discuss what you will gain from the study of personal finance. introduction to the subject of...
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Discuss what you will gain from the study of personal finance.
•Introduction to the subject of personal finance
•Identify the key components of a financial plan, and
•Outline the steps involved in developing your personal financial plan.
Step 1 Think back to your formative experiences with money and consider what these memories have taught you about who you were then and how they affect who you are today.
Step 2 Replace your financial fears with new, positive, empowering messages (i.e. "I have more money than I will ever need"; "I am in control of all my affairs"; "I have the power to put my money in good hands").
Step 3 Be honest with yourself about your current financial status and decide how you want to start spending your money.
Step 4 Be responsible to those you love by taking care of these "must-do's"wills, trusts, life insurance, durable power of attorney for health care, long-term-care insurance, and estate planning.
Step 5 Respect yourself and your money by investing wisely in retirement plans, stocks, money market accounts, and mutual funds and by eliminating credit card debt. Your actions will give that respect meaning.
Step 6 You must trust yourself more than you trust others. Pay attention to your inner voice it will tell you if how and in what you are investing is right for you.
Step 7 Give a portion of your money to others. By releasing an anxious grasp on your money, you will open yourself to receive all that is meant to be yours.
Step 8 Understand and accept the cycles of money. The setbacks you may have today or next year will not keep you from financial freedom. If you hold on to your goals and dreams, you will get there.
Step 9 Learn to recognize true wealth. Money itself will not make you financially free. That comes as a result of only that powerful state of mind which tells us that we are worth far more than our money.
“. . . True financial freedom doesn’t depend on how muchmoney you have. Financial freedom is when you havepower over your fears and anxieties instead of the other way around.” -- Suze Orman, The 9 Steps to Financial Freedom, p.2
• Financial literacy -- the vocabulary necessary to manage one’s personal finances
• Personal finance -- the study of personal and family resources considered important in achieving financial success.
• Personal financial planning – the process of planning your spending, financing, and investing to optimize your financial situation.
• Financial success -- the achievement of financial aspirations that are desired, planned, or attempted. It is defined by the individual or family that seeks it.
Discuss what you will gain from the study of personal finance.
1 Maximizing Earnings and Wealth– Wealth -- an abundance of money,
property, investments, and other resources.
2 Practicing Efficient Consumption– We use money for two purposes:
consumption and savings3 Finding Life Satisfaction4 Reaching Financial Security
– Financial Security -- the comfortable feeling that your financial resources will be adequate to fulfill any needs you have as well as most of your wants.
– To reach financial security, first you need to set and prioritize your long-and short-term goals.
5 Accumulating Wealth for Retirement and an Estate
Describe five lifetime financial objectives of most people
Overview of Financial Plan
Financial Planning Decisions
Your Cash Inflow
Your Cash Outflow-
Your Net Cash Flows= Value of Your Assets
Value of Your Liabilities
Your Net Worth
-
=
Use dollars toIncrease assets
Use dollars toIncrease assets
How Financial Planning Affects Your Cash Flow
1. Budgeting and Tax Planning
YourCash
Products and
Service
5. Investing
4. Income and AssetProtection
2. Managing Liquidity(Cash and Credit Management)
3. Managing expendituresfor major purchases
$ Credit
$ Deposit
$ Loans
$ Spending
$ Investments
$ Invest for Retirement
$ Insu
rance
$ Income6.Retirement and
Estate Planning
Median Weekly Earnings of Full-Time Workers by Education Attainment and Sex
$- $200 $400 $600 $800 $1,000 $1,200
College graduates, total
Some collete orassociate degree
High school graduates,no college
Less than a high schooldiploma
Women's earnings 2002
Men's earnings 2002
Median Annual Earnings of Full-Time Workers by Education Attainment and Sex
$0 $10,000 $20,000 $30,000 $40,000 $50,000 $60,000
College graduates, total
Some collete orassociate degree
High school graduates,no college
Less than a high schooldiploma
Women's earnings 2002
Men's earnings 2002
Note: Data are for workers 25 years of age and older.
