Chapter 1


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Chapter 1

  1. 1. Chapter 1 Personal Financial Planning: An Introduction McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
  2. 2. Financial Planning and Its Benefits <ul><li>Personal financial planning - Process of managing money to achieve personal economic satisfaction. </li></ul><ul><li>Advantages of personal financial planning: </li></ul><ul><ul><li>1) Increased effectiveness in obtaining, using, and protecting your financial resources. </li></ul></ul><ul><ul><li>2) Increased control of your financial affairs. </li></ul></ul><ul><ul><li>3) Improved personal relationships. </li></ul></ul><ul><ul><li>4) A sense of freedom from financial worries obtained by looking to the future. </li></ul></ul>1-2
  3. 3. The Financial Planning Process <ul><li>Determine your current financial situation. </li></ul><ul><li>Develop your financial goals. </li></ul><ul><li>Identify alternative courses of action. </li></ul><ul><li>Evaluate your alternatives. </li></ul><ul><li>Create and implement your financial action plan. </li></ul><ul><li>Review and revise your plan. </li></ul>1-3
  4. 4. Consequences of Choices: Opportunity Cost <ul><li>Opportunity cost - What you give up </li></ul><ul><li>when you make a choice </li></ul><ul><li>The cost, or trade-off of a decision, cannot always be measured in dollars. Sometimes the cost is your time. </li></ul><ul><ul><li>What opportunity costs do you have </li></ul></ul><ul><ul><li>from being a college student? </li></ul></ul>1-4
  5. 5. Every Financial Decision Involves Evaluating Types of Risk <ul><li>Inflation risk . </li></ul><ul><ul><li>Rising prices cause lost buying power. </li></ul></ul><ul><li>Interest-rate risk. </li></ul><ul><ul><li>Effect costs of borrowing and rate of return. </li></ul></ul><ul><li>Income risk. </li></ul><ul><ul><li>The loss of a job. </li></ul></ul><ul><li>Personal risk . </li></ul><ul><ul><li>Health, safety, or costs. </li></ul></ul><ul><li>Liquidity risk . </li></ul><ul><ul><li>Higher return may mean less liquidity . </li></ul></ul>1-5
  6. 6. Financial Planning Information Sources <ul><li>Printed materials. </li></ul><ul><li>Financial institutions. </li></ul><ul><li>School courses and educational seminars. </li></ul><ul><li>The internet, online sources, computer </li></ul><ul><li>software. </li></ul><ul><li>Financial specialists. </li></ul><ul><ul><li>Financial planners, bankers, accountants, insurance agents, lawyers and tax preparers. </li></ul></ul>1-6
  7. 7. Developing Personal Financial Goals <ul><li>Types of financial goals include those ... </li></ul><ul><ul><li>Influenced by the time frame in which you want to achieve your goals. </li></ul></ul><ul><ul><li>Influenced by the financial need that drives your goals. </li></ul></ul><ul><li>Timing of goals. </li></ul><ul><ul><li>Short-term, intermediate and long-term goals. </li></ul></ul><ul><li>Goals for different financial needs </li></ul><ul><ul><li>Consumer product goals, etc. </li></ul></ul>1-7
  8. 8. Goal-Setting Guidelines <ul><li>Goals should be realistic </li></ul><ul><li>Goals should be stated in specific terms </li></ul><ul><li>Goals should have a time frame </li></ul><ul><li>Goals should indicate the action to be taken </li></ul><ul><li>Discuss some of your goals </li></ul>1-8
  9. 9. Influences on Personal Financial Planning <ul><li>Adult life cycle stage. </li></ul><ul><li>Marital status, household size, and employment. </li></ul><ul><li>Major events. </li></ul><ul><ul><li>Graduation, marriage, children, retirement, etc. </li></ul></ul><ul><li>Values. </li></ul><ul><ul><li>What values are important to you? </li></ul></ul><ul><li>Global influences </li></ul><ul><li>Economic conditions </li></ul>Life situation and personal values 1-9
  10. 10. Changing Economic Conditions <ul><li>Consumer The value of the dollar prices changes in inflation . </li></ul><ul><li>Consumer The demand for goods and spending services by individuals and households. </li></ul><ul><li>Interest rates The cost of money; cost of credit when you borrow; return on your money when you save or invest. </li></ul>1-10
  11. 11. Changing Economic Conditions (continued) <ul><li>Money Supply The dollars available for spending in our economy . </li></ul><ul><li>Unemployment The number of individuals without employment who are willing and able to work. </li></ul><ul><li>Housing starts Number of new homes being built. </li></ul>1-11
