Download 21. Integrating the Components of a Financial Plan

Personal Finance
SIXTH EDITION
Chapter 21
Estate
Planning
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Chapter Objectives
21.1 Review the components of a financial plan
21.2 Illustrate how a financial plan’s components
are integrated
21.3 Provide an example of a financial plan
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Review of Components Within a
Financial Plan (1 of 8)
• Budgeting
– Allows you to forecast how much money you will have
at the end of the month so you can anticipate cash
shortages or surpluses
– Budgeting trade-off
 A trade-off between spending today and allocating funds for
the future
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Review of Components Within a
Financial Plan (2 of 8)
 Biggest problem is excessive spending
 Financial planning involves decisions about how much money
to allocate for liquidity, insurance, investments, and retirement
planning
 Overspending on cars is common error
 Many spend now and think about saving later
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Review of Components Within a
Financial Plan (3 of 8)
• Managing Liquidity
– Ensuring that you have enough liquid assets to cover
any budget deficits
 Checking account, savings account, money market, or shortterm financing
– Liquidity trade-off
 A trade-off between liquid assets which earn low interest rates
and non-liquid assets which earn higher interest rates
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Review of Components Within a
Financial Plan (4 of 8)
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Review of Components Within a
Financial Plan (5 of 8)
• Personal financing
– Allows you to make purchases without having the full
amount of cash
 Useful for large purchases like a car or a home
– Personal financing tradeoff
 Trade-off between tax advantages of mortgage loans with
potential budgeting problems
 Trade-off between longer maturities with lower payments and
more interest and shorter maturities with higher payments and
less interest
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Review of Components Within a
Financial Plan (6 of 8)
• Protecting your assets and income
– Insurance protects against events that could reduce
your income or your wealth
– Insurance trade-off
 Insurance needs come before investing
• Managing investments
– Making investment choices that meet your financial
needs and your risk tolerance
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Review of Components Within a
Financial Plan (7 of 8)
– Investment trade-off
 Trade-off between low risk, low interest investments and high
risk, high interest investments
 Trade-off between high risk, single investments and lower risk,
diversified investments
 Trade-off between using money now and investing it for the
future
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Review of Components Within a
Financial Plan (8 of 8)
• Retirement planning
– Ensures sufficient funds at the time you retire
– Retirement account trade-off
 Saving for retirement limits current spending
• Maintaining your financial documents
– You should store all financial documents in one place,
either a safe at home or a safety deposit box at a bank
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Financial Planning Online (1 of 2)
• Go to http://www.kiplinger.com
• This Web site provides useful information about
financial planning that can help you complete and
refine your financial plan.
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Integrating the Components
• As time passes, your financial position will change
• Your financial goals may also change
• You will need to revise your financial plan to meet
your financial goals
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Exhibit 21.2 Documents Used for
Financial Planning (1 of 2)
EXHIBIT 21.2 Documents Used for Financial Planning
Liquidity
• Certificates of deposit
• Bank account balances
• Any other money market securities owned
Financing
• Credit card account numbers
• Credit card balances
• Personal loan (such as car loan) agreements
• Mortgage loan agreement
Insurance
• Insurance policies
• Home inventory of items covered by homeowner’s insurance
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Exhibit 21.2 Documents Used for
Financial Planning (2 of 2)
EXHIBIT 21.2 Documents Used for Financial Planning
Investments
• Stock certificates
• Bonds
• Account balance showing the market value of stocks
• Account balance showing the market value of bonds
• Account balance showing the market value of mutual funds
Retirement and Estate Plans
• Retirement plan contracts
• Retirement account balances
• Will
• Trust agreements
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Exhibit 21.3 Update on Stephanie
Spratt’s Personal Balance Sheet (1 of 2)
EXHIBIT 21.3 Update on Stephanie Spratt’s Personal Balance Sheet
Initial Personal Balance Sheet
(from Chapter 2)
As of Today
Assets
Liquid Assets
Cash
$500
$200
Checking account
3,500
200
0
2,600
$4,000
$3,000
$0
$108,000
Car
1,000
15,000
Furniture
1,000
1,000
$2,000
$124,000
Money market fund (MMF)
Total liquid assets
Household Assets
Home
Total household assets
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Exhibit 21.3 Update on Stephanie
Spratt’s Personal Balance Sheet (2 of 2)
EXHIBIT 21.3 Update on Stephanie Spratt’s Personal Balance Sheet
Investment Assets
Stocks
$3,000
$3,200
Mutual funds
0
2,000
Investment in retirement account
0
800
Total investment assets
$3,000
$6,000
TOTAL ASSETS
$9,000
$130,000
Credit card balance
$2,000
$0
Total current liabilities
$2,000
$0
Car loan
$0
$17,000
Mortgage
0
100,000
$0
$117,000
TOTAL LIABILITIES
$2,000
$117,000
Net Worth
$7,000
$13,000
Liabilities and Net Worth
Current Liabilities
Long-Term Liabilities
Total long-term liabilities
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Exhibit 21.4 Update on Stephanie Spratt’s
