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Interest-bearing Bank Accounts & Inflation Part II-Math w/Business Apps, Compound Interest Chapter - YouTube
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In this section will look at time deposit
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accounts and inflation. Another type of
account that pays interest is called a
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certificate of deposit. The good
positives for a CD is generally they're
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issued from a bank that has the Federal
Deposit Insurance Corporation backing in
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the event that the institution goes out of
business you will get your money out of
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that. They do pay a higher interest
rate than a regular savings account or
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an interest bearing checking. Part of a
certificate of deposits'
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requirement is that the money needs to
be in the account for a designated amount
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of time. And it can be as short as
perhaps 3 months and as long as 5
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years or even longer.
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The downside is it does require a minimum
deposit. The bank is counting on this
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money being there, a substantial amount of
money being there so that they can in
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turn then use it to make money on your
money. And should you need this money and
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withdraw before the maturity date it is
subject to a penalty which is typically
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the last interest or so that's earned.
Here's a table of some CD rates being
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paid currently we can see here we have
3 months at $500 is earning
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1/10 of 1%. If we drop down we
can get a .35% for a
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2 year CD but a $10,000 minimum
deposit needs to be made. And here at the
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bottom to get a 1.25% interest
rate you need to sign up for a 5 year
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deposit of $10,000 or more.
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Compound interest table for longer
periods we will look at daily
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compounding for more than just 1 day
up to 90 days. And we need a table for
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that we can always use the formula but
the table saves a little bit a of time
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and here we have a table showing the
number of years and the interest rates
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for the compounded daily. In this example
W.C. wants to deposit $4,000 his account
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is paying 5% compounded daily
certainly not something that's happening
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for us currently. And the question is
should he leave it in there for 2 or
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3 years? So we will determine what
that value is for both of those
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possibilities. Using the compound
interest for time deposit accounts
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compounded daily we'll look up two years
and corresponding with 5% here's our
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multiplier. We'll times that by $4000
and see that the account has
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grown to $4420.65. If the
money is in there for another year tied
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up can you stand to not have access to
that money versus the gain in this
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account. And we're talking a little over
$200 additional interest is earned by
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having it in there in three years. And
this is a decision you need to make when
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you're taking out a certificate of
deposit. Know that you don't want to put
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money into an account for 2 or 3 or 5 years whatever the case may be
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that it's your emergency money that you
may need to pull it out.
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It's much better that you know you won't
be replacing the car you have emergency
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funds available to you and so that you
won't be cashing out. Not that it's the
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worst thing in the world but
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you should go with shorter lengths of time
and sacrifice your interest rate to
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avoid having to cash out early and
paying a penalty. The other topic in this
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section is dealing with the consumer
price index which is a measure of our inflation.
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An inflation is a rise in
general price levels of goods and
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services. And we can illustrate here what
inflation actually does. In 1950, if you
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had $100,000 today or at least in 2015
you would need almost a million dollars
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to have the same purchasing power that
you did in 1950, sixty-five
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years later. The measure of inflation
here in the United States is called
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the consumer price index and it's based
on a series of standard goods and
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services. It's a common bundle that they
calculate from one year to the next. What
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is your electricity bill and certain
groceries and commuting and so on. And
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just for your information here, last year 2015
for the 12 months running the United
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States inflation rate was 0.7%.
So let's take a look at
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what happens when we have a current
income and there's no raise but we have
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an inflation or consumer price index
increase of 4%. If that was the case,
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this individual would have to have instead of
$23,000 they would have to have $23,920
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to have the same buying power
because of that 4% inflation
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factor. And where is the $920 coming from?
If you take the current salary times
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the inflation factor of 4% as a
decimal times one year that means we
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have an increase of $920. So what if you
didn't get that corresponding 4% raise?
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It means you will need to trim $920 out
of your current budget so that you can
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stay status quo and not be short on
being able to pay your expenses and live
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at the standard that you previously were.
If we have a current income of $23,000
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and we saw a 4% consumer price index we
know we need $920. But what if, you
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received a 2.4% raise? Well it's not what you need to
keep up with inflation but at least
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you're not as far behind. And that $23,552 comes from taking the beginning
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salary $23,000 times the
wage increase of 2.4%, expressed as a decimal
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for a year is $552. So if someone received a
2.4% raise its better than no raise but
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it's still not keeping up with the
inflation rate for that year. And so if we
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look at what the 4% does compared to the
2.4% raise there's still $368 drop in
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buying power. To keep your level of
lifestyle the same you would need to cut
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$368 worth of
expenditures to maintain your status quo.
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Here we have another example, someone has
$1,800 in a savings account for
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1 year that pays 3.5% interest
compounded daily. What is the loss or
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gain in purchasing power if the consumer
price index went up 3.9%? We can see
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right now the interest is not high
enough keeping up with the inflation
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factor here so there will be a loss but
let's calculate it out. We have another
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table for 3.5%
interest compounded daily only expressed
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in quarters and one year would be four
quarters. So here we have a multiplier we
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will find the maturity value of that
$1,800 times 4 quarters which would
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be the one year for the 3.5%
interest compounded daily. So
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after one year the balance in this
account would have this value (1863.22) and if we
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subtract off that principle of $1,800 it
has made $63.22 in interest in the
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past year. What is the result or the
impact of the inflation factor 3.9%
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on our $1800? We'll take 1800 times
.039 the decimal equivalency of
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3.9%
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and we see that the gain to have still the
same buying power of the $1800 needed to
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have an increase of $70.20. We can take
the difference right here between the
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interest gained and what the inflation
factor or the buying power now of $1800 is a
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year later. Or we can compare the
inflation value of our $1,800 compared
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to putting it in a savings account.
Either way the difference between those
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2 is a loss of almost $7 in buying
power.
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