Published on

Published in: Economy & Finance, Business
  • Be the first to comment

  • Be the first to like this


  1. 1. Chapter One The Importance of Personal Finance
  2. 2. Learning Objectives <ul><li>List the benefits of studying personal finance. </li></ul><ul><li>Summarize the six key steps in successful personal financial planning. </li></ul>
  3. 3. Learning Objectives (continued) <ul><li>Understand the current economic environment and forecast the state of the economy, inflation, and interest rates over the next few years. </li></ul><ul><li>Explain fundamental economic considerations that affect decision making in personal finance. </li></ul>
  4. 4. Learning Objectives (continued) <ul><li>Make use of time value of money calculations when making financial decisions. </li></ul><ul><li>Recognize how employer-related money decisions can affect success in personal finance. </li></ul>
  5. 5. Financial Literacy <ul><li>Financial literacy is knowledge of: </li></ul><ul><ul><li>facts </li></ul></ul><ul><ul><li>concepts </li></ul></ul><ul><ul><li>principles </li></ul></ul><ul><ul><li>technological tools </li></ul></ul><ul><ul><li>that are fundamental to being smart about </li></ul></ul><ul><ul><li>money. </li></ul></ul>
  6. 6. Financial Responsibility <ul><li>Financial responsibility is being accountable for: </li></ul><ul><ul><li>your financial decisions and </li></ul></ul><ul><ul><li>your own financial well-being. </li></ul></ul>
  7. 7. Why You Should Study Personal Finance <ul><li>Personal finance–the study of how people </li></ul><ul><ul><li>spend </li></ul></ul><ul><ul><li>save </li></ul></ul><ul><ul><li>protect </li></ul></ul><ul><ul><li>invest their financial resources. </li></ul></ul>
  8. 8. Personal Financial Planning <ul><li>Personal financial planning is the development and implementation of long-range plans to achieve financial success. </li></ul>
  9. 9. Financial Planning <ul><li>Financial Planning relates to: </li></ul><ul><ul><li>Consuming–spending on goods and services. </li></ul></ul><ul><ul><li>Saving–income not spent on current consumption. </li></ul></ul><ul><ul><li>Investing–assets purchased to provide income from the asset itself. </li></ul></ul>
  10. 10. Financial Planning (continued) <ul><li>Financial planning helps you manage your level of living </li></ul><ul><ul><li>what you actually experience financially </li></ul></ul><ul><li>In order to attain your standard of living. </li></ul><ul><ul><li>where you would like to be financially </li></ul></ul>
  11. 11. Financial Planning (continued) <ul><li>Financial planning helps you achieve </li></ul><ul><ul><li>Financial Success – achievement of financial aspirations. </li></ul></ul><ul><ul><li>Financial Security – being able to fulfill any needs and most wants. </li></ul></ul><ul><ul><li>Wealth – an abundance of money and other financial resources. </li></ul></ul><ul><ul><li>Financial Happiness – the satisfaction you feel about money matters. </li></ul></ul>
  12. 12. Figure 1.1: Objectives and Steps in Personal Financial Success
  13. 13. Figure 1.2: The Building Blocks of Financial Success
  14. 14. How the Economic Environment Will Affect Your Personal Finances <ul><li>Forecasting–predicting, estimating, or calculating in advance. </li></ul>
  15. 15. Know the State of the Economy <ul><li>Economy–a system of managing the resources of a country, state, or community. </li></ul><ul><li>Economic Growth–increasing production and consumption in the economy. </li></ul><ul><li>Business/Economic Cycle–Pattern of economic activity including: </li></ul><ul><ul><li>expansion </li></ul></ul><ul><ul><li>recession </li></ul></ul><ul><ul><li>recovery </li></ul></ul>
  16. 16. Know the State of the Economy (continued) <ul><li>Expansion– </li></ul><ul><ul><li>production high </li></ul></ul><ul><ul><li>unemployment low </li></ul></ul><ul><li>Recession–a recurring period of decline in: </li></ul><ul><ul><li>total output </li></ul></ul><ul><ul><li>income </li></ul></ul><ul><ul><li>employment </li></ul></ul><ul><ul><li>trade </li></ul></ul><ul><li>Recovery–production, employment, and retail sales begin to improve. </li></ul>
  17. 17. Figure 1.3: Phases of the Business Cycle
  18. 18. Predict Future Directions for the Economy <ul><li>Gross Domestic Product (GDP)–Value of all goods and services produced in the U.S. </li></ul><ul><li>Index of Leading Economic Indicators (LEI)–Composite index suggesting the future direction of the U.S. economy. </li></ul>
  19. 19. Predict Future Directions of Prices and Inflation <ul><li>Inflation–Steady rise in the general level of prices. </li></ul><ul><li>Deflation–Falling prices. </li></ul>
  20. 20. How Inflation Affects Income and Consumption <ul><li>Purchasing Power–A measure of goods and services one’s income will buy goes down during inflation. </li></ul><ul><li>Personal incomes rarely keep up in times of high inflation. </li></ul><ul><li>Real Income–Income measured in constant prices relative to some base time period goes down during inflation. </li></ul>
  21. 21. Percentage Change in Income Formula
  22. 22. Real Income Formula
  23. 23. How Inflation is Measured <ul><li>Consumer Price Index (CPI)–broad measure of changes in the prices of all goods and services purchased for consumption by urban house holds. </li></ul><ul><li>Personal inflation rate–the rate of increase in prices of items purchased by a particular person. </li></ul>
