Download Planning Your Financial Future

An Overview of
Personal Finance
Chapter 1
Planning Your Financial Future, 4e
by: Boone, Kurtz & Hearth
The Meaning and Importance
of Personal Finance
 Can improve your standard of living
 Today’s environment has impacted personal
finance over the years

Sluggish growth in personal income
 After adjusting for inflation and taxes, personal income growth
has only been about 2% a year for the last two decades

Changes in the labor market
 Most people starting jobs today will work at
numerous companies during their career(s)

More options
 Many more options available today in investments, retirement
planning, banking, etc.
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Personal Financial Planning—A
Lifelong Activity
 No matter how old you are, you’ll have
financial goals
 What works when you’re 20, won’t
necessarily work when you’re 40
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In your 20s, your goals may be paying off
student loans or buying your first house
In your 70s, your goal may be making sure your
retirement funds last your lifetime
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Personal Financial Toolbox
 Once you graduate from college (and now
have a ‘real’ job)

Figure out your current financial standing
 How much do you owe?
 What assets do you have?
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Prepare an income statement and balance sheet
Put yourself on a budget
Insure yourself against financial ruin
 Life, health, property
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Personal Financial Toolbox
 Get your debts under control (if
already)

they’re not
Pay off high-rate loans (or roll over into lower-rate
loans)
 Start saving for retirement
 Set up a regular savings program (pay yourself)

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Have money automatically transferred from checking to
savings
Treat this like a fixed expense
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Getting Professional Help
 Many colleges & universities offer credit
counseling
 May use services of a CPA or professional
investment advisor
 Dozens of financial self-help books
 Online financial information is available
 If you use a financial planner, make sure
they are qualified
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Web Links
 http://www.moneycentral.com
 http://www.quicken.com
 http://www.motleyfool.com
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A Personal Financial
Management Model
 A financial plan is a guide to help you reach
your targeted future goals

Step 1: Develop short and long-term goals
 Influenced by your personal values & current
financial situation


Step 2: Establish financial strategies
Step 3: Put plan in action & monitor
performance
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General Themes Common to
All Financial Plans
 Maximizing income and wealth

The amount of money you earn is a vital part of any
plan
 Using money more effectively

Spend (and save) your money wisely
 Little things add up
 Monitoring expenditures


Use a budget to help control expenditures
The more you know about loans, investments, etc., the
more likely you are to make a good decision
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Pitfalls of Poor Financial
Planning
 Missed or late payments will be noticed

Creditors may:
 Repossess your property
 Garnish your wages
 Force you to file for personal bankruptcy

A bad credit record can last for years
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Setting Personal Goals
 Your values will influence your financial goals

What things in life are important to you?
 Your financial goals are influenced by your current
financial situation

Prepare current financial statements
 Review them to determine what you own, what you owe, &
where you’re spending your money


Prepare a budget
Prepare a list of short- and long-term goals
 Make sure they are realistic and obtainable

Write down your goals and periodically review them
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Your Personal Financial
Decisions
 Career choice

Most of your income comes from salaries/wages – determines your
lifestyle
 Basic money management

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Prepare a budget
Select the right bank
Establish a regular savings plan
 Credit management
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Don’t bite off more than you can chew
Find a good credit card
Learn how to compute interest charges/monthly payments
Find out your credit history (report)
Learn what to do if you get into trouble
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Your Personal Financial
Decisions
 Tax planning

How can you reduce your taxes?
 Effective buying

Real estate, cars, etc.
 Renting vs. owning
 Insurance

How much insurance should you have (if any)?
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Life
Health
Property
Disability
Liability
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Your Personal Financial
Decisions
 Investment management

Invest to increase your future wealth
 Difficult to substantially increase future wealth without
investing

Investments are risky, choices include:

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Mutual funds
Stocks
Bonds
Options and futures
Real estate
Art
Coins
Metals (gold, silver, etc.)
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Financial Planning for Tomorrow
 Planning for your children’s college education

Becoming more and more expensive
 Retirement planning
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How do you want to live your retirement?
How much (if any) do you want to pass along to your
heirs?
How long remains until you retire?
Will Social Security be enough?
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External Factors
 Government policy

Changes to federal student loan programs
 Will costs of student loans increase due to loan
consolidation limits?

Social Security reform
 Will it be privatized?
 Will benefits be reduced?
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External Factors
 Economic conditions

The business cycle
 Shorter-term sequences of expansions and contractions
(recession)

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Typical business cycle has four stages: prosperity, decline,
recession, and recovery
Gross domestic product
 Represents the total value of goods and services produced by a
nation’s economy

Important determinant of personal income
 Disposable personal income – what remains after income
taxes
 Discretionary personal income – what remains after all
necessary living expenses have been paid
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External Factors

Unemployment rate
 The percentage of the workforce currently looking for a job

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Inversely related to economic activity
Inflation
 Inflation decreases the purchasing power of the dollar
 Inflation has been about 3% in recent years
 Income sources with cost-of-living increases are tied to inflation

Interest rates
 If you think interest rates are going to rise sharply, buy that house/car
now instead of waiting
 Interest rates are tied to inflation
 Nominal interest rates are those that you pay or receive, whereas real
interest rates are nominal rates less the rate of inflation

For instance, if a six-month CD pays a 5% nominal rate, but inflation is
2%, then you are earning a real rate of 3%
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External Factors
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Government policy and economic activity
 Government influences economy
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If taxes increase and government spending remains
unchanged, economic growth will slow
Federal Reserve Board can increase or decrease the supply
of money
 Impacts interest rates, inflation, and economic growth
Recession/Expansion
 If you think a recession is in the near future, save
more now (in case you get laid off)
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Figure 1.5: Change in Real GDP
Source: Based on data from the Federal Reserve Board and the Statistical Abstract of the United States.
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Figure 1.6: Breakdown of
Personal Income
Source: Based on data from the Federal Reserve Board and the Statistical Abstract of the United States.
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The Time Value of Money
 Why money has time value
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Risk of not getting your money back
Risk of inflation
Opportunity cost
 You have to give up something when you invest (you
can’t use the money for something else)
 Because money has time value you should
expect to earn interest on an investment
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Future Value
 Value at some point in the future of
a current sum
of money

If you invest $1,000 in an account and it earns 6%, after
one year you will have $1,060
 $1,000 × 0.06 = $60 interest + $1,000 beginning amount

After two years, the $1,000 investment would be worth
 $1,060 × 0.06 = $63.60 interest + $1,060 = $1,123.60
 Or, $1,000 × 1.062 = $1,123.60
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Future Value
 Compound interest

Payment of interest on interest
 Simple interest
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Interest on the original deposit only
 Multiple cash flows

An annuity is a series of cash payments or
receipts
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Present Value
 The value today of
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a future sum of money
A dollar received tomorrow is worth less than a
dollar today
Finding present value is called discounting
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