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PERSONAL
FINANCE FOR
ENGINEERS
CS 007: SESSION 8
FINANCIAL
PLANNING &
GOALS
CS 007
PLANNING
how to set financial goals and meet them
WHAT IS A FINANCIAL PLAN?
• Comprehensive evaluation of current & future
financial state.


• “The process of determining whether and how
an individual can meet life goals through the
proper management of financial resources”


— CFP Board


• Cash flow, assets, withdrawals.


• Key components


• Net Worth


• Cash Flow Analysis


• Retirement Strategy


• Risks / Insurance


• Investment Strategy


• Tax Strategy


• Estate Plan
WHY IS FINANCIAL PLANNING NEEDED?
• People tend to spend more than
they need to, if they lack
sufficient motivation for saving.


• Short term rewards vs. Long term
payoff. Need time to build assets.


• Making a financial plan explicit
increases likelihood of success


• Extremely important when more
than one person involved
(couples / families)
WHAT ARE FINANCIAL ADVISORS?
• Term can be used by anyone. Be extremely wary.


• Two accreditations are well respected:


CFP & CFA.


• Most have a very high variable cost (1%+) and high
minimums ($1M+)


• There is evidence that financial planners
significantly help people avoid behavioral errors.
Vanguard estimates that value at 150 bps! *


• Communication about money is often dysfunctional
for couples. Financial advisors force transparency
& joint planning, which is essential.


• Industry is rife with conflict of interest & high
commissions.


• Will likely be disrupted by personalized, data-
driven automated solutions over the next 10 years.
* Quantifying Vanguard Advisor’s Alpha


https://www.vanguard.com/pdf/ISGQVAA.pdf
WHY DO FINANCIAL ADVISORS CHARGE SO MUCH?
• A financial advisor has a very small client
base, typically between 50 - 75 clients.


• A financial advisor has to cover high fixed
costs (expensive office) and high variable
costs (their salary & support team)


• If an advisor wants to make $100,000, and
their business has overhead of $100,000,
they need $4,000 per client per year, just to
break even.


• The higher quality the advisor, the larger
that problem becomes.


• Solution: high minimums, high fees, hidden
product placement kickbacks / commissions.
TYPES OF GOALS
e.g. build an emergency fund, retire
WHAT ARE FINANCIAL GOALS?
• Any goal with significant financial
requirements (assets / income)


• Time frame matters.


Short-term, medium-term, long-term,
indeterminate & conditional goals.


• Examples


• Emergency Fund


• Get out of Debt


• Buy a car


• Buy a house


• Start a business


• College


• Retirement
* http://brokegirlrich.com/doin-it-by-the-decade-the-wealthy-barber-review/
HOW TO PROJECT SAVINGS GOING FORWARD?
• Cash accounts, assume FDIC rates for
the appropriate time frame.


• For diversified portfolio, use historical
rates of return, adjusted for inflation.


• Inflation can be estimated from the
difference from US Treasuries to TIPS.
(currently about 2.6%)


• Simple method: assume annual rate,
divide by 12 for monthly, build out
projection month by month.


• More sophisticated: Monte Carlo uses
statistical projection to estimate a
huge number of potential outcomes,
and assign probabilities.
SIMPLE GOAL: EMERGENCY FUND
• One of the most important short
term goals.


• Priority: Liquidity & Safety


• Typical target: 3-6 months of
expenses, in an FDIC-insured bank
account.


• Simple projection: monthly savings x
number of months.


• Example: $12,000 emergency fund
might require $1,000 in savings per
month for a year.
MORE COMPLEX GOAL: HOUSE
• US Census: 65.4% homeownership rate


(as of Q3 2021)


• Two key components: down payment & income
requirement (cash flow)


• Down payment typically 20%. For $1M house, that’s
$200K. Plus closing costs.


• Common debt / income ratio for banks is 36% (pre-
tax). In high cost areas, might stretch to 40% or more.


• Do you have flexible timeline? If so, you likely can
afford some level of market risk. If not, stick to cash.


• Houses dramatically lower liquidity (hard to get $ out)
and mobility (relocation for work)


• Long term track record for real estate is positive:
combination of beating inflation & leveraged
investment.
MORE COMPLEX GOAL: COLLEGE
• Very expensive goal. Wealthfront estimates
that sending my son to Stanford in 2027
will cost $358,942. Inflation adjusted!


• College costs have increased faster than
inflation (Wealthfront uses 1.1% faster than
inflation as the long term trend)


• Limited time frame. You have 40-50 years
for retirement. 18 years is not a lot of time
for compounding to become significant.


• 529 College Savings Plans have significant
tax advantages, at the cost of liquidity.


