expenses in the future. While HSAs generally earn interest, it is quite low. Their main benefit is that any money you deposit into HSA reduce your taxable income. (However, if you withdraw it for other reasons, you will incur a penalty.) These are low-risk, low-reward opportunities.

Bonds - A bond is a loan you make to a business or government. If you hold a bond, you will be entitled to a pre-specified payment at some future date (called the “maturity date.”) When the payment date comes, the bond “matures.” Bonds can have a variety of payment dates from months into the future to decades. Usually, bonds with longer maturity dates will offer a greater return. Some bonds pay interest payments (called “coupons”). Depending on the business or government, the risk of a bond will differ. Agencies with a long history of repaying bonds are less risky and offer lower returns. Agencies with less of a proven history of repaying debts need to offer higher returns. While you technically cannot get your money from a bond before its maturity date, you can sell your rights to the bond on a financial market. Bonds can have a low-to-moderate amount of risk, depending on the agency and time frame (and a low-to-moderate return).

Stocks - A stock, loosely speaking, is a representation of partial ownership of a company. How much a stock is valued depends a number of things. Some stocks pay “dividends,” which is a small share of profits the company earned. The value of the company’s assets influence the stock’s price. There is also a most squishy concept in that the value of a stock can change due to how much others are willing to pay for a stock. Stock values can change greatly day-to-day. A fire in a company’s headquarters can tank a stock’s value. A positive end-of-year earnings report can make a stock’s price soar. So, there is a great deal of risk with buying and selling stocks. They are high-risk, high-reward assets.

Mutual Fund - In general, it is advised to invest in a bunch of different stocks rather than just one (“diversification”). The idea is that, even if one company that you’ve invested in loses a lot of value, the others you’ve invested in can help cushion that blow. Some financial institutions offer mutual funds that can help with this. When you invest in a mutual fund, you are contributing money to a large pool that is used to buy a large number of different stocks. Mutual funds can be for stocks in a particular sector (like technology or oil production) or can be for an entire market. Mutual funds will come with some kind of fee structure for the service provided in management of the mutual fund. An index fund is a type of mutual fund with a more passive approach to selecting stocks, but they come with lower fees. Mutual funds are considered moderate-risk, moderate reward assets.

Commodities and Options - A “commodity” is a tangible asset like gold, oil, or rice. You can theoretically buy and sell these commodities on a market. More realistically, investors purchase “options.” An option is a right to buy or sell a commodity to someone at a moment in time. Usually, the commodity isn’t actually traded, making options essentially a gamble based on how you predict a commodity’s value to change over time. You can also purchase options on stocks. Consider an example. Stock XYZ currently has a value of $100. You think the stock’s value will increase, but you do not want to buy the stock. You can purchase the option to buy the stock later at a particular price. (The option price will depend on a variety of factors.) Suppose you pay $10 for the option to buy the stock for $100 in a month. If in one month, the stock’s value is $150, you will essentially get $40. (A $150 stock for $100 minus the $10 option fee.) If the stock’s value instead drops to $50, you do not buy the stock, and you lose that $10. Options are considered high-risk, high-reward assets. They are recommended only for experience investors.

Currency exchanges - You can also invest in a different currency. The idea is that if you invest in a currency that grows in value relative to the American dollar, you can sell that currency for a profit. (Or a loss if it loses value.) Cryptocurrency is a digital form of currency. Because of the high fluctuations in cryptocurrency values, it is considered high-risk, high-reward.