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FIN 200: Personal Finance

Topic 25–Integrating Your Financial PlanLawrence Schrenk, Instructor

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Learning Objectives

1. Explain the goals and strategies of lifetime financial planning. ▪

2. Discuss role of human capital in financial planning.

3. Develop an integrated financial plan. ▪

Goal of Life: Happiness

Supreme happiness would be nice, but… ▪ We might need to settle for happiness that is

Evenly Distributed, and Smooth

We want to avoid Ups and Downs, and Spikes ▪

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Rule of Financial Planning ▪

Derive financial goals from your life goals. Financial goals should support life goals. Financial decisions are ethical decisions.

Consider the financial implications of every decision you make.

Decide nothing solely on its financial implications. ▪

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Goal of Financial Planning: Consumption What is consumption?

‘Buying’ Leisure Opportunity Cost

For happiness to be even and smooth, Should consumption be even and smooth?

Preferences change over your lifetime Value of consumption changes over your

lifetime. Value to you of a dollar changes over your lifetime.

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Strategy

Life Goals

Financial Goals

Consumption Levels

Short Term Horizon Long Term Horizon

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Income and Wealth Cycles

Age ▪

Income

College Career Retirement

Saving

Wealth

Dis-saving ▪Borrowing

Objectives

Short Term Smooth Consumption Avoid Consumption ‘Shocks’

Long Term Reach Desired Consumption Levels

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Methods and Tools: Short Term

How to Smooth Consumption Liquidity

Credit Short Term Savings

Flexibility Job Characteristics

Insurance ‘Reactive’ Strategies

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Digression: Money and Time I

Function of Saving and Borrowing Transfer Wealth across Time Rate of Return

‘Saving’ versus ‘investing’ Investment Portfolio

‘Borrowing’ versus ‘XXX’? Borrowing Portfolio

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Digression: Money and Time II

Ideally, what would you like? Limits to Transferring Wealth across Time

Uncertainty Incentive Problems

Structures for Transferring Wealth across Time Contracts Legal System

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Methods and Tools: Long Term How to Reach Consumption Levels

Increase Income Education Experience Effort

Adjust Wealth Saving and Investment Borrowing Inflation Issues

‘Proactive’ Strategies

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Remember: Human Capital

What is human capital? Facts about Human Capital

Low Risk Changing Proportion of Wealth

Counterexamples

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Sources of Value

Financial Assets Investment Portfolio and Short Term Savings Credit

Human Capital Labor Income

Real (Non-Financial) Assets House Collections, Other Property People

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Diversification

Being Well-Diversifiedversus

Holding a Well-Diversified Portfolio

Differences: Human Capital Real (Non-Financial) Assets

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Interdependencies

Income

House Portfolio ▪

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Your Risk Profile

To what risks are you exposed? A Small Sampling

Investment Risk Job Loss/Reduced Income Longevity Risk Theft Health Problems Correlation Risk Etc...

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Responses to Risks

Passive: Diversification Dampening Consumptions Shocks Low Costs Incomplete

Active: Hedging Managing Consumptions Shocks More Cost More Complete

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Hedging

What is hedging? Examples

Insurance Structured ‘Stand of Living’ Products ‘Targeted’ Products ‘Bundled’ Products Future Developments?

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Two Approaches

Simple Follow Practical Guidelines

Complex Statistical Analysis

Excel Web Resources if available

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Practical Issues Lifetime Horizon Review and Revise Insurance Avoid or Divest Company Stock Plan for Inflation Habit Formation Consider a Financial Planner/Advisor

On life-cycle planning, read Paula H. Hogan, “Life-Cycle Investing Is Rolling Our Way”

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Exam Coverage

Main Focus–Topics 20-25 A Few Earlier Questions

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How to Study for the Short Answer Questions Study the slides–full slide ‘rule’. Read the textbook and know the key words. Answer the selected end of chapter questions. Review the PowerPoint slides and your class

notes. Know the bold words on the slides.

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How to Study for the Calculation Problems Study the examples done in class and the

worked problem set. Practice with your calculator. Answer the selected end of chapter

problems.

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