Statistics taken from www.bls.gov/opub/ted/2003/art04.htm
Understanding the Economic Environment of Personal Finance
• The State of the Economy
– Economy is a system of managing the productive and employment resources of a country, community, or business.
– Economic growth is a condition of increasing production and consumption in the economy.
– Business cycle (or economic growth) is a wavelike pattern of economic activity that includes temporary phases that undulate from boom to bust.
6 Steps of Personal Financial Planning
1. Develop financial goals. 2. Determine your current financial situation. 3. Identify and evaluate alternative plans to achieve your
goals. 4. Select and implement the best alternative to achieve your
goals. 5. Create and implement a financial action plan. 6. Reevaluate and revise your plan.
Phases of the Business (Economic Cycle)
Expansion(Prosperity)
Recession(or Depression)
Recovery
Average growth rate expected in economy
Bus
ines
s P
rodu
ctio
n an
d R
etai
l Sal
es
1. Make sure the goal you are working for is something you really want, not just something that sounds good.
2. One goal cannot contradict any of your other goals.
3. Develop goals in the 6 areas of life:1. Family and Hom.
2. Financial and Career
3. Spiritual and Ethical
4. Physical and Health
5. Social and Cultural
6. Mental and Educational
4. Write your goal in the positive instead of the negative.
5. Express your goal in time and unit detail.
6. Make sure your goal is high enough.
7. Write your goals down.
8. Share your goals with people that will help you achieve them.
Goal Setting
Understanding the Economic Environment of Personal Finance
• The State of the Economy
– Economy is a system of managing the productive and employment resources of a country, community, or business.
– Economic growth is a condition of increasing production and consumption in the economy.
– Business cycle (or economic growth) is a wavelike pattern of economic activity that includes temporary phases that undulate from boom to bust.
– Expansion occurs when production is at a high capacity, unemployment is low, retail sales are high, and prices and interest rates are low or falling.
– Recession is generally a decline in business “a recurring period of decline in total output, income, employment, trade, usually lasting from six months to a year and marked by widespread contractions in many sectors of the economy.”
– Depression is a severe downward phase of the economic cycle where unemployment is very high, prices are very low, the level of living decreases sharply, and economic activity virtually ceases.
Understanding the Economic Environment of Personal Finance
(cont.)
• Tracking at least two statistics may help understand the direction of the economy:
– Gross Domestic Product (GDP) -- the value of all goods and services produced by workers and capital located in the United States, regardless of ownership.
The Impact of Inflation
• Inflation-- a steady rise in the general level of prices.
• Deflation -- falling prices.
• When prices are rising, an individual’s income also must rise to maintain its purchasing power, which is a measure of the goods and services that one’s income will buy.
• Your real income reflects the actual buying power of your nominal income (also called money income.)
Personal Finance Calculations
• Percentage change in personal income -– (nominal income after raise/nominal income before raise -1) x 100
• For example, if Edward received a $1,600 raise to increase his annual salary from $37,000 to $38,600 during a year with annual inflation of 4%, his personal change in income would be calculated as follows:
His nominal increase would be:
$38,600
37,000 = 1.043 -1 x 100 = 4.3%
However, because inflation was 4%, his real increase was only .3% (4.3% nominal increase – 4% inflation = .3% real increase). In real dollars Edward’s increase would be calculated as follows:
• Real income -– nominal income after raise/1 + previous inflation rate
• Edward’s real income =
$38,600
1 + 0.040 = $37,115
The Impact of Inflation
• Inflation-- a steady rise in the general level of prices.
• Deflation -- falling prices.
• When prices are rising, an individual’s income also must rise to maintain its purchasing power, which is a measure of the goods and services that one’s income will buy.
• Your real income reflects the actual buying power of your nominal income (also called money income.)
• Interest is the price of money. Savers make no money when the inflation rate is equal to or higher than their interest rate. In fact, they are worse off -- “going broke slowly.”
• Federal fund rate -- the rate banks charge one another on overnight loans.
Economic Considerations That Affect Decision Making
• Opportunity Costs -- the value of the next best alternative that must forgone.– Opportunity costs are hard to quantify because most involve personal tastes and preferences
“[For many, the] biggest problems in life today . . . Are directly connected with their early, formative experience with money.” (9 Steps to Financial Freedom, p. 7).
