Personal Financial Planning


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Personal Financial Planning

  1. 1. Chapter Two Financial Planning
  2. 2. Learning Objectives <ul><li>Explain elements of successful financial planning. </li></ul><ul><li>Describe the balance sheet and the cash-flow statement. </li></ul><ul><li>Use financial ratios to evaluate your financial strength and progress. </li></ul><ul><li>Know which financial records to maintain and where to keep them. </li></ul><ul><li>Understand which factors to consider when choosing a professional financial planner. </li></ul>
  3. 3. Setting the Stage for Successful Personal Financial Planning <ul><li>Financial Planning: </li></ul><ul><ul><li>developing and implementing financial plans in order to achieve financial success. </li></ul></ul><ul><ul><li>is unique to each individual or family. </li></ul></ul><ul><ul><li>Question: What are some components of financial planning? </li></ul></ul>
  4. 4. Figure 2.1: Overview of Effective Personal Financial Management
  5. 5. Values Provide the Base for Financial Planning <ul><li>Values: Fundamental beliefs about what is important, desirable, and worthwhile. </li></ul>Activity 1: “10 Things I Like to Do” Activity 2: “Needs versus Wants”
  6. 6. Financial Goals Follow from Values <ul><li>Financial Goals: objectives to be attained through financial planning and management </li></ul><ul><li>Financial goals should be specific in terms of both dollar amounts and the projected dates by which they are to be achieved. </li></ul><ul><li>SMART goals: S pecific, M easurable, A chievable, R ealistic, and T ime-Related </li></ul><ul><li>Examples of SMART goals? </li></ul>
  7. 7. Developing Financial Statements <ul><li>What are Financial Statements? </li></ul><ul><li>Compilations of personal financial data used to analyze financial situation </li></ul><ul><ul><li>Net worth statement (a.k.a., balance sheet) </li></ul></ul><ul><ul><li>Cash-flow (a.k.a., income and expense) statement </li></ul></ul>
  8. 8. Balance Sheet = Net Worth <ul><li>Balance Sheet (Net Worth Statement): </li></ul><ul><ul><li>Describes an individual’s or family’s financial condition on a specified date. </li></ul></ul><ul><ul><li>A “snapshot” of your finances </li></ul></ul><ul><li>Components of a Balance Sheet </li></ul><ul><ul><li>Assets </li></ul></ul><ul><ul><li>Liabilities </li></ul></ul><ul><ul><li>Net Worth </li></ul></ul>
  9. 9. Assets and Debts <ul><li>What is Owned - Assets </li></ul><ul><ul><li>Monetary Assets/Liquid Assets </li></ul></ul><ul><ul><li>Tangible (or Use) Assets </li></ul></ul><ul><ul><li>Investment Assets/Capital Assets </li></ul></ul><ul><li>What Is Owed –Liabilities </li></ul><ul><ul><li>Short-term (or Current) Liabilities </li></ul></ul><ul><ul><li>Long-term Liabilities </li></ul></ul>
  10. 10. Net Worth–What Is Left <ul><li>Net Worth Formula: </li></ul><ul><ul><li>Net worth = assets - liabilities </li></ul></ul><ul><ul><li>or </li></ul></ul><ul><ul><li>Net worth = what is owned - what is owed </li></ul></ul><ul><ul><li>Questions: What is YOUR net worth? </li></ul></ul><ul><ul><li> Is it a positive number? </li></ul></ul><ul><ul><li> How do you increase net worth? </li></ul></ul><ul><ul><li> </li></ul></ul>
  11. 11. Table 2.2: Balance Sheet for a College Student
  12. 12. The Cash-Flow Statement Tracks Income and Expenses <ul><li>Cash-Flow (Income and Expense) Statement: </li></ul><ul><ul><li>Lists and summarizes income and expense transactions that have taken place over a specific period of time (e.g., a month). </li></ul></ul><ul><ul><li>Many people don’t have a clue about small expenses that add up. </li></ul></ul><ul><ul><li>Suggestion: Track your income and expenses for the coming week! </li></ul></ul>
  13. 13. Income <ul><li>Income is not limited to what is earned from salaries and wages. </li></ul><ul><li>It also includes... </li></ul><ul><ul><li>Gifts </li></ul></ul><ul><ul><li>Interest </li></ul></ul><ul><ul><li>Stock dividends </li></ul></ul><ul><ul><li>Scholarships </li></ul></ul><ul><ul><li>Other sources? </li></ul></ul>
  14. 14. Expenses <ul><li>Fixed Expenses: </li></ul><ul><ul><li>Usually paid in the same amount during each time period </li></ul></ul><ul><ul><li>They are often contractual </li></ul></ul><ul><li>Variable Expenses: </li></ul><ul><ul><li>Expenditures you can control. </li></ul></ul><ul><ul><li>Items/amounts differ from month to month. </li></ul></ul><ul><li>Occasional Expenses </li></ul><ul><ul><li>Pay infrequently (e.g., quarterly) </li></ul></ul>
  15. 15. Surplus (Loss) <ul><li>The surplus (loss) </li></ul><ul><ul><li>shows the amount remaining after subtracting expenditures from income. </li></ul></ul><ul><li>Surplus/deficit formula: </li></ul><ul><ul><li>Surplus(deficit) = total income - total expenses </li></ul></ul><ul><ul><li>Surplus = Positive cash flow </li></ul></ul><ul><ul><li>Deficit = Negative cash flow </li></ul></ul>
  16. 16. Table 2.4: Cash-Flow Statement for a College Student
  17. 17. Financial Ratios Assess Your Financial Strength and Progress <ul><li> Financial Ratios: </li></ul><ul><ul><li>Calculations based on information contained in financial statements. </li></ul></ul><ul><ul><li>Simplify judgments regarding financial strength and condition. </li></ul></ul><ul><ul><ul><li>Adequacy of emergency savings </li></ul></ul></ul><ul><ul><ul><li>Amount of household debt </li></ul></ul></ul><ul><ul><li>Often used by lenders, financial advisors </li></ul></ul>
  18. 18. Basic Liquidity Ratio <ul><li>Liquidity: The speed and ease with which an asset can be converted to cash. </li></ul>Question: What types of assets are liquid and what assets are not?
