Econ Test 3

Stocks

Small pieces of a company you can buy. They can be risky because prices go up and down a lot, but over many years they usually make the most money.

• Stocks are risky because their prices change a lot.

• But over many years, they usually make the most money.

• The stock market often recovers after it falls.

• People who stay invested instead of selling during crashes usually do better later.

• Future crashes could possibly be bigger because the world and technology are changing fast.

How Compound Interest Works

If you invest money:

1. You earn interest.

2. The interest gets added to your total.

3. Next time, you earn interest on the bigger amount.

Over time, the money grows faster and faster.

Numerical Example of Compound Interest

uppose you invest $1,000 with 10% interest per year.

Year 1:
1000(1.10)=11001000(1.10)=11001000(1.10)=1100

You now have $1,100.

Year 2:
1100(1.10)=12101100(1.10)=12101100(1.10)=1210

You now have $1,210.

You earned interest on the original $1,000 AND on the extra $100 earned from Year 1.

Why Compound Interest is Helpful

• Your savings grow faster over time.

• Starting early gives compound interest more time to work.

• Small investments can become large amounts in the future.

What can people do to make sure their savings are worth more in the future?

• Invest money instead of only keeping it in cash.

• Use savings accounts, stocks, bonds, or retirement accounts.

• Start saving early.

• Continue adding money regularly.

Where retirement money comes from

Most retirees rely on different income sources:

• 58% → Social Security

• 34% → Pension (money from past jobs)

• 29% → 401(k) plans (retirement savings accounts from work)

Types of Financial Investments

Social Security – A government program that provides income to retirees, disabled people, and survivors, funded by payroll taxes.

Pension Plans – Employer-sponsored retirement plans that give workers a fixed monthly income after retirement.

Stocks – Ownership shares in a company that can increase in value and may pay dividends.

Bonds – Loans you give to a company or government that pay you back with interest over time.

Mutual Funds – A pool of money from many investors used to buy a diversified mix of stocks and bonds.

401(k) Plan – A retirement savings plan offered by employers where employees invest part of their paycheck, often with employer matching.

403(b) Plan – A retirement plan for employees of public schools and non-profit organizations, similar to a 401(k).

457 Plan – A retirement savings plan for government and some non-profit employees, allowing tax-deferred contributions.

IRA (Individual Retirement Account) – A personal retirement account where individuals save money with tax advantages.

Annuities – Insurance contracts where you pay money upfront and receive regular payments later, often used for retirement income.

Social Security

A government-run retirement and disability program funded by payroll taxes. Workers and employers each pay 6.2% of income (up to a set limit).

People can start receiving benefits between ages 62 and 70, and the amount depends on how much they earned and when they choose to start collecting.

Payments are received monthly for life, and spouses or dependents may also receive benefits if the worker dies.

Social Security benefits may be taxed depending on total income:

• Under $25,000: not taxed

• $25,000–$34,000: up to 50% taxed

• Above $34,000: up to 85% taxed

The system helps provide basic income security for retirees, disabled individuals, and surviving family members.

Pension Plan (Defined Benefit Plan)

• A retirement plan provided by an employer (company or government)

• Gives you a guaranteed monthly payment after you retire

• Based on salary and years worked, not investments

• Employees usually contribute part of their paycheck (about 7–10%)

• You qualify after a set age or years of service (often ~30 years or age 60)

• Payments are taxed when received

• Payments usually continue for life

• May include spousal benefits after death if chosen

Stocks

• A stock is a share of ownership in a company

• You can buy stocks through a broker (online, phone, or firm)

• You can invest any amount of money

• You can earn money in two main ways:

  • Dividends (company profit payments)

  • Capital gains (selling at a higher price than you bought)

• Average long-term return in U.S. stocks is about 6% after inflation

• Returns depend on how well the company performs

• Stocks can be bought or sold at any time

• Taxes:

  • Held under 1 year → taxed as income

  • Held over 1 year → taxed as capital gains

• Stocks can be passed to a beneficiary after death

Bonds

• A bond is a loan you give to a government or company

• You can buy bonds through a broker or government websites

• Any amount of money can be invested

• You earn money in two ways:

  • Interest payments on the money you lend (principal)

  • Selling the bond for a different price than you bought it

• Returns:

  • Corporate bonds: about 1–6% (higher risk, higher return)

  • Government bonds: about 0.5–3% (lower risk, safer)

• Safer because governments are less likely to default

• Taxes:

