Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved Personal Finance SIXTH EDITION Chapter 1 Overview of a Financial Plan

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved Chapter Objective 1.1 Explain how you benefit from personal finance 1.2 Identify the key components of a financial plan 1.3 Explain how financial planning affects your cash flows 1.4 Outline the steps involved in developing your financial plan

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved Definitions Personal finance: the process of planning your spending, financing, and investing to optimize your financial situation Personal financial plan: a plan that specifies your financial goals and describes the spending, financing, and investing plans that are intended to achieve those goals Opportunity cost: what you give up as a result of a decision

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved How You Benefit from an Understanding of Personal Finance Make your own financial decisions –Every spending decision has an opportunity cost Judge the advice of financial advisors –Make informed decisions Become a financial advisor –Many career opportunities available

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved Components of a Financial Plan Budgeting and tax planning Managing your liquidity Financing your large purchases Protecting your assets and income (insurance) Investing your money Planning your retirement and estate

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved A Plan for Your Budgeting and Tax Planning Budget planning: The process of forecasting future expenses and savings –Evaluate your current financial position  Assets: what you own  Liabilities: what you owe  Net worth: the value of what you own minus the value of what you owe

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved Budget and Tax Planning

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved A Plan to Manage Your Liquidity (1 of 2) Liquidity: access to funds to cover any short-term cash deficiencies Money management: decisions regarding how much money to retain in a liquid form and how to allocate the funds among short-term investment instruments

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved A Plan to Manage Your Liquidity (2 of 2) Credit management: decisions regarding how much credit to obtain to support your spending and which sources of credit to use

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved Managing Your Liquidity

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved A Plan for Your Financing Loans often needed for large expenditures – College tuition, car, house – Managing loans  How much can you afford to borrow?  Determining maturity of the loan  Selecting a loan with a competitive interest rate

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved Financing Your Large Purchases

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved A Plan for Protecting Your Assets and Income Insurance planning: Determining the types and amount of insurance needed to protect your assets –Automobile and homeowner’s insurance protect assets –Health insurance limits potential medical expenses –Disability and life insurance protect your income

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved A Plan for Your Investing Any funds beyond what you need to maintain liquidity should be invested –Primary objective to earn a high return –Potential investments include stocks, bonds, mutual funds and real estate –Risk: uncertainty surrounding the potential return on an investment –Manage investments to keep risk at a tolerable level

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved A Plan for Your Retirement and Estate This includes insurance planning, retirement planning, and estate planning –Retirement planning: determining how much money should be set aside each year for retirement and how you should invest those funds –Estate planning: determining how your wealth will be distributed before or upon your death

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved Building Your Own Financial Plan Enhances your net worth Builds your wealth All components of your financial plan affect your cash inflows and outflows and how much cash you have available

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved How Financial Plan Decisions Affect Your Cash Flows (1 of 13) How the components relate to your cash flows –Cash inflows are cash that you receive –Cash outflows are cash that you spend –Budgeting balances income and spending –Liquidity deals with cash excesses or shortages

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved How Financial Plan Decisions Affect Your Cash Flows (2 of 13) Part 1 – Tools for Financial Planning College tuition, car, house –Budgeting allows you to plan how you will use the cash you receive in a given period  How much should you work this month (if your employer allows flexibility)? –Budget decisions determine how much you spend and the amount of your cash outflows each month  What products or services should you purchase this month?

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved How Financial Plan Decisions Affect Your Cash Flows (3 of 13)

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved How Financial Plan Decisions Affect Your Cash Flows (4 of 13) Part 2 – Managing Your Liquidity –If you have excess cash this month, how much cash should you add to your checking or saving account? –If you have a cash deficiency this month, how much cash should you withdraw from your checking or savings account? –If you have a cash deficiency this month, how much credit should you use from credit cards or other sources?

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved How Financial Plan Decisions Affect Your Cash Flows (5 of 13)

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved How Financial Plan Decisions Affect Your Cash Flows (6 of 13) Part 3 – Personal Financing –Should you lease a car? –Should you borrow money to purchase a car? –Should you borrow money to purchase a home? –How much cash will you need to borrow? –How long a period will you need to borrow funds? –What is the ideal source from which you will borrow funds?

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved How Financial Plan Decisions Affect Your Cash Flows (7 of 13)

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved How Financial Plan Decisions Affect Your Cash Flows (8 of 13) Part 4 – Protecting Your Wealth –What types of insurance do you need? –How much insurance should you purchase to protect your assets? –How much insurance should you purchase to protect your income?

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved How Financial Plan Decisions Affect Your Cash Flows (9 of 13)

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved How Financial Plan Decisions Affect Your Cash Flows (10 of 13) Part 5 – Personal Investing –How much cash should be used to make investments? –What types of investments should you make? –How much risk should you tolerate when making investments?

