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Discuss what you will gain from the
study of personal finance.
•Introduction to the subject of
personal finance
•Identify the key components of a
financial plan, and
•Outline the steps involved in
developing your personal financial
plan.
“. . . True financial freedom doesn’t depend on how much
money you have. Financial freedom is when you have
power over your fears and anxieties instead of the other
way around.”
-- Suze Orman, The 9 Steps to Financial Freedom, p.2
Step 1 Think back to your formative experiences with money and consider what these memories have taught you about who you were then
and how they affect who you are today.
Step 2 Replace your financial fears with new, positive, empowering messages (i.e. "I have more money than I will ever need"; "I am in control
of all my affairs"; "I have the power to put my money in good hands").
Step 3 Be honest with yourself about your current financial status and decide how you want to start spending your money.
Step 4 Be responsible to those you love by taking care of these "must-do's"wills, trusts, life insurance, durable power of attorney for health care,
long-term-care insurance, and estate planning.
Step 5 Respect yourself and your money by investing wisely in retirement plans, stocks, money market accounts, and mutual funds and by
eliminating credit card debt. Your actions will give that respect meaning.
Step 6 You must trust yourself more than you trust others. Pay attention to your inner voice it will tell you if how and in what you are investing
is right for you.
Step 7 Give a portion of your money to others. By releasing an anxious grasp on your money, you will open yourself to receive all that is meant
to be yours.
Step 8 Understand and accept the cycles of money. The setbacks you may have today or next year will not keep you from financial freedom.
If you hold on to your goals and dreams, you will get there.
Step 9 Learn to recognize true wealth. Money itself will not make you financially free. That comes as a result of only that powerful state of
mind which tells us that we are worth far more than our money.
Discuss what you will gain from the
study of personal finance.
•
•
•
•
Financial literacy -- the
vocabulary necessary to manage
one’s personal finances
Personal finance -- the study of
personal and family resources
considered important in achieving
financial success.
Personal financial planning – the
process of planning your spending,
financing, and investing to
optimize your financial situation.
Financial success -- the
achievement of financial
aspirations that are desired,
planned, or attempted. It is defined
by the individual or family that
seeks it.
Describe five lifetime financial
objectives of most people
1
2
3
4
5
Maximizing Earnings and Wealth
– Wealth -- an abundance of money,
property, investments, and other
resources.
Practicing Efficient Consumption
– We use money for two purposes:
consumption and savings
Finding Life Satisfaction
Reaching Financial Security
– Financial Security -- the comfortable
feeling that your financial resources will
be adequate to fulfill any needs you
have as well as most of your wants.
– To reach financial security, first you
need to set and prioritize your long-and
short-term goals.
Accumulating Wealth for Retirement and
an Estate
Overview of Financial Plan
Financial Planning Decisions
Your Cash Inflow
=
Your Cash Outflow
Your Net Cash Flows
Use dollars to
Increase assets
-
Use dollars to
Increase assets
=
Value of Your Assets
Value of Your Liabilities
Your Net Worth
How Financial Planning Affects Your Cash Flow
1. Budgeting and Tax
Planning
$ Income
6.Retirement and
Estate Planning
$ Credit
Your
Cash
$ Deposit
2. Managing Liquidity
(Cash and Credit Management)
5. Investing
$ Spending
4. Income and Asset
Protection
Products
and
Service
3. Managing expenditures
for major purchases
Median Weekly Earnings of Full-Time Workers by Education Attainment and Sex
Less than a high school
diploma
High school graduates,
no college
Women's earnings 2002
Men's earnings 2002
Some collete or
associate degree
College graduates, total
$-
$200
$400
$600
$800
$1,000
$1,200
Median Annual Earnings of Full-Time Workers by Education Attainment and Sex
Less than a high school
diploma
High school graduates,
no college
Women's earnings 2002
Men's earnings 2002
Some collete or
associate degree
College graduates, total
$0
$10,000
$20,000
$30,000
Note: Data are for workers 25 years of age and older.
Statistics taken from www.bls.gov/opub/ted/2003/art04.htm
$40,000
$50,000
$60,000
Understanding the Economic
Environment of Personal Finance
•
The State of the Economy
– Economy is a system of managing the productive and employment resources of a country,
community, or business.
– Economic growth is a condition of increasing production and consumption in the economy.
– Business cycle (or economic growth) is a wavelike pattern of economic activity that includes
temporary phases that undulate from boom to bust.
6 Steps of Personal Financial Planning
1. Develop financial goals.
2. Determine your current financial situation.
3. Identify and evaluate alternative plans to achieve your
goals.
4. Select and implement the best alternative to achieve your
goals.