• Layered planning for multiple children
rewards over-saving early.
COMPLEX: RETIREMENT
• Extremely complicated goal.


• Four interrelated problems


• Projecting income for 40+ years


• Replacing income for 30+ years


• Tax efficiency


• Planning for multiple people


• Long term asset allocation


(diversified portfolio)


• Asset location


(where to put which investments)


• Tax-deferred accounts


401(k), IRA, Roth IRA, etc.


• Beware of the life insurance charlatans
COMPLEX: RETIREMENT
• Projecting Income


Can use wage inflation as a proxy


• Replacing Income


Can use the “4% rule” as a first
approximation


• Tax Efficiency


Leverage tax-deferred accounts, like 401(k)
plans. Roth accounts have significant
advantages for some high income savers.


• Family Planning


Ensure you know the retirement plans of
each partner, and have estimated timing for
major expenses for children. Look at total
household income & assets collectively.
COUPLES
how financial planning changes with a partner
PLANNING FOR TWO (OR MORE)
• Financial planning is difficult.
Requires projecting the future &
prioritizing choices


• Exponentially harder with couples,
because of different timelines,
priorities & possibilities.


• Key issues include communication,
transparency, relationship & values.


• Money & related issues are some
of the most common reasons
relationships fail.
COUPLES: BUDGETS & SPENDING
• How to manage budgeting / spending with
two people?


• One account approach: one joint account, fully
shared.


• Two account approach: separate accounts,
coordination on bill paying.


• Three account approach: two personal
accounts & one joint account.


• None of these tactics solve the core problem:
communication & values.


• “magic” number for size of expense to discuss


• Warning: Joint liability for credit is a serious
commitment. Not to be taken lightly.
JOINT ACCOUNT
PERSONAL 1 PERSONAL 2
PERSONAL
SPENDING
PERSONAL
SPENDING
COMMON


BILL
JOINT


SAVINGS
JOINT
INVESTMENTS
COMMON


BILL
COMMON


BILL
COMMON


BILL
401K / IRA 401K / IRA
COUPLES: SAVING & INVESTING
• Retirement accounts (401k & IRA) are
individual.


• Brokerage accounts can be individual or
joint. Equity compensation is individual.


• Social security can be individual or joint,
depends on how you claim.


• Varying incomes, careers, time lines and
complicate savings rates.


• Quality of benefits at different companies
can vary significantly (e.g. Google 401(k) vs.
a startup 401(k))


• Likely needs to be revisited as situations
adapt / change.
JOINT ACCOUNT
PERSONAL 1 PERSONAL 2
PERSONAL
SPENDING
PERSONAL
SPENDING
COMMON


BILL
JOINT


SAVINGS
JOINT
INVESTMENTS
COMMON


BILL
COMMON


BILL
COMMON


BILL
401K / IRA 401K / IRA
LIFE INSURANCE
how does it work? when does it make sense?
LIFE INSURANCE: WHY DOES IT EXIST?
• Death Insurance


• There are costs associated with death.


• People with dependents need a way to provide
for them after death.


• Retirement plans often take decades to
execute. Life insurance can replace income that
was never received due to death.


• There is a fundamental economic benefit to
pooling risk around uncertainty. When a person
will die is the original actuarial case for adding
value this way.


• Life insurance has several tax benefits. The
owner is not taxed on the potential benefit size,
and the beneficiary is not taxes on receipt.
LIFE INSURANCE: WHAT TYPES ARE THERE?
• Term Life Insurance is the plain vanilla variety. You pay
monthly for a time period to ensure payment to a
beneficiary if you die. Payout can be level or decreasing.


• Whole Life Insurance provides a death benefit no matter
how old you are. AKA “permanent” life insurance.


• Universal Life Insurance is similar to whole, but with
greater flexibility to change death benefit & cash value.


• Variable Life Insurance has fixed premiums and death
benefit can increase based on rate of return of the cash
value.


• Every combination you can imagine has been tried. This
is a $2 Trillion industry in the US.


• High expenses & fees, with punitive clauses for exiting
agreements makes life insurance a poor financial product
choice for long term investment. Stick with term life
insurance.
LIFE
INSURANCE
TERM PERMANENT
LEVEL VARIABLE
UNIVERSAL
WHOLE
DECREASING
LIFE INSURANCE: HOW MUCH DO YOU NEED?
• Think of costs associated with death.


• Think of dependents and expenses that
require your income for funding.


House. College. Retirement.


• Think about the time frame before you will
have accumulated the assets to pay those
costs out of pockets.


• Costs are non-linear because probability of
dying increases with age. 30 year policy is
not just 3x a 10 year policy.