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved How Financial Plan Decisions Affect Your Cash Flows (11 of 13)

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved How Financial Plan Decisions Affect Your Cash Flows (12 of 13) Part 6 – Retirement and Estate Planning –How much cash should you invest toward your retirement each month? –What types of investments should you make for your retirement accounts?

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved How Financial Plan Decisions Affect Your Cash Flows (13 of 13)

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved Summary of Financial Plan Components (1 of 3) Notice how the financial plan components are integrated Each component can be a source of cash or a use of cash

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved Summary of Financial Plan Components (2 of 3) Summary of sources of cash from each component –Attempt to work more hours (Part 1) –Withdraw cash from savings (Part 2) –Obtain a loan (Part 3) –Cash in an insurance policy (Part 4) –Sell some of your investments (Part 5) –Withdraw funds from your retirement account (Part 6)

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved Summary of Financial Plan Components (3 of 3) Summary of uses of cash –Purchase products and services (Part 1) –Deposit cash in your checking or savings account (Part 2) –Pay interest payments on a loan or pay off a loan (Part 3) –Make insurance payments (Part 4) –Make new investments (Part 5) –Contribute toward your retirement account (Part 6)

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved How Financial Planning Relates to Cash Flow

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved Integration of the Financial Plan Components (1 of 2) Budgeting decisions affect liquidity management decisions Liquidity management decisions can affect your financing decisions Financing decisions can affect your insurance decisions Insurance decisions can affect your investment decisions

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved Integration of the Financial Plan Components (2 of 2) Investment decisions can affect your retirement planning decisions Retirement planning decisions can affect your budgeting decisions

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved How Psychology Affects Your Financial Plan (1 of 3) Psychology has a major impact on human behavior and decision making Psychology has a major impact on spending behavior and ability to implement an effective financial plan Consider two different types of spending behavior –Focus on immediate satisfaction and peer pressure –Focus on the future

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved How Psychology Affects Your Financial Plan (2 of 3) Assess your own spending behavior –Do you pay rent for a single apartment rather than share an apartment? –Do you have large monthly car payments? –Do you have credit card bills that you only make the minimum monthly payment toward each month?

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved How Psychology Affects Your Financial Plan (3 of 3) –Do you spend all of your income that is not needed for rent or car loans payments within the first day or two of receiving your paycheck? –Do you always find a reason each month to spend all of your income?

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved Developing the Financial Plan (1 of 15) Step 1. Establish Your Financial Goals –Types of financial goals  Car, home, college, wealth, charity –Set realistic goals  Stronger likelihood of reaching goals –Timing of goals  Short term (within one year)  Intermediate (between 1–5 years)  Long term (beyond five years)

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved Developing the Financial Plan (2 of 15) Step 2. Consider Your Current Financial Position –How your future financial position is tied to your education  Consider your skills, interests, and career paths –How your future financial position is tied to your career choice  Choose a career that will be enjoyable and suit your skills

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved Developing the Financial Plan (3 of 15) –How your future financial position is tied to the economy  Economic conditions affect types of jobs available, salaries offered, price of services, value of assets  Financial crisis of affected financial positions in many ways –Reduction in new job opportunities –Elimination of some jobs –Lower salaries for existing jobs –Value of many assets declined

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved Developing the Financial Plan (4 of 15)

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved Developing the Financial Plan (5 of 15)

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved Developing the Financial Plan (6 of 15) EXHIBIT 1.7 Fastest-Growing Occupations OccupationGrowth Rate Over the 2012–2022 PeriodAnnual Median Pay Industrial organizational psychologist53%$83,580 Personal care aides49%$19,190 Home health aides48%$20,820 Insulation workers47%$39,170 Interpreters and translators46%$45,430 Diagnostic medical sonographers46%$65,860 Masons43%$28,220 Occupational therapy assistants43%$53,240 Genetic counselors41%$56,800 Physical therapy assistants41%$52,160

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved Developing the Financial Plan (7 of 15) EXHIBIT 1.7 Fastest-Growing Occupations OccupationGrowth Rate Over the 2012–2022 PeriodAnnual Median Pay Physical therapy aides40%$23,880 Skincare specialists40%$28,640 Physician assistants38%$90,930 Segmental pavers38%$33,720 Helpers for electricians38%$27,670 Information security analysts37%$86,170 Occupational therapy aides36%$26,850 Health specialties36%$81,140 Medical secretaries36%$31,350 Physical therapists36%$79,860 Source: U.S. Bureau of Labor Statistics, 2014.

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved Developing the Financial Plan (8 of 15) Step 3. Identify and Evaluate Alternative Plans That Could Achieve Your Goals –Plans could be