Guest Post: Money Lessons 101 - College Edition Part II

For years John has educated his nieces and nephews on the important issues surrounding money and investing. He has offered to share his knowledge with the readers of Crazyville. Please take a moment and read his important advice. The first part of this series can be found here. 
- Sharon, The Mayor

Credit cards are a promise to pay for whatever you buy with the credit card.  The card issuer is giving you credit, essentially giving you a loan.  It is constrained only by the credit limit, or what the issuer thinks you can pay back.  Unlike the amount of cash you have in your pocket, you can buy many things with a credit card with little thought of paying it back. You do have to pay it back sometime!  Lots of people get in trouble by racking up large credit card bills without the ability to pay them back.  Don’t get into this situation.  The credit card companies will give you more credit than you deserve.  They hope you don’t repay on time so they can charge high rates of interest on the unpaid balance.  That is one form of debt.  We’ll talk more about debt later.

At the low rates for checking ands saving accounts, you know you will never make any money.  The next stop in search of returns is the time deposit.  Instead of demanding your money at any time with a checking or savings account, with time deposits you tie up your money for a set period of time.  That could be CD’s (Certificate of Deposits) at banks, saving banks, credit unions, bonds from corporations, and notes, bills, or bonds from the Federal Government.

You might think that CD’s etc. are a simple, low risk way to make your money work for you.  It’s not that simple.  There are risks to a time deposit.  There is default risk, that the institution will not be able to pay you back.  If it is a bank with the FDIC, for instance, that risk is gone.  If it is a corporation, it might go bankrupt.  As a bondholder you will have a higher claim to assets than a stockholder, but it will still be pennies on the dollar. If it is the Federal Government Treasury bill, note or bond, that risk is also very low.  If the Federal government can’t pay its bills, you have a lot more to worry about than just an investment.  There is interest rate risk – that rates may go up substantially during the time your money is held up. And there is the risk of inflation.

Let’s say you have a $10,000 CD at a bank paying 3%.  Every year you get $300.00. But you have to pay tax on that, at rate of 15 per cent.  So your net return is $255, then there is inflation.  The cost of goods goes up almost every year.

Here’s a table with the most recent inflation rates.

2004	2.7
2005	3.4
2006	3.2
2007	2.8
2008	3.8
2009	-0.4
2010	1.6
2011	3.2
2012	2.1
2013	1.5
2014	1.6
Average	2.4

So if it is an average year, inflation eats into your $10,000.00 investment $240.  Your net after taxes is $14.00.  That is calculated at a rate of 3%.  I picked 3% to make the math easier to understand.  3% is not a very realistic rate.  Today the rate on a ten-year treasury note is only 1.83 percent. You’ll never get rich that way. 

By now you’re probably discouraged and disheartened, so I’ll stop.  But before I do, know that there is a way for you to stay ahead of inflation and get ahead.  But that is for next time.

- Uncle John

Have a questions for John?  Ask away.