  12. 12. Changing Economic Conditions (continued) <ul><li>GDP: Gross Total value of goods and Domestic Product services produced in a country. </li></ul><ul><li>Trade balance Difference between a country’s exports and imports. </li></ul><ul><li>Market indexes The relative value of stocks as represented by the index, such as the Dow Jones Average or the S&P 500. </li></ul>1-12
  13. 13. Opportunity Costs and Financial Results Evaluated When Making Decisions Personal Opportunity Costs (time, effort, health) Financial Opportunity Costs (Interest, liquidity, safety ) 1-13 Financial Acquisitions (automobile, home, college education, investments, insurance, retirement fund)
  14. 14. Time Value of Money <ul><li>Increases in an amount of money as a result of interest earned. </li></ul><ul><ul><li>Saving today means more money tomorrow. Spending means lost interest. </li></ul></ul><ul><li>Saving and spending decisions involve considering the trade-offs. Current needs can make spending worthwhile. </li></ul>1-14
  15. 15. How Simple Interest is Computed <ul><li>Simple Interest. Amount in savings x annual interest rate x time period equals the interest. $100 x 5% x 1 (1 year) 100 x .05 x 1 = $5.00 In one year you have $100 in principle plus $5.00 in interest for a total of $105 at the end of the year. </li></ul>1-15
  16. 16. Future Value <ul><li>Future value is the amount to which current savings will increase based on a certain interest rate and a certain time period. </li></ul><ul><li>Future value is also call compounding - earning interest on previously earned interest. </li></ul><ul><li>Future value can be computed for a single amount or for a series of deposits. </li></ul>1-16
  17. 17. Present Value <ul><li>The current value for a future amount based on a certain interest rate and a certain time period. </li></ul><ul><li>Present value calculations are also called discounting. </li></ul><ul><li>The present value of the amount you want in the future will always be less than the future value. (See Exhibit 1-8C) </li></ul><ul><li>Present value can be computed for a single amount or for a series of deposits. </li></ul>1-17
  18. 18. Components of Financial Planning <ul><li>Obtaining (chapter 2) </li></ul><ul><li>Planning (chapters 3, 4) </li></ul><ul><li>Saving (chapter 5) </li></ul><ul><li>Borrowing (chapters 6, 7) </li></ul><ul><li>Spending (chapters 8, 9) </li></ul><ul><li>Managing risk (chapters 10-12) </li></ul><ul><li>Investing (chapters 13-17) </li></ul><ul><li>Retirement and estate planning (chapters 18, 19) </li></ul>1-18
  19. 19. Developing a Flexible Financial Plan <ul><li>A financial plan is a formalized report that... </li></ul><ul><ul><li>Summarizes your current financial situation. </li></ul></ul><ul><ul><li>Analyzes your financial needs. </li></ul></ul><ul><ul><li>Recommends future financial activities. </li></ul></ul><ul><li>Your financial plan can be created by you, with assistance from a financial planner, or made using a money management software package. </li></ul>1-19
  20. 20. Implementing Your Financial Plan <ul><li>Develop good financial habits. </li></ul><ul><ul><li>Use a well conceived spending plan to help you stay within your income, while allowing you to save and invest for the future. </li></ul></ul><ul><ul><li>Have appropriate insurance protection to prevent financial disasters. </li></ul></ul><ul><ul><li>Become informed about tax and investment alternatives. </li></ul></ul><ul><ul><li>Study personal finance. </li></ul></ul>1-20
  21. 21. Implementing Your Financial Plan (continued) <ul><li>Achieving your financial objectives requires two things. </li></ul><ul><ul><li>A willingness to learn. </li></ul></ul><ul><ul><li>Appropriate information sources (see Appendix A). </li></ul></ul><ul><ul><ul><li>Current periodicals. </li></ul></ul></ul><ul><ul><ul><li>Financial institutions. </li></ul></ul></ul><ul><ul><ul><li>Courses and seminars. </li></ul></ul></ul><ul><ul><ul><li>Personal financial software. </li></ul></ul></ul><ul><ul><ul><li>The World Wide Web. </li></ul></ul></ul><ul><ul><ul><li>Financial specialists. </li></ul></ul></ul>1-21
  22. 22. Lucky You <ul><li>Suppose you just won a $100 million </li></ul><ul><li>lottery and you are given the choice </li></ul><ul><li>of taking a lump sum or payments </li></ul><ul><li>over 20 years. Which would you do? Why? </li></ul>1-22