chapter 1 introduction to personal economic wealth
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Chapter 1
Introduction to Personal Economic Wealth
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1. Why study personal financial planning?
Achieve financial goals
Financial planning is not an inherent skill
Learn the language of personal finance
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2. The personal financial planning process
1. evaluate your current financial state2. define your financial goals 3. develop a plan of action4. implement your plan 5. review progress, reevaluate, and revise
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More on…3. develop a plan of action
• Plans vary and should consider the following:– Flexibility– Liquidity– Protection– Minimization of taxes– Other considerations
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3. Financial Goals
• goals cover 3 main time horizons– short term – intermediate term – long term
• rank goals
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4. The life cycle of financial planning
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Go to: http://ca.finance.yahoo.com
• This website provides much information and many tools that can be used for all aspects of financial planning, including tax rates, bank deposit rates, loan rates, and quotations and analysis of stocks, bonds, mutual funds, and insurance policies. It also provides information for creating retirement plans and wills
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6. 15 axioms of personal finance
• Understanding the following 15 axioms are prerequisites to understanding personal finance
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1. The risk-return trade-off
– Investors demand a minimum return for saving (delaying consumption)
– The level of return is directly related to the risk incurred
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2. The time value of money
• Money received today is worth more than money received next year. Why?
• The concept of compound interest
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3. Diversification reduces risk
• A variety of different investments is needed to reduce risk.
• How much risk can be eliminated?
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4. All risk is not equal
• Total risk is reduced to the degree determined by how the investment returns move together.
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5. The “curse” of competitive investment markets
• The concept of “efficient markets”
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Efficient markets
• Competitive
• Difficult for an investor to “beat the market”
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6. Taxes affect personal finance decisions
• Maximizing after-tax investments is the goal
• Taxes are not the same on all investments
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7. Stuff happens, or the importance of liquidity
• Adequate liquid funds need to be available for the unexpected
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8. Nothing happens without a plan
• Savings must be planned.
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9. The best protection is knowledge
• protects you from the unethical, incompetent, and unscrupulous
• enables you to understand the importance of planning for your future
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10. Protect yourself against major catastrophes
• insurance
• policies often only have subtle differences
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11. The time dimension of investing
• Studies show that losing money in the stock market is virtually impossible over time horizons over 10 years
• More risky investments are most suitable for long time horizons
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12. The agency problem
• describes the situation where agents who are to act in your best interest may actually act in their own interests
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13. Pay yourself first
• Set aside savings first, spend the residual
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14. Money is not everything
• Personal financial planning allows you to act responsibly and be realistic
• Do not let financial goals consume you, money does not bring happiness
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15. Just do it!
• The most difficult step is making the commitment to actually get started.