Saving: bank deposits and securities
Saving means keeping part of your income for later instead of spending it all. Where you keep it matters.
Bank deposits. You give the bank your money and it pays you interest, because it lends your money to other people. A savings (demand) deposit lets you take money out any time, with low interest. A term (fixed) deposit locks the money for a set time and pays more. With simple interest you earn on the original amount only; with compound interest you also earn on past interest, so the amount grows faster. Most countries guarantee bank deposits up to a limit, so they are very safe.
Securities. These are tradable papers that show you own or have lent something. A bond is a loan to a government or company: it pays fixed interest and returns the money on a date. A share is a small part-ownership of a company: it can pay a dividend and its price can rise or fall. Mutual funds pool many people's money to buy a basket of bonds or shares.
Safety, return and access. Deposits are safest but pay little. Bonds are in the middle. Shares can give more over many years but can also lose money. A good rule is: the higher the possible return, the higher the risk. Also, if prices rise (inflation) faster than your interest, your money buys less. See also the lesson Saving: growing your money safely.
Borrowing: consumer, mortgage and personal loans
A loan gives you money now. You repay the principal (the amount borrowed) plus interest (the price of borrowing), usually in equal monthly payments (an EMI or instalment).
- Consumer loan: small to medium, to buy a thing such as a phone, a fridge or a bike. Often short and with a high rate.
- Personal loan: a general loan for any need, such as a wedding, study fees or a medical bill. Usually with no security, so the rate is higher.
- Mortgage (home) loan: large and long (10 to 30 years), to buy a home. The home itself is the security (collateral). If you stop paying, the bank can sell the home. Because of this the rate is lower.
Before you borrow, check the total cost (all payments minus the amount borrowed), the rate, the fees and the term. A longer term gives a smaller payment but a bigger total interest. A safe rule: all loan payments together should stay under about one-third of your monthly income. See the lesson Credit and loans for the EMI formula.
Insurance: compulsory and optional (life, health, pension, property)
Insurance is a deal. You pay a small regular amount, the premium. In return, the insurer promises to pay a large sum if a named bad event happens. It works by sharing risk: many people pay in, and the few who suffer a loss are paid from the common pool.
Compulsory insurance is required by law because the harm falls on others or on society. Examples in many countries: third-party insurance for a motor vehicle, a contribution to national health insurance or social security, and in some countries insurance for homes in disaster-prone areas.
Optional (voluntary) insurance is your own choice:
- Life insurance pays your family a sum if you die, so they can keep going.
- Health insurance pays all or part of hospital and treatment bills.
- Pension plans collect money during your working years and pay a regular income when you retire (state pension, workplace provident fund or private pension).
- Property insurance pays for damage to a home, shop or vehicle by fire, flood, storm or theft.
Insurance is not saving. If no bad event happens, the premium is not returned; it paid for protection. Always read what is excluded. See also Insurance: principles and types.
Putting the three together: a simple money plan
- First: cover the big risks with insurance (health, vehicle, home).
- Second: build an emergency fund of a few months of expenses in an easy-access deposit.
- Third: borrow only for things that help you in the long run, such as a home or study, and keep payments below one-third of income.
- Fourth: after that, save longer-term in bonds, shares or a pension.
The three tools help each other. Insurance protects your savings. Savings stop you needing a loan for small shocks. A small loan taken wisely helps you build something you could not buy at once.
Try it: your own block plan
In the 3D: set the years slider to 5, the loan term to 3, then to 8. Which term gives the smaller yearly payment? Which gives more orange interest blocks? Then switch insurance on, press Storm, and compare with insurance off.
At home: take 20 coins or buttons as your money. Give a friend the role of the bank. Move your coins to the bank; each "year" the bank adds one extra coin per 20. Then ask for a loan of 10 coins that you must return as 12 coins. Last, put 1 coin each round into a shared bowl with three friends. When one friend's "house" is hit by a storm card, take 6 coins from the bowl to repair it. Notice how the bowl protects everyone.
Key formulas and definitions
- Simple interest: I = P × r × t
- Compound amount: A = P × (1 + r)^t
- Monthly payment (EMI): EMI = P × i ÷ (1 − (1 + i)^(−n)), i = monthly rate, n = number of months
- Cost of a loan = total repaid − amount borrowed
- Payment-to-income ratio = monthly loan payments ÷ monthly income (keep under about 1/3)
- Fair premium ≈ chance of loss × size of loss (insurers add a bit for costs and profit)
Worked examples
1. You deposit 1000 at 5% a year with compound interest. How much is it after 3 years?
A = 1000 × 1.05³ = 1000 × 1.157625 = 1157.63. The interest earned is 157.63.
2. Compare simple and compound interest on 2000 at 4% a year for 2 years.
Simple: 2000 × 0.04 × 2 = 160. Compound: 2000 × 1.04² = 2163.20, so interest is 163.20. Compound gives 3.20 more because the second year's interest is earned on the first year's interest too.
3. A consumer loan of 10 000 at 12% a year is repaid in 12 equal monthly payments. Find the EMI and the cost of the loan.
Monthly rate i = 12% ÷ 12 = 1% = 0.01. EMI = 10 000 × 0.01 ÷ (1 − 1.01⁻¹²) = 100 ÷ 0.11255 ≈ 888.49. Total repaid = 888.49 × 12 = 10 661.9. Cost of the loan = 10 661.9 − 10 000 = 661.9.
4. In the 3D scene a loan of 40 at 8% a year is repaid in equal yearly payments over 5 years. How much is repaid in total?
Yearly payment = 40 × 0.08 ÷ (1 − 1.08⁻⁵) = 3.2 ÷ 0.3194 ≈ 10.02. Total = 10.02 × 5 ≈ 50.1. Interest cost ≈ 10.1, the orange blocks.
5. A flat costs 200 000. The bank gives a mortgage for 80% of the price. How much must the buyer pay as a down payment?
Loan = 80% of 200 000 = 160 000. Down payment = 200 000 − 160 000 = 40 000 (20%).
6. A family earns 3000 a month and pays 900 a month on loans. Is this within the safe rule?
Ratio = 900 ÷ 3000 = 0.30 = 30%. The safe limit is about one-third (33%), so 30% is just inside it but leaves little room for new loans.
7. In a town 1000 houses each have a 1 in 100 chance of a storm loss of 30 000 in a year. What is the fair yearly premium per house? Why might the real premium be higher?
Expected number of damaged houses = 1000 × 1/100 = 10. Total payout = 10 × 30 000 = 300 000. Per house = 300 000 ÷ 1000 = 300. The insurer also has costs and wants a profit, so the real premium is a little higher, for example 360.
Common mistakes
- Thinking insurance is a way to save money. If no event happens, the premium is not returned.
- Looking only at the monthly payment of a loan and ignoring the total cost and the term.
- Choosing the highest-return product without checking its risk (shares and some funds can lose money).
- Not reading what an insurance policy excludes, and then finding a claim is refused.