Download Chapter 1 - The Financial Planning Process

The Financial
Planning
Process
Learning Objectives
1. Explain why personal financial planning is
so important.
2. Describe the five basic steps of personal
financial planning.
3. Set your financial goals.
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Learning Objectives
4. Explain how career management and
education can determine your income
level.
5. List ten principles of personal finance.
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Introduction
 It’s easier to spend than to save.
 Personal financial planning is an ongoing
process—it changes as your financial
situation and position in life change.
 Manage and control your finances with a
personal financial plan.
 It helps you achieve financial and lifestyle
goals.
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Importance of Personal Financial
Planning
 Accumulate wealth for special expenses
 Save for retirement
 “Cover your assets”
 Invest intelligently
 Minimize payments to Uncle Sam
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Five basic steps to personal
financial planning
1. Evaluate your financial health
2. Define your financial goals
3. Develop a plan of action
4. Implement your plan
5. Review your progress, reevaluate, and revise
your plan
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Step 1: Evaluate Your Financial
Health
 Examine your current financial situation.
 How much money do you make?
 How much are you spending and on what?
 Use careful record keeping to track
finances and spending.
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Step 2: Define Your Financial
Goals
 Write or formalize them
 Attach a financial cost to each one.
 When will you need the money to
achieve the goal?
 Analyze and revise your goals.
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Step 3: Develop a Plan of Action
 Flexibility:
 Plan for life changes and the unexpected.
 Liquidity
 Immediate use of cash by quickly and easily
converting an asset.
 Protection
 Prepare for the unexpected with insurance.
 Minimize Taxes
 Keep more of what you earn.
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Step 4: Implement Your Plan
 Stick to it.
 Use your financial plan as a road map
to achieve goals.
 Keep goals in mind and work towards
them.
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Step 5: Review, Reevaluate,
and Revise
 Review progress
 Reevaluate and revise for changes in
your life
 Be prepared to formulate a different
plan to meet your goals.
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Figure 1.1
The Budgeting and Planning Process
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Short-term -- within 1 year
Intermediate-term -- 1 to 10 years
Long-term -- more than 10 years
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Short–Term Goals
 Accumulate Emergency Funds
Equaling 3 Months’ Living Expenses
 Pay Off Bills and Credit Cards
 Purchase Insurance
 Purchase a Major Item
 Finance a Vacation
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Intermediate-Term Goals
 Save for Older Child’s College
 Save for a Down Payment
 Pay Off Major Debt
 Finance Large Items (Weddings)
 Purchase a Vacation Home
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Long-Term Goals
 Save for Younger Child’s College
 Purchase Retirement Home
 Create a Retirement Fund to Maintain
Current Standard of Living
 Take Care of Elderly Family Members
 Start a Business
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Figure 1.2
Personal Financial Goals Worksheet
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Figure 1.3
A Typical Individual’s Financial Life Cycle
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Stage 1 The Early Years—A
Time of Wealth Accumulation
 Prior to age 54
 Develop a regular savings pattern:
 How much can be saved?
 Is that enough?
 Where should the savings be invested?
 Cost of raising children
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Table 1.1
The Cost of Raising a Child
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Stage 2 Approaching
Retirement—The Golden Years
 Transition years between ages 55-64.
 Depends on preparation for retirement.
 Reassess financial goals and decisions—
retirement, insurance protection and
estate planning.
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Stage 3 The Retirement Years
 After age 65, live off savings
 Retirement age depends on savings.
 Less risky investment strategy
 Consider extended nursing home protection.
 Estate planning decisions and documents
are critical.
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A series of positions to show your skills.
Is the job important, enjoyable, and
satisfying?
Does it provide for your desired lifestyle?
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Figure 1.4
Job Search Worksheet
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Figure 1.4
Job Search Worksheet
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Figure 1.4
Job Search Worksheet
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Choosing a Major and a Career
 Effective self-assessment
 Interests, skills, values, personal traits
 Desired lifestyle
 Research career alternatives and match
with your skills and interests
 Research potential earnings
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Table 1.2
What Different College Majors Earn
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Getting a Job
 Start early
 Prepare and practice for interviews
 Research the company
 Dress appropriately, be confident,
and follow-up
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Table 1.3
Most Common Interview Questions
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Being Successful in Your Career
 Do good work.
 Project the right image.
 Understand and work within the power
structure.
 Gain visibility.
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Being Successful in Your Career
 Take new assignments.
 Acquire new skills and keep up with
technology.
 Develop a strong network.
 Be ethical.
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What Determines Your Income?
 Skills
 Education
 The wealthy are married
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Figure 1.5
Education and Earnings
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The foundation of personal finance.
Principle 1: The Best Protection
Is Knowledge
 Understand the basics of personal
finance.
 Take responsibility for your lifetime
financial plan.
 Seek professional advice wisely.
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Principle 2: Nothing Happens
Without a Plan
 Easier to think about spending than
about saving.
 Saving must be planned.
 Putting off a financial plan means
goals are harder to achieve.
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Principle 3: The Time
Value of Money
 Money received today is worth more than
money received in the future.
 Understand how savings and investments
grow over time
 Understand compound interest.
 Understand spending now and paying later
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Table 1.4 Importance of Starting Early—Just Do
It!—to Accumulate $1 Million by Age 67 Investing
Your Money at 12%
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Principle 4: Taxes Affect
Personal Finance Decisions
 Know the effect of taxes on the rate of
return of investments
 Compare investment alternatives on an
after-tax basis.
 Understand tax laws.
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Principle 5: Stuff Happens,
or the Importance of Liquidity
 Plan for unexpected events
 Have money or liquid funds available
 Liquid funds should cover 3 to 6 months of
living expenses
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Principle 6: Waste Not, Want
Not - Smart Spending Matters
 Differentiate want from need
 Do homework before the purchase
 Make the purchase at the best price
 Maintain your purchase
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Principle 7: Protect Yourself
Against Major Catastrophes
 Have the right kind of insurance before a
tragedy occurs.
 Know your insurance policy coverage.
 Focus insurance on major catastrophes
which can be financially devastating.
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Principle 8: The Risk and
Return Go Hand in Hand
 Saving and investing grows money.
 Investors demand a minimum return
above anticipated inflation.
 Investors demand higher return for added
risk.
 Diversification by spreading money in
several investments reduces risk
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Figure 1.6
The Risk-Return Trade-Off
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Principle 9: Mind Games and
Your Money
 Behavioral biases lead to big financial
mistakes.
 Mental accounting impacts financial
decisions.
 “Sunk cost effect” pours good money after
bad money because of bias.
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Principle 10: Just Do It!
 Taking the first step towards your goals is
difficult.
 The following steps become easier.
 First step is to pay yourself first—save
then spend.
 Saving early can make a big difference.
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Summary
 Personal financial planning allows you to
manage your finances and achieve lifecycle
financial goals.
 There are five basic steps to personal
financial planning.
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Summary
 Set your financial goals in order to achieve
them with a financial plan.
 The more educated your are, the more you
will earn.
 There are ten basic principles on which
personal financial planning is built.
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