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Chapter 1
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 the personal finance lessons
learned in the recent economic downturn.
5. Explain how career management and
education can determine your income level.
6. List ten principles of personal finance.
7. Understand that achieving financial security
is more difficult for women.
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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 your goals. An unwritten
goal is simply a Dream!
• 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
happens.
• Liquidity
– Immediate use of cash by quickly and easily
(costlessly) 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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ESTABLISHING YOUR
FINANCIAL GOALS
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 at
least 3 Months’ Living Expenses
• Pay Off Bills and Credit Cards
• Purchase Insurance
• Purchase a smallish Major Item
• Finance a Vacation
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Intermediate-Term Goals
•
•
•
•
•
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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 1.3
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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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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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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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: 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 1.7 The Risk-Return
Trade-Off
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Principle 9: Mind Games, Your
Financial Personality, 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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Women and Personal Finance
• Tougher to achieve financial security.
• Generally earn less.
• Less likely to have pensions.
• Qualify for less Social Security.
• Live longer than men.
• Planning for financial independent more
difficult for them than it is for men.
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Women and Personal Finance
• Need to take charge of their money and
financial future.
• Acquire knowledge.
• Make things happen—need a plan.
• See a financial planner about specific
concerns.
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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.
• Set your financial goals in order to achieve
them with a financial plan.
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Summary
• An emergency fund can help protect
yourself in the event of an economic
downturn.
• The more educated your are, the more you
will earn.
• There are ten basic principles on which
personal financial planning is built.
• Planning is especially important for the
financial future of women.
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Figure 1.6 How Long Households Go
Without Income Before Hardship Sets In
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