These are the slides from the 5th session of the Stanford University class, CS 007 "Personal Finance for Engineers" This seminar focuses on liquidity, emergency funds, assets & liabilities, and net worth.
4. WHAT IS LIQUIDITY?
โข How quickly can you get access to
cash when you need it?
โข Market liquidity refers to the extent
a marketplace allows assets to be
bought & sold at stable prices.
โข Accounting liquidity measures the
ease an individual or company can
meet their financial obligations with
the liquid assets available to them.
โข Donโt underestimate the value of
liquidity. Liquidity matters.
5. WHY DOES LIQUIDITY MATTER?
โข Liquidity is the only thing
that matters when you
need to pay for
something.
โข Liquidity is the power to
take advantage of
investment opportunities.
6. LIQUIDITY & RETURNS
โข Liquidity is typically inversely
correlated with returns
โข Examples
โข Cash is very liquid
โข Private Equity is very illiquid
โข Safety โ Liquidity
โข 5 Year CD is safe, โจ
but illiquid
โข Tesla stock is liquid, but
volatile!
8. 8: WHAT % OF AMERICANS HAVE $400 FOR EMERGENCIES?
โข US Federal Reserve
reported in 2015 that
47% of Americans do not
have sufficient savings to
cover a $400 emergency
expense.
โข Liquidity means having
access to money when
you need it.
9. WHY EMERGENCY FUNDS?
โข Practical outcome of need
for liquidity
โข Example of โmental
accountingโ used for
financial health
โข Goal is to protect your long
term assets / plans from
unexpected short term
needs.
10. HOW LARGE SHOULD AN EMERGENCY FUND BE?
โข Standard recommendation is at
least 3 months of living
expenses in cash or cash-
equivalents
โข Calculated based on impact of
losing employment
โข National average is 3-6 months
to find a job of equal pay.
โข Time increases in recession &
based on your seniority.
11. COMMON MISTAKES WITH EMERGENCY FUNDS
โข Donโt focus on investment
return or opportunity cost.
โข Think of it as a buffer, or as
insurance. Not as an asset.
โข First on the list to fill, first to
refill if tapped for
emergency.
โข Do not tap it for frivolous
needs. It is for emergencies.
13. WHAT IS AN ASSET?
โข Any resource with
economic value
โข Financial assets are
investments in cash, bonds,
stocks, etc.
โข Real assets are
investments in real estate,
collectibles, commodities,
etc.
14. DIFFERENT TYPES OF ASSETS
โข Liquid vs. Illiquid
โข Financial vs. Real
โข Appreciating vs.
Depreciating
โข Tangible vs. Intangible
โข Debt owed to you
* https://www.wealthfront.com/plan
15. WHAT ABOUT HUMAN CAPITAL?
โข Easy to argue that your
skills & capabilities are the
largest asset you have.
โข Donโt ignore โintangible
assetsโ - sometimes they
are the best investments.
โข Do remember that human
capital varies significantly
in liquidity.
* https://www.wealthfront.com/plan
16. WHAT ARE LIABILITIES?
โข A liability is a financial
obligation, typically debt.
โข Most common personal
liability is a loan.
โข Common types
โข Mortgage
โข Auto Loan
โข Student Loan
โข Credit Cards
โข Tax Liability
17. DIFFERENT TYPES OF LIABILITY
โข Short term vs. Long term
โข Secured vs. Unsecured
โข Tax Liability
18. CREDIT SCORES
โข Lenders report to 3 major centralized
credit agencies when you apply for debt,
receive debt, and when you pay off debt.
โข Building a good credit score is essential
for qualifying for most loans. It can affect
other services too, as it is used for
identity verification.
โข Issues that affect credit score: length of
history, on time payment, percent of
capacity utilized, new applications for
debt, bankruptcy.
โข Credit Karma ๐ฏโจ
http://www.creditkarma.com
19. IS DEBT A BAD THING?
โข Modigliani-Millerโจ
market value is determined by
earning power & risk of
underlying assets, not by the
method of financing.
โข Assumes no taxes, transaction
costs, bankruptcy costs
โข Tradeoff Theory of Leverageโจ
There is an optimal capital
structure.
20. SHOULD I PAY OFF ALL OF MY DEBT?
โข More debt = more risk
โข Not all debt is the same
โข Compounding is not your friend with
debt, especially high interest debt.
โข Some debt is subsidized (e.g.
Mortgage, Student Loans)
โข Paying off debt can be emotionally
satisfying, but financially irrational.
โข Paying off debt can improve savings
rates over time.
22. WHAT IS YOUR NET WORTH?
โข Assets - Liabilities
โข Total net worth includes all
assets.
โข Liquid net worth excludes
illiquid assets & primary
home (and related liabilities)
โข Do not confuse with cash
flow. Very different.
* https://www.census.gov/data/tables/2013/demo/wealth/wealth-asset-ownership.html
23. WHAT IS A BALANCE SHEET?
โข A balance sheet is a financial
statement that summarizes a
companies assets, liabilities &
shareholdersโ equity.
โข Assets = Liabilities + Equityโจ
(see, it has to balance)
โข Common ratios
โข Cash Ratio
โข Quick Ratio
โข Debt to Equity
โข Asset Turnover
โข ROA (Return on Assets)
* http://www.investopedia.com/articles/04/031004.asp?ad=dirN&qo=investopediaSiteSearch&qsrc=0&o=40186
24. CREATING YOUR PERSONAL BALANCE SHEET
โข Very simple summary of a
personal balance sheet
โข Some recommend
excluding primary
residence (and related
mortgage)
โข Very different than income
statement, but useful for
evaluating progress
(excluding primary residence)