Monthly Cash Flow Statement (1 of 2)
EXHIBIT 21.4 Update on Stephanie Spratt’s Monthly Cash Flow Statement
Initial Cash Flow
Statement
Most Recent
Cash Flow Statement
Change in the
Cash Flow Statement
Cash Inflows
Disposable (after-tax)
income
$2,500
$3,000
+$500
Interest on deposits
0
0
No change
Dividend payments
0
0
No change
$2,500
$3,000
+$500
$600
$0
– $600
Internet
50
50
No change
Electricity and water
60
80
+20
Cellular
60
60
No change
Groceries
300
300
No change
Health and disability
insurance and expenses
130
140
+10
Total cash inflows
Cash Outflows
Rent
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Exhibit 21.4 Update on Stephanie Spratt’s
Monthly Cash Flow Statement (2 of 2)
EXHIBIT 21.4 Update on Stephanie Spratt’s Monthly Cash Flow Statement
Initial Cash Flow
Statement
Most Recent
Cash Flow Statement
Change in the
Cash Flow Statement
Cash Outflows
Clothing
100
100
No change
Car insurance and maintenance
200
100
–100
Recreation
600
400
–200
Car loan payment
0
412
+412
Mortgage payment (includes
property taxes and insurance)
0
966
+966
Life insurance payment
0
10
+10
Contribution to retirement plan
0
300
+300
$2,100
$2,918
+$818
$400
$82
–$318
Total cash outflows
Net cash flows
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Exhibit 21.5 Stephanie Spratt’s Financial
Plan (1 of 5)
EXHIBIT 21.5 Stephanie Spratt’s Financial Plan
BUDGET PLAN
My monthly salary of $3,000 after taxes is direct deposited to my checking
account. I will use this account to cover all bills and other expenses. My total
expenses (including recreation) should be about $2,918 per month. This leaves
me with net cash flows of $82. I will also receive an annual tax refund of about
$3,000. The taxes I pay during the year will exceed my tax liability, as the interest
payments on my mortgage will reduce my taxable income.
I will use the net cash flows each month to cover any unanticipated expenses
that occurred during the month. My second priority is to use the net cash flows to
keep about $2,600 in my money market fund (MMF) to ensure liquidity. If this
fund is already at that level, I will use the net cash flows each month to invest in a
mutual fund.
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Exhibit 21.5 Stephanie Spratt’s Financial
Plan (2 of 5)
EXHIBIT 21.5 Stephanie Spratt’s Financial Plan
PLAN FOR MANAGING LIQUIDITY
Since my salary is direct deposited to my checking account, I have a convenient
means of covering my expenses. My backup source of liquidity is my MMF, which
currently contains $2,600; I will maintain the account balance at about that level
to ensure liquidity. If I ever need more money than is in this account, I could rely
on my net cash flows. In addition, I could sell some shares of my mutual fund, or I
could cover some expenses with a credit card, and would hope to use part of my
next paycheck to pay off the credit card bill.
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Exhibit 21.5 Stephanie Spratt’s Financial
Plan (3 of 5)
EXHIBIT 21.5 Stephanie Spratt’s Financial Plan
PLAN FOR FINANCING
I have two finance payments: a monthly car loan payment of $412, and a monthly
mortgage payment of $966 (including property taxes and homeowner’s
insurance). I would like to pay off the car loan early if possible. The interest rate
on that loan is 7.60%, and the interest is not tax-deductible. The principal
remaining on the car loan will decrease over time as I pay down the debt with my
monthly payments.
I may consider selling my shares of the mutual fund and using the proceeds to
pay off part of the car loan. My decision will depend on whether I believe the
mutual fund can provide a higher return to me than the cost of the car loan.
When I pay off the car loan, my cash outflows will be reduced by $412 per month.
Thus, I should have more net cash flows that I can use to make investments and
increase contributions to my retirement account.
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Exhibit 21.5 Stephanie Spratt’s Financial
Plan (4 of 5)
EXHIBIT 21.5 Stephanie Spratt’s Financial Plan
INSURANCE PLAN
I have car insurance that covers the car and limits my liability. I have
homeowner’s insurance that covers the full market value of my home. I have
health insurance through my employer. I have disability insurance that will provide
financial support if I become disabled. I have life insurance, with my two nieces
named as the beneficiaries. If I decide to have children in the future, I will
purchase additional life insurance in which they would be named as the
beneficiaries.
PLAN FOR INVESTING
I have an individual stock that I plan to sell, and I will use the proceeds to invest in
a stock mutual fund. This creates more diversification and reduces my exposure
to risk.
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Exhibit 21.5 Stephanie Spratt’s Financial
Plan (5 of 5)
EXHIBIT 21.5 Stephanie Spratt’s Financial Plan
RETIREMENT AND ESTATE PLAN
I would like to allocate an additional $100 per month toward an individual
retirement account (IRA) as I expect that it would increase my retirement fund by
an estimated $185,710 at the time of my expected retirement. However, I am not
likely to have an extra $100 each month that I could contribute to an IRA at this
time. I will contribute even more income to my retirement (up to the maximum
limit allowed) as my income increases over time.
I will also create a will to ensure that any wealth that I have accumulated is
allocated in the manner that I desire.
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Financial Planning Online (2 of 2)
• Go to the personal finance section of
http://www.cnn.com
• This Web site provides a variety of financial
planning calculators that can help you conduct an
integrated financial plan, including tax planning,
mortgage financing, retirement planning, and
investing.
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