  • Corporate bonds → taxed like stocks

  • Government bonds → often tax-advantaged or tax-free

• Bonds can usually be cashed in or sold before maturity

• Bonds can be passed to a beneficiary after death

Inflation-Protected Government Bonds

• Two main types: Series I Bonds and Series EE Bonds

• You can invest up to a set limit each year

• You must hold for at least 1 year before selling

Series I Savings Bonds

• Annual limit: up to $15,000 per person

• Earnings come from:

  • Fixed interest rate

  • Inflation-based rate (adjusts twice a year)

• Protects against inflation (value rises when prices rise)

• Earns interest for up to 30 years or until cashed in

• Taxes: federal tax only (no state/local tax)

Series EE Savings Bonds

• Annual limit: up to $10,000 per person

• Must be held for at least 1 year

• Government guarantees:

  • Value doubles if held for 20 years

• Very low fixed interest rate (around 0.10% in some years)

• Taxes: federal tax only (no state/local tax)

Mutual Funds

• A mutual fund is a collection of stocks and/or bonds pooled together

• Managed by a financial professional or follows an index (like the S&P 500)

• You can invest any amount of money

• Bought through a broker or financial company

• You earn money in two ways:

  • Dividends

  • Capital gains (buy/sell price changes)

• Returns depend on how the underlying investments perform

• Less risky than individual stocks because money is spread across many investments

• Taxed similarly to stocks

• Can be passed to a beneficiary after death

401(k) Plan

• A voluntary retirement savings plan offered by for-profit employers

• Employees can invest up to $24,500/year (more if over age 50)

• Money is usually invested in mutual funds through a brokerage

• Employers may match contributions (often 3–5% of salary)

• Contributions are made with pre-tax income (tax-free when invested)

• Investment growth depends on performance of chosen funds

• Money usually cannot be withdrawn until age 59½ (except hardship cases)

• Withdrawals are taxed as regular income

• Funds are managed by a brokerage, not the employer

• Account can be passed to a beneficiary after death

457 Plan

• A retirement savings plan offered by government employers

• Similar to a 401(k) plan

• Money is invested (usually in mutual funds) through a brokerage

• Contributions are made with pre-tax income

• Investment growth depends on performance of the funds

• Main difference from a 401(k):

  • You can withdraw money before age 59½ if you leave your job

• Withdrawals are taxed as regular income

• Can be passed to a beneficiary after death

403(b) Plan

• A retirement savings plan offered by non-profit and some public school employers

• Very similar to a 401(k) plan

• Employees invest pre-tax income (tax-free when contributed)

• Money is usually placed into mutual funds or annuities

• Investment growth depends on market performance

• Employers may offer matching contributions (in some cases)

• Money usually cannot be withdrawn until age 59½ (except special cases)

• Withdrawals are taxed as regular income

• Can be passed to a beneficiary after death

Traditional IRA

• An individual retirement account you open on your own (not through an employer)

• You can invest up to $7,500/year ($8,600 if over age 50)

• Invested in mutual funds, stocks, or bonds inside the account

• Contributions are made with pre-tax money (tax-free in the year invested)

• Requires some extra paperwork to set up

• Investment growth depends on market performance

• You cannot withdraw money until age 59½

• Withdrawals are taxed as regular income

• Can be passed to a beneficiary after death

• May have income limits (around $150,000) for eligibility

Roth IRA

• An individual retirement account you open on your own

• Similar to a Traditional IRA, but taxes are handled differently

• You contribute after-tax money (you pay taxes now)

• Investments grow based on stocks, bonds, or mutual funds

• Money cannot usually be withdrawn until age 59½ (with some exceptions)

• Withdrawals in retirement are completely tax-free (including profits)

• No tax when you take the money out later

• Can be passed to a beneficiary after death

Annuities

• An annuity is a financial product offered by insurance companies

• It works like a long-term savings plan that turns into monthly income later

• You save money first, then receive regular payments (often monthly) in retirement

• Types of annuities:

  • Fixed annuity: earns a steady return (about 2–4% per year)

  • Variable annuity: invested in mutual funds, so returns change with the market

• Contributions may grow tax-deferred (tax-free while growing, depending on rules/income)

• Withdrawals are taxed as regular income

• Commonly used in retirement to provide steady income for life

• Some people roll over 401(k) or IRA savings into annuities for stability and simplicity

Personal Financial File

A personal financial file is a record of all your financial information, such as:

• Income and savings

• Bank and investment accounts (stocks, bonds, IRA, 401(k), etc.)

• Retirement plans and annuities

• Taxes and important documents

It helps you track your money, plan for retirement, and stay organized financially.