  24. 24. Estimating Future Interest Rates <ul><li>Long-term interest rates are generally higher than short-term interest rates. </li></ul><ul><li>You can forecast interest rates by paying attention to changes in the federal funds rate: </li></ul><ul><ul><li>the rate that banks charge one another on overnight loans. </li></ul></ul><ul><ul><li>provides an early indication of Fed policy and trends for longer-term interest rates. </li></ul></ul>
  25. 25. Opportunity Costs and Trade-offs in Decision Making <ul><li>Opportunity Cost–Value of the next best alternative that must be foregone. </li></ul><ul><li>Opportunity cost reflects the best alternative of what one could have done instead of choosing to spend, save, or invest money. </li></ul><ul><li>Trade-offs occur when you give up one thing for another. </li></ul>
  26. 26. Marginal Analysis in Decision Making <ul><li>Utility–The ability of a good or service to satisfy a human want. </li></ul><ul><li>Marginal Utility–Extra satisfaction from one more incremental unit of a good or service. </li></ul><ul><li>Marginal Cost–Additional cost of one more unit of some item. </li></ul><ul><ul><li>Compare the benefits of the additional options with the additional costs. </li></ul></ul>
  27. 27. Income Taxes in Decision Making <ul><li>Marginal Tax Rate–Tax rate at which your last dollar earned is taxed. </li></ul><ul><li>Tax-Exempt Income–Income that is totally and permanently free of taxes. </li></ul><ul><li>Tax-Sheltered Income–Income exempt from income taxes in the current year. </li></ul>
  28. 28. Figure 1.4.: Tax-Sheltered Returns Are Greater Than Taxable Returns
  29. 29. The Time Value of Money in Decision Making <ul><li>Time Value of Money compares: </li></ul><ul><ul><li>amounts to be received in the future with dollar amounts received today </li></ul></ul><ul><ul><li>or dollar amounts received today with dollar amounts to be received in the future. </li></ul></ul><ul><li>Interest–the price of money. </li></ul>
  30. 30. Compound Interest <ul><li>Compound Interest–earning interest on interest. </li></ul><ul><li>Compounding–earning compound interest–is the best way to to build value over time. </li></ul>
  31. 31. Calculating Future Values <ul><li>Future Value (FV)–Value of an asset at the end of a particular time period. </li></ul>
  32. 32. Future Value of a Lump Sum <ul><li>What the principal will grow to over time. </li></ul><ul><li>Formula: </li></ul><ul><ul><li>FV = (Present Value) (i +1.0)n where, </li></ul></ul><ul><ul><li>i = the interest rate </li></ul></ul><ul><ul><li>n = the number of time periods. </li></ul></ul>
  33. 33. Figure 1.5: Future Value of $10,000 with Interest Compounded Annually
  34. 34. The Rule of 72 <ul><li>Rule of 72–Calculates the number of years it takes for principal to double. </li></ul><ul><ul><li>Years = 72 divided by interest rate. </li></ul></ul>
  35. 35. Figure 1.6: The Rule of 72
  36. 36. Future Value of an Annuity <ul><li>What the principal will grow to over time if a series of deposits are made. </li></ul>
  37. 37. Figure 1.7: Future Value of $2000 Annual Investments
  38. 38. Present Value Calculations <ul><li>Present/Discounted Value–Current value of an asset that will be received in the future. </li></ul>
  39. 39. Present Value of a Lump Sum <ul><li>Present value of an amount to be received in the future. </li></ul>
  40. 40. Present Value of an Annuity <ul><li>Present value of a stream of payments to be received in the future. </li></ul>
  41. 41. Career-Related Money Decisions <ul><li>Employee Benefit–Compensation for employment other than </li></ul><ul><ul><li>wages </li></ul></ul><ul><ul><li>salaries </li></ul></ul><ul><ul><li>commissions </li></ul></ul><ul><ul><li>other cash payments </li></ul></ul>
  42. 42. Employer-Sponsored Tax-Sheltered Spending Accounts <ul><li>Flexible Spending Arrangement (FSA) </li></ul><ul><li>Health Savings Account (HSA) </li></ul>
  43. 43. Employer-Sponsored Qualified Retirement Plans <ul><li>Plans that give tax advantages, making it easier to save for retirement; e.g. a 401(k). </li></ul>
  44. 44. First Advantage: Tax-Deductible Contributions <ul><li>The amounts you and your employer contribute into the account is not included in your taxable income for the year contributed. </li></ul>
  45. 45. Second Advantage: Tax-Deferred Growth <ul><li>The investment earning off of the funds in your account are not subject to income tax during the year they are earned. </li></ul><ul><li>Taxes will be paid when the earnings are withdrawn. </li></ul><ul><li>All employer-based plans will have the second advantage. Most will also have the first. </li></ul>
  46. 46. How To Maximize the Benefits from a Tax-Sheltered Retirement Plan <ul><li>Start early to boost your retirement. </li></ul><ul><li>Plan to be a millionaire. </li></ul><ul><li>Saving just 1 percent more of your pay makes a big difference. </li></ul><ul><li>Never make a hardship withdrawal from a tax-sheltered retirement plan. </li></ul>
  47. 47. Golden Rules of Personal Finance <ul><li>Pay yourself first by spending less than you earn. </li></ul><ul><li>Stay up-to-date about current economic conditions. </li></ul><ul><li>Use marginal and opportunity costs and time value of money calculations when making financial decisions. </li></ul>
  48. 48. Golden Rules of Personal Finance (continued) <ul><li>Map your financial future by establishing goals and realistic plans to achieve them. </li></ul><ul><li>Take advantage of opportunities to tax-shelter some income through your employer’s benefits program, including fully funding your 401(k) retirement account. </li></ul><ul><li>Develop expertise in financial matters and heed your own advice because you are responsible for your own financial success. </li></ul>