5. Create and implement a financial action plan.
6. Reevaluate and revise your plan.
Business Production and Retail Sales
Phases of the Business (Economic Cycle)
Expansion
(Prosperity)
Recession
(or Depression)
Recovery
Average growth rate expected
in economy
Understanding the Economic
Environment of Personal Finance
•
The State of the Economy
– Economy is a system of managing the productive and employment resources of a country,
community, or business.
– Economic growth is a condition of increasing production and consumption in the economy.
– Business cycle (or economic growth) is a wavelike pattern of economic activity that includes
temporary phases that undulate from boom to bust.
– Expansion occurs when production is at a high capacity, unemployment is low, retail sales are
high, and prices and interest rates are low or falling.
– Recession is generally a decline in business “a recurring period of decline in total output,
income, employment, trade, usually lasting from six months to a year and marked by
widespread contractions in many sectors of the economy.”
– Depression is a severe downward phase of the economic cycle where unemployment is very
high, prices are very low, the level of living decreases sharply, and economic activity virtually
ceases.
Understanding the Economic Environment of
Personal Finance
(cont.)
•
Tracking at least two statistics may help understand the direction of the economy:
– Gross Domestic Product (GDP) -- the value of all goods and services produced by workers
and capital located in the United States, regardless of ownership.
The Impact of Inflation
•
•
•
•
Inflation-- a steady rise in the general level of prices.
Deflation -- falling prices.
When prices are rising, an individual’s income also must rise to maintain its purchasing power,
which is a measure of the goods and services that one’s income will buy.
Your real income reflects the actual buying power of your nominal income (also called money
income.)
Personal Finance Calculations
•
Percentage change in personal income –
(nominal income after raise/nominal income before raise -1) x 100
•
•
For example, if Edward received a $1,600 raise to increase his annual salary from $37,000 to $38,600
during a year with annual inflation of 4%, his personal change in income would be calculated as follows:
His nominal increase would be:
$38,600
37,000 = 1.043 -1 x 100 = 4.3%
However, because inflation was 4%, his real increase was only .3% (4.3% nominal increase – 4%
inflation = .3% real increase). In real dollars Edward’s increase would be calculated as follows:
Real income –
nominal income after raise/1 + previous inflation rate
•
Edward’s real income =
$38,600
1 + 0.040 = $37,115
The Impact of Inflation
• Inflation-- a steady rise in the general level of prices.
• Deflation -- falling prices.
• When prices are rising, an individual’s income also must rise to
maintain its purchasing power, which is a measure of the goods and
services that one’s income will buy.
• Your real income reflects the actual buying power of your nominal
income (also called money income.)
• Interest is the price of money. Savers make no money when the
inflation rate is equal to or higher than their interest rate. In fact, they
are worse off -- “going broke slowly.”
• Federal fund rate -- the rate banks charge one another on overnight
loans.
Economic Considerations That
Affect Decision Making
•
Opportunity Costs -- the value of the next best alternative that must forgone.
–
•
•
•
Opportunity costs are hard to quantify because most involve personal tastes and preferences
“[For many, the] biggest problems in life today . . . Are directly connected with their early,
formative experience with money.” (9 Steps to Financial Freedom, p. 7).
Utility -- the ability of a good or service to satisfy a human want.
Marginal Utility -- the extra satisfaction derived from having one more incremental
unit of a product or service.
Marginal Costs -- the additional cost of one more incremental unit of some item.
Income Taxes in Decision Making
•
Marginal Tax Rate -- is the tax rate at which your last dollar earned is taxed.
Assume Juanita has taxable income of $32,000 and receives a $1,000 bonus from her
employer. Juanita’s federal tax rate is 28% and her state tax rate is 6%. What is
Juanita’s effective marginal tax rate?
1,000 x .28
= $280.00 Federal taxes
1,000 x .06
= $ 60.00 State taxes
1,000 x .0765 = $ 76.50 Social Security Taxes
Total Taxes
.4165 $416.40
Tax Sheltered Returns Are Greater
Than Taxable Returns
$250,000
$200,000
Taxable Returns
Tax Sheltered Returns
$150,000
$100,000
$50,000
$0
10
15
20
25
30
Years Years Years Years Years
The Time Value of Money in
Decision Making
•
Time value of money is the idea that paying or receiving money over time is affected
by the fact that money can earn a positive rate of return over time.
–
•
•
For example, if you were to win the lottery and be offered the choice to receive a lump sum of
$1,000,000 now or payments of $60,000 per year for 20 years for a total of $1,200,000. The
more favorable answer for you depends upon the interest rate you could earn on your
investment.
Present value (or discounted value) is the current value of an asset that will be received
in the future.
Future value is the valuation of an asset projected to the end of a particular time period
in the future.
Basic calculations:
FV = (Present value of sum of money)( I + 1.0)(I + 1.0)(I + 1.0) . . .