• Very inexpensive for young people.


• Typically purchased at marriage or during
planning for a child.
*
QUESTIONS
CS 007

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Stanford CS 007-08 (2021): Personal Finance for Engineers / Financial Planning & Goals

  • 3. PLANNING how to set financial goals and meet them
  • 4. WHAT IS A FINANCIAL PLAN? • Comprehensive evaluation of current & future financial state. • “The process of determining whether and how an individual can meet life goals through the proper management of financial resources” 
 — CFP Board • Cash flow, assets, withdrawals. • Key components • Net Worth • Cash Flow Analysis • Retirement Strategy • Risks / Insurance • Investment Strategy • Tax Strategy • Estate Plan
  • 5. WHY IS FINANCIAL PLANNING NEEDED? • People tend to spend more than they need to, if they lack sufficient motivation for saving. • Short term rewards vs. Long term payoff. Need time to build assets. • Making a financial plan explicit increases likelihood of success • Extremely important when more than one person involved (couples / families)
  • 6. WHAT ARE FINANCIAL ADVISORS? • Term can be used by anyone. Be extremely wary. • Two accreditations are well respected: 
 CFP & CFA. • Most have a very high variable cost (1%+) and high minimums ($1M+) • There is evidence that financial planners significantly help people avoid behavioral errors. Vanguard estimates that value at 150 bps! * • Communication about money is often dysfunctional for couples. Financial advisors force transparency & joint planning, which is essential. • Industry is rife with conflict of interest & high commissions. • Will likely be disrupted by personalized, data- driven automated solutions over the next 10 years. * Quantifying Vanguard Advisor’s Alpha 
 https://www.vanguard.com/pdf/ISGQVAA.pdf
  • 7. WHY DO FINANCIAL ADVISORS CHARGE SO MUCH? • A financial advisor has a very small client base, typically between 50 - 75 clients. • A financial advisor has to cover high fixed costs (expensive office) and high variable costs (their salary & support team) • If an advisor wants to make $100,000, and their business has overhead of $100,000, they need $4,000 per client per year, just to break even. • The higher quality the advisor, the larger that problem becomes. • Solution: high minimums, high fees, hidden product placement kickbacks / commissions.
  • 8. TYPES OF GOALS e.g. build an emergency fund, retire
  • 9. WHAT ARE FINANCIAL GOALS? • Any goal with significant financial requirements (assets / income) • Time frame matters. 
 Short-term, medium-term, long-term, indeterminate & conditional goals. • Examples • Emergency Fund • Get out of Debt • Buy a car • Buy a house • Start a business • College • Retirement * http://brokegirlrich.com/doin-it-by-the-decade-the-wealthy-barber-review/
  • 10. HOW TO PROJECT SAVINGS GOING FORWARD? • Cash accounts, assume FDIC rates for the appropriate time frame. • For diversified portfolio, use historical rates of return, adjusted for inflation. • Inflation can be estimated from the difference from US Treasuries to TIPS. (currently about 2.6%) • Simple method: assume annual rate, divide by 12 for monthly, build out projection month by month. • More sophisticated: Monte Carlo uses statistical projection to estimate a huge number of potential outcomes, and assign probabilities.
  • 11. SIMPLE GOAL: EMERGENCY FUND • One of the most important short term goals. • Priority: Liquidity & Safety • Typical target: 3-6 months of expenses, in an FDIC-insured bank account. • Simple projection: monthly savings x number of months. • Example: $12,000 emergency fund might require $1,000 in savings per month for a year.
  • 12. MORE COMPLEX GOAL: HOUSE • US Census: 65.4% homeownership rate 
 (as of Q3 2021) • Two key components: down payment & income requirement (cash flow) • Down payment typically 20%. For $1M house, that’s $200K. Plus closing costs. • Common debt / income ratio for banks is 36% (pre- tax). In high cost areas, might stretch to 40% or more. • Do you have flexible timeline? If so, you likely can afford some level of market risk. If not, stick to cash. • Houses dramatically lower liquidity (hard to get $ out) and mobility (relocation for work) • Long term track record for real estate is positive: combination of beating inflation & leveraged investment.
  • 13. MORE COMPLEX GOAL: COLLEGE • Very expensive goal. Wealthfront estimates that sending my son to Stanford in 2027 will cost $358,942. Inflation adjusted! • College costs have increased faster than inflation (Wealthfront uses 1.1% faster than inflation as the long term trend) • Limited time frame. You have 40-50 years for retirement. 18 years is not a lot of time for compounding to become significant. • 529 College Savings Plans have significant tax advantages, at the cost of liquidity. • Layered planning for multiple children rewards over-saving early.