• Utility -- the ability of a good or service to satisfy a human want.
• Marginal Utility -- the extra satisfaction derived from having one more incremental unit of a product or service.
• Marginal Costs -- the additional cost of one more incremental unit of some item.
Effect of Compound InterestSimple Interest Compound Interest
Year Principal Rate TimeInterestEarned
NewBalance Principal Rate Time
InterestEarned
NewBalance
1 100.00 10% 1 10.00 110.00 100.00 10% 1 10.00 110.00 2 100.00 10% 1 10.00 120.00 110.00 10% 1 11.00 121.00 3 100.00 10% 1 10.00 130.00 121.00 10% 1 12.10 133.10 4 100.00 10% 1 10.00 140.00 133.10 10% 1 13.31 146.41 5 100.00 10% 1 10.00 150.00 146.41 10% 1 14.64 161.05 6 100.00 10% 1 10.00 160.00 161.05 10% 1 16.11 177.16 7 100.00 10% 1 10.00 170.00 177.16 10% 1 17.72 194.87 8 100.00 10% 1 10.00 180.00 194.87 10% 1 19.49 214.36 9 100.00 10% 1 10.00 190.00 214.36 10% 1 21.44 235.79
10 100.00 10% 1 10.00 200.00 235.79 10% 1 23.58 259.37 11 100.00 10% 1 10.00 210.00 259.37 10% 1 25.94 285.31 12 100.00 10% 1 10.00 220.00 285.31 10% 1 28.53 313.84 13 100.00 10% 1 10.00 230.00 313.84 10% 1 31.38 345.23 14 100.00 10% 1 10.00 240.00 345.23 10% 1 34.52 379.75 15 100.00 10% 1 10.00 250.00 379.75 10% 1 37.97 417.72 16 100.00 10% 1 10.00 260.00 417.72 10% 1 41.77 459.50 17 100.00 10% 1 10.00 270.00 459.50 10% 1 45.95 505.45 18 100.00 10% 1 10.00 280.00 505.45 10% 1 50.54 555.99
180.00 455.99
Income Taxes in Decision Making
• Marginal Tax Rate -- is the tax rate at which your last dollar earned is taxed.
Assume Juanita has taxable income of $32,000 and receives a $1,000 bonus from her employer. Juanita’s federal tax rate is 28% and her state tax rate is 6%. What is Juanita’s effective marginal tax rate?
1,000 x .28 = $280.00 Federal taxes
1,000 x .06 = $ 60.00 State taxes
1,000 x .0765 = $ 76.50 Social Security Taxes
Total Taxes .4165 $416.40
Tax Sheltered Returns Are Greater Than Taxable Returns
$0
$50,000
$100,000
$150,000
$200,000
$250,000
10Years
15Years
20Years
25Years
30Years
Taxable ReturnsTax Sheltered Returns
The Time Value of Money in Decision Making
• Time value of money is the idea that paying or receiving money over time is affected by the fact that money can earn a positive rate of return over time.
– For example, if you were to win the lottery and be offered the choice to receive a lump sum of $1,000,000 now or payments of $60,000 per year for 20 years for a total of $1,200,000. The more favorable answer for you depends upon the interest rate you could earn on your investment.
• Present value (or discounted value) is the current value of an asset that will be received in the future.
• Future value is the valuation of an asset projected to the end of a particular time period in the future.
Basic calculations:
FV = (Present value of sum of money)( I + 1.0)(I + 1.0)(I + 1.0) . . .
Or FV = (PV)(1 + I) n
PV = (FV)(1 + I) -n
(Calculation assumes compound interest)
The Time Value of Money in Decision Making
• Assume you have the option of two different investment options. First, a friend wanted to borrow $5,000 for three years and pay you back $6,000 in a lump sum. Second, you could invest the same $5,000 for three years in a government bond paying 7 percent annual interest. Which investment would be the best financial decision?
FV = (PV)(1 + I) n
= (5,000)(1+.07)3
= 5,000 x 1.225043
= $6,125.22
You would earn $125.22 more by investing in the government bonds.