Or FV = (PV)(1 + I) n
PV = (FV)(1 + I) -n
(Calculation assumes compound interest)
The Time Value of Money in
Decision Making
•
Assume you have the option of two different investment options. First, a friend wanted
to borrow $5,000 for three years and pay you back $6,000 in a lump sum. Second, you
could invest the same $5,000 for three years in a government bond paying 7 percent
annual interest. Which investment would be the best financial decision?
FV = (PV)(1 + I) n
= (5,000)(1+.07)3
= 5,000 x 1.225043
= $6,125.22
You would earn $125.22 more by investing in the government bonds.
Future Value of $1 After a Given
Number of Periods
Periods
1
2
3
4
5
6
5%
1.0500
1.1025
1.1576
1.2155
1.2763
1.3401
6%
1.0600
1.1236
1.1910
1.2625
1.3382
1.4185
7%
1.0700
1.1449
1.2250
1.3108
1.4026
1.5007
8%
1.0800
1.1664
1.2597
1.3607
1.4693
1.5869
The Difference Between Simple
Interest and Compound Interest
•
•
Simple Interest is the interest computed on principal only
Interest = Principle x Rate x Time or I = P x R x T.
Compound Interest is the calculation of interest on interest as well as interest on the
original investment.
Future Value of $10,000 with Interest Compounded Annually
$600,000
$500,000
14%
$400,000
12%
$300,000
10%
8%
$200,000
6%
$100,000
$0
0
10
20
30
Rule of 72
•
A handy formula to calculate the
number of years it takes to double
principal using compound interest is the
Rule of 72. You simply divide the
interest rate the money will earn into
the number 72. For example, if interest
is compounded at a rate of 7 % per
year, your principle will double every
10.3 years. If the rate is 6 %, it will
take 12 years.The rule of 72 also works
for determining how long it would take
for the price of something to double
given a rate of increase in the price.
For example, if college tuition costs are
rising 8 % per year, the cost of college
education doubles in just over nine
years.
The Rule of 72
18
16
14
12
10
8
6
4
2
0
12% 10% 8% 6% 4%
How Work Decisions Affect Success
in Personal Finance
•
Fringe Benefit is compensation for employment that does not take form of wages,
salaries, commissions, or other cash payments. Examples include paid holidays, health
insurance, and a retirement plan. Some fringe benefits are tax-sheltered, such as a
flexible spending accounts and retirement accounts.
How Work Decisions Affect Success
in Personal Finance
•
Fringe Benefit is compensation for employment that does not take form of wages, salaries,
commissions, or other cash payments. Examples include paid holidays, health insurance, and a
retirement plan. Some fringe benefits are tax-sheltered, such as a flexible spending accounts and
retirement accounts.
The Positive Effects of a Flexible Spending Account
Without
the Plan
With
The Plan
Monthly salary
$2,500
To FSA account
-Taxable salary
$2,500
Income tax*
(248)
Social Security tax
(191)
Salary after taxes
$2,061
Medical and/or
Dependent care expenses (410)
Take home pay
$1,651
FSA reimbursement
--
$2,500
(410)
$2,090
(186)
(160)
$1,744
Effective take home pay $1,651
$1,744
(410)
$1,344
410
Flexible Spending
Account
-$410
(410)
A Typical Individual’s Financial Life Cycle
Stage 1
Stage 2
Early years-A time of
Approaching
RetirementThe Golden
Years
$
Wealth accumulation
Stage 3
The Retirement Years
Reassessment of Retirement Goals
Tax and Estate Planning
Family Formation
Saving for Goals-Pay Yourself First
Insurance Planning
Home Purchase
Initial Goal Setting
20
30
40
50
Age
60
70
80
Steps in Successful Management of
Personal Finance
Lifetime Financial Objectives
Retirement and estate planning
Wealth
Investment planning
Income and asset protection
Managing expenditures
Cash and credit management
Financial planning
Accumulate wealth for retirement
Reach financial security
Find life satisfaction
Practice efficient consumption
Maximize earnings and wealth
The Building Blocks of Financial
Success
Achieve
Financially
Successful Life
Mutual
Funds
Stocks and
Bonds
Real
Estate
Pension
Plans
Credit
Cards
Installment
Loans
Savings
Accounts
Education
Costs
Invest
Handle
Housing
Expenses
Transportation
Expenses
Insurance
Expenses
Income
Taxes
Contingencies
Manage
Long-Term
Goals
Short-Term
Goals
Organized
Financial Records
Realistic
Budget
Emergency
Savings Fund
Establish
Checking
Account
Savings
Account
Money Market
Account
Insurance
Protection
Employee
Fringe Benefits
Use of regular income to provide basic lifestyle and savings to meet emergencies
Base
Foundation
Good Debt vs. Bad Debt
• Debt incurred for consumption is bad debt.
Bad Debt
= Debt Danger Ratio
Annual Income
Debt Danger Ratio beyond 25% can spell trouble.