  • 14. COMPLEX: RETIREMENT • Extremely complicated goal. • Four interrelated problems • Projecting income for 40+ years • Replacing income for 30+ years • Tax efficiency • Planning for multiple people • Long term asset allocation 
 (diversified portfolio) • Asset location 
 (where to put which investments) • Tax-deferred accounts 
 401(k), IRA, Roth IRA, etc. • Beware of the life insurance charlatans
  • 15. COMPLEX: RETIREMENT • Projecting Income 
 Can use wage inflation as a proxy • Replacing Income 
 Can use the “4% rule” as a first approximation • Tax Efficiency 
 Leverage tax-deferred accounts, like 401(k) plans. Roth accounts have significant advantages for some high income savers. • Family Planning 
 Ensure you know the retirement plans of each partner, and have estimated timing for major expenses for children. Look at total household income & assets collectively.
  • 16. COUPLES how financial planning changes with a partner
  • 17. PLANNING FOR TWO (OR MORE) • Financial planning is difficult. Requires projecting the future & prioritizing choices • Exponentially harder with couples, because of different timelines, priorities & possibilities. • Key issues include communication, transparency, relationship & values. • Money & related issues are some of the most common reasons relationships fail.
  • 18. COUPLES: BUDGETS & SPENDING • How to manage budgeting / spending with two people? • One account approach: one joint account, fully shared. • Two account approach: separate accounts, coordination on bill paying. • Three account approach: two personal accounts & one joint account. • None of these tactics solve the core problem: communication & values. • “magic” number for size of expense to discuss • Warning: Joint liability for credit is a serious commitment. Not to be taken lightly. JOINT ACCOUNT PERSONAL 1 PERSONAL 2 PERSONAL SPENDING PERSONAL SPENDING COMMON 
 BILL JOINT 
 SAVINGS JOINT INVESTMENTS COMMON 
 BILL COMMON 
 BILL COMMON 
 BILL 401K / IRA 401K / IRA
  • 19. COUPLES: SAVING & INVESTING • Retirement accounts (401k & IRA) are individual. • Brokerage accounts can be individual or joint. Equity compensation is individual. • Social security can be individual or joint, depends on how you claim. • Varying incomes, careers, time lines and complicate savings rates. • Quality of benefits at different companies can vary significantly (e.g. Google 401(k) vs. a startup 401(k)) • Likely needs to be revisited as situations adapt / change. JOINT ACCOUNT PERSONAL 1 PERSONAL 2 PERSONAL SPENDING PERSONAL SPENDING COMMON 
 BILL JOINT 
 SAVINGS JOINT INVESTMENTS COMMON 
 BILL COMMON 
 BILL COMMON 
 BILL 401K / IRA 401K / IRA
  • 20. LIFE INSURANCE how does it work? when does it make sense?
  • 21. LIFE INSURANCE: WHY DOES IT EXIST? • Death Insurance • There are costs associated with death. • People with dependents need a way to provide for them after death. • Retirement plans often take decades to execute. Life insurance can replace income that was never received due to death. • There is a fundamental economic benefit to pooling risk around uncertainty. When a person will die is the original actuarial case for adding value this way. • Life insurance has several tax benefits. The owner is not taxed on the potential benefit size, and the beneficiary is not taxes on receipt.
  • 22. LIFE INSURANCE: WHAT TYPES ARE THERE? • Term Life Insurance is the plain vanilla variety. You pay monthly for a time period to ensure payment to a beneficiary if you die. Payout can be level or decreasing. • Whole Life Insurance provides a death benefit no matter how old you are. AKA “permanent” life insurance. • Universal Life Insurance is similar to whole, but with greater flexibility to change death benefit & cash value. • Variable Life Insurance has fixed premiums and death benefit can increase based on rate of return of the cash value. • Every combination you can imagine has been tried. This is a $2 Trillion industry in the US. • High expenses & fees, with punitive clauses for exiting agreements makes life insurance a poor financial product choice for long term investment. Stick with term life insurance. LIFE INSURANCE TERM PERMANENT LEVEL VARIABLE UNIVERSAL WHOLE DECREASING
  • 23. LIFE INSURANCE: HOW MUCH DO YOU NEED? • Think of costs associated with death. • Think of dependents and expenses that require your income for funding. 
 House. College. Retirement. • Think about the time frame before you will have accumulated the assets to pay those costs out of pockets. • Costs are non-linear because probability of dying increases with age. 30 year policy is not just 3x a 10 year policy. • Very inexpensive for young people. • Typically purchased at marriage or during planning for a child. *