Future Value of $1 After a Given Number of Periods
Periods 5% 6% 7% 8%1 1.0500 1.0600 1.0700 1.08002 1.1025 1.1236 1.1449 1.16643 1.1576 1.1910 1.2250 1.25974 1.2155 1.2625 1.3108 1.36075 1.2763 1.3382 1.4026 1.46936 1.3401 1.4185 1.5007 1.5869
The Difference Between Simple Interest and Compound Interest
• Simple Interest is the interest computed on principal only Interest = Principle x Rate x Time or I = P x R x T.
• Compound Interest is the calculation of interest on interest as well as interest on the original investment.
Future Value of $10,000 with Interest Compounded Annually
$0
$100,000
$200,000
$300,000
$400,000
$500,000
$600,000
0 10 20 30
14%
12%
10%
8%
6%
Rule of 72
• A handy formula to calculate the number of years it takes to double principal using compound interest is the Rule of 72. You simply divide the interest rate the money will earn into the number 72. For example, if interest is compounded at a rate of 7 % per year, your principle will double every 10.3 years. If the rate is 6 %, it will take 12 years.The rule of 72 also works for determining how long it would take for the price of something to double given a rate of increase in the price. For example, if college tuition costs are rising 8 % per year, the cost of college education doubles in just over nine years.
02468
1012141618
12% 10% 8% 6% 4%
The Rule of 72
How Work Decisions Affect Success in Personal Finance
• Fringe Benefit is compensation for employment that does not take form of wages, salaries, commissions, or other cash payments. Examples include paid holidays, health insurance, and a retirement plan. Some fringe benefits are tax-sheltered, such as a flexible spending accounts and retirement accounts.
The Positive Effects of a Flexible Spending Account
Without With Flexible Spending the Plan The Plan AccountMonthly salary $2,500 $2,500 --
To FSA account -- (410) $410
Taxable salary $2,500 $2,090
Income tax* (248) (186)
Social Security tax (191) (160)
Salary after taxes $2,061 $1,744
Medical and/or
Dependent care expenses (410) (410)
Take home pay $1,651 $1,344
FSA reimbursement -- 410 (410)
Effective take home pay $1,651 $1,744
How Work Decisions Affect Success in Personal Finance
• Fringe Benefit is compensation for employment that does not take form of wages, salaries, commissions, or other cash payments. Examples include paid holidays, health insurance, and a retirement plan. Some fringe benefits are tax-sheltered, such as a flexible spending accounts and retirement accounts.
20 30 40 50 60 70 80
Initial Goal Setting
Home Purchase
Insurance Planning
Saving for Goals-Pay Yourself First
Family Formation
Age
$
Tax and Estate Planning
Reassessment of Retirement Goals
Stage 1
Early years-A time of
Wealth accumulation
Stage 2
Approaching Retirement-The Golden
Years
Stage 3
The Retirement Years
A Typical Individual’s Financial Life Cycle
Steps in Successful Management of Personal Finance
Retirement and estate planning
Investment planning
Income and asset protection
Managing expenditures
Cash and credit management
Financial planning
Lifetime Financial ObjectivesAccumulate wealth for retirement
Reach financial security
Find life satisfaction
Practice efficient consumption
Maximize earnings and wealth
Wea
lth
The Building Blocks of Financial Success
Stocks andBonds
MutualFunds
Real Estate
InstallmentLoans
EducationCosts
CreditCards
PensionPlans
TransportationExpenses
OrganizedFinancial Records
HousingExpenses
InsuranceExpenses
SavingsAccounts
RealisticBudget
Short-TermGoals
Long-TermGoals
ContingenciesIncomeTaxes
EmergencySavings Fund
InsuranceProtection
EmployeeFringe Benefits
CheckingAccount
SavingsAccount
Money MarketAccount
Use of regular income to provide basic lifestyle and savings to meet emergencies
FinanciallySuccessful Life
Achieve
Invest
Handle
Manage
Establish
Base
Foundation
Good Debt vs. Bad Debt
• Debt incurred for consumption is bad debt.
Bad Debt
= Debt Danger Ratio
Annual Income
Debt Danger Ratio beyond 25% can spell trouble.
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