  19. 19. Basic Liquidity Ratio (Continued) <ul><li>Tells how long you could meet monthly expenses with monetary assets after a loss of income. </li></ul><ul><li>A higher number is better…Why? </li></ul><ul><li>Three months is a good cushion (emergency fund). </li></ul><ul><li>More may be needed if income varies significantly from month to month. </li></ul>
  20. 20. Asset-to-Debt Ratio <ul><li>Compares total assets with total liabilities. </li></ul><ul><li>A higher number is better…Why? </li></ul><ul><li>Is 1.0 or larger if net worth is positive </li></ul><ul><li>Should grow as you get older </li></ul>
  21. 21. Debt Service-to-Income Ratio <ul><li>Provides a view of total debt burden </li></ul><ul><li>Should be a ratio of .36 or lower </li></ul><ul><li>A lower number is better…Why? </li></ul><ul><li>Indicates ability to make payments for debts and housing payments </li></ul><ul><ul><li>Rent or mortgage payments </li></ul></ul>
  22. 22. Debt Payments-to-Disposable Income Ratio <ul><li>Disposable Personal Income: Take-home pay remaining after all deductions are withheld (a.k.a., “net income”) </li></ul>Question: What are some common payroll deductions?
  23. 23. Debt Payments-to-Disposable Income Ratio (Continued) <ul><li>Indicates ability to handle monthly debt payments other than a mortgage. </li></ul><ul><li>20 percent or more is very high. </li></ul><ul><li>Over 15% can cause problems </li></ul><ul><ul><li>(Even 10% for some families!) </li></ul></ul><ul><li>A lower number is better…Why? </li></ul>
  24. 24. Investment Assets-to-Total Assets Ratio <ul><li>Compares the value of investment assets to total assets. </li></ul><ul><li>A higher number is better…Why? </li></ul><ul><li>Should increase as you get older. </li></ul><ul><ul><li>Less than 20% in 20s </li></ul></ul><ul><ul><li>50% or more in later life </li></ul></ul>
  25. 25. Savings Ratio <ul><li>Compares dollars saved to after-tax income. </li></ul><ul><li>A higher number is better…Why? </li></ul>
  26. 26. Financial Recordkeeping Saves Time and Money <ul><li>Some records will be original, legal documents such as receipts, insurance policies,canceled checks, retirement account statements. </li></ul><ul><li>Other records will be ones you develop in the course of financial planning such as balance sheets and budgets. </li></ul>
  27. 27. Financial Recordkeeping Saves Time and Money (Continued) <ul><li>Some records can be stored safely at home in a fire-resistant cabinet or safe. </li></ul><ul><ul><li>Examples? </li></ul></ul><ul><li>Others records should be safeguarded more securely such as in a safe-deposit box at bank. </li></ul><ul><ul><li>Examples? </li></ul></ul><ul><li>Keep a list of s.d. box items </li></ul>
  28. 28. Where to Seek Professional Financial Planning Advice <ul><li>A true financial planner should be able to analyze a family’s total needs in... </li></ul><ul><ul><li>Investments </li></ul></ul><ul><ul><li>Taxes </li></ul></ul><ul><ul><li>Insurance </li></ul></ul><ul><ul><li>Education goals </li></ul></ul><ul><ul><li>Retirement planning </li></ul></ul><ul><ul><li>Estate planning </li></ul></ul><ul><li>Develop a cohesive plan </li></ul>
  29. 29. How are Financial Planners Compensated? <ul><li>Commission-Only Financial Planners </li></ul><ul><ul><li>Paid solely by commissions on products sold </li></ul></ul><ul><li>Fee-Only Financial Planners </li></ul><ul><ul><li>Charge a fee for services; no product sales </li></ul></ul><ul><li>Fee-Based Financial Planners </li></ul><ul><ul><li>Charge a fee and commissions on products </li></ul></ul><ul><li>Fee-Offset Financial Planners </li></ul><ul><ul><li>Fee reduced by commissions earned on products sold to client </li></ul></ul>
  30. 30. Golden Rules of Financial Planning <ul><li>Develop a balance sheet; update annually </li></ul><ul><li>Develop cash-flow statements monthly or quarterly and compile into annual statement </li></ul><ul><li>Calculate financial ratios periodically and use them to assess financial progress </li></ul><ul><li>Develop a list of financial goals. Update and revise your goals annually </li></ul><ul><li>Start an uncomplicated personal financial record-keeping system to meet your needs </li></ul>