Unit 3 · Topic 3.1 · about 35 minutes
Saving for Future Purchases
Explain why people save and what gets in the way, then build a savings plan that sets a monthly amount and picks the savings vehicle that fits the goal and the time frame.
Predict first
You put $1,000 in a savings account that pays 1% interest a year. Over the same year, the prices of the things you buy rise 3%. At the end of the year, what can your savings buy?
Earning, spending and saving
Most people earn income by working for an organization: a business, a nonprofit or a government entity. Some also earn it from self-employment, rental properties, government programs, investments or retirement accounts. Most of that income gets spent on products that address their problems, needs and wants.
What is not spent can be saved. People save for significant future purchases, such as a car, a home or college tuition. They save for emergencies, such as losing a job or getting sick. And they save so they will have a source of income in retirement, after they stop working.
Saving creates a personal asset, something of value that you own. Savings may also earn interest, which is income you can use now or leave in the account for later. How much interest you earn depends on the interest rate, the amount you have saved, conditions in the economy and the type of account the money is in. Keep $5,000 for a year in an account paying 4% and you earn about $200. At 0.5%, the same $5,000 earns about $25.
What makes saving hard
Some barriers are about the money itself. Inconsistent income, such as tips that swing from week to week or hours that get cut, makes it hard to set aside the same amount every month. And when recurring expenses exceed income, there is nothing left over to save.
Other barriers are psychological:
- Instant gratification is wanting the reward now rather than later. A concert this weekend feels more real than a car next spring.
- Lifestyle inflation is spending more every time you earn more. A $300 raise that turns into $300 more in rent leaves your savings exactly where they were.
- Impulse buying is buying things you had not planned to buy, often because they were in front of you at the right moment.
Some programs are built to work against these barriers. An automated savings plan moves a set amount of income into savings during each pay period, so the money is gone before instant gratification gets a vote. A retirement savings plan lets you save on taxes when you save for retirement, and a health savings account lets you save on taxes when you set money aside for health-related expenses.
Sort it
Tap each card, then tap the bin it belongs in.
Gets in the way of saving
Encourages saving
How PESTEL factors affect saving
PESTEL factors (political, economic, social, technological, environmental and legal) can change what savings are worth and how much reason people have to save. Economic, political and legal factors are good examples.
Economic factors. The stability and performance of the economy affect people's incomes and the cost of living. In a weak economy, people lose jobs or hours. In a strong economy, the cost of living can climb. Either one can leave less income after paying necessary expenses, which makes saving harder.
Inflation, an increase in the prices of goods and services, is an economic factor that works directly on savings. It erodes the purchasing power of savings, because the same money will buy fewer goods and services in the future. When people expect that loss, some decide saving is not worth it, so inflation can discourage saving.
Political factors. Government tax policies can encourage saving, for example by letting people put part of their income into an account designated for retirement, health care, childcare or other purposes without paying income tax on it that year.
Legal factors. Government agencies regulate financial institutions, such as commercial banks and credit unions, to improve consumer protection and keep the institutions financially stable.
Where to keep savings
A savings vehicle is wherever you keep your savings. The ones banks and credit unions offer include savings accounts, money market accounts and certificates of deposit.
A savings account is a deposit account that typically pays interest. It is insured by the federal government up to a maximum amount ($250,000 as of 2024), which means you do not lose your deposit if the bank goes out of business. Some savings accounts charge a monthly fee, and the minimum deposit, interest rate and fees all differ by institution.
A money market account is similar and also federally insured. Compared with a savings account, it may require a larger minimum deposit and charge higher monthly fees, but it may pay a higher interest rate and give you easier access to your cash.
A certificate of deposit (CD) is also similar and federally insured. It typically pays more than either of the others, but you are restricted from withdrawing the money for a set period, usually one month to five years. A CD typically requires a larger minimum deposit and charges no monthly fee.
Money you are not saving is usually held as cash or in a checking account, a federally insured deposit account designed for frequent transactions: deposits, withdrawals, debit card purchases and payments. Checking accounts pay little or no interest and may charge monthly maintenance fees or overdraft fees, so people pick one for its fees, its access (ATMs, online banking) and how easy it makes day-to-day spending.
Some people keep savings in a mobile payment account, which makes the money easy to spend, or a cryptocurrency account, which they hope will gain value as an asset. Unless an insured financial institution offers them, these accounts are not federally insured, and they typically pay no interest.
| Account | Interest | Access and costs | Federally insured? |
|---|---|---|---|
| Savings account | Typically pays interest | Minimum deposit and fees differ by institution | Yes |
| Money market account | May pay more than a savings account | Easier access to cash; may need a larger minimum deposit and charge higher fees | Yes |
| Certificate of deposit (CD) | Typically the highest of the three savings vehicles | Withdrawals restricted for a set term; larger minimum deposit; typically no monthly fee | Yes |
| Checking account | Little or none | Built for frequent transactions; may charge maintenance or overdraft fees | Yes |
| Mobile payment or cryptocurrency account | Typically none | Mobile payment money is easy to spend; cryptocurrency users hope it gains value | Not unless an insured financial institution offers it |
Building a savings plan
A savings plan answers two questions: how much, and where.
How much depends on your personal and financial goals and on your current income and expenses. People tend to save more when they have defined goals and face fewer barriers, which is why a plan starts with a goal, a dollar amount and a date.
Where depends on how much you are saving, what the money is for, how long you have, PESTEL factors such as inflation, and the benefits and costs of each savings vehicle. When you compare financial institutions, look at interest rates, fees, minimum deposit requirements and potential risk, along with location, convenience and reputation.
Expect tradeoffs. Accounts that pay higher interest often come with higher minimum balances or other requirements, and a CD's higher rate comes with restrictions on withdrawing the money before its term ends.
Worked exampleElena's car fund
Elena, a high school junior, takes home $820 a month from a part-time job. Her phone, gas and other regular costs come to $340 a month. She has $700 in checking and wants $4,200 for a used car in 14 months. Her credit union offers a savings account (0.75% interest, no monthly fee), a money market account (2.50% interest, $2,500 minimum deposit) and a 12-month CD (4.00% interest, $1,000 minimum deposit). Build her a savings plan.
Find the monthly amount. She still needs 4,200 minus 700 = $3,500. Spread over 14 months, that is 3,500 divided by 14 = $250 a month.
Check it against her income and expenses. 820 minus 340 leaves $480 a month. Saving $250 still leaves her $230, so the goal is realistic. An automated transfer of $250 on payday each month means the plan does not depend on willpower.
Choose the vehicle. With $700, she cannot meet the money market account's $2,500 minimum or the CD's $1,000 minimum. A CD also suits money that can sit untouched for its whole term, and Elena is adding to hers every month. The savings account fits: no monthly fee, access when she needs it, and federal insurance.
Estimate the interest. At 0.75%, her growing balance earns about $20 over the 14 months. The interest is a bonus. The plan works because of the $250 a month.
Save $250 a month by automatic transfer into the credit union savings account. Elena reaches $4,200 in 14 months, with about $20 of interest on top.
Check your understanding
Kim's savings account pays 1% interest a year. Over the same year, the prices of goods and services rose 4%. What happened to the purchasing power of her savings?
Jae got a raise worth $400 a month. Six months later he saves no more than before, because a newer car payment and a pricier apartment used up the raise. Which barrier to saving does this describe?
Grace wants $3,000 for a used car in 15 months, and she already has $600 saved. How much must she save each month to reach her goal on time? Ignore interest, and give your answer in dollars.
Tomas has $6,000 that he will not touch for three years, when he plans to use it for college. He wants federal insurance and as much interest as he can get. Which savings vehicle fits best?
A federal agency enforces the regulations that banks and credit unions must follow to protect their customers and stay financially stable. Which PESTEL factor that affects saving is this?
Course alignment, for teachers
AP Business with Personal Finance topic 3.1, Unit 3: Personal Saving and Borrowing / Business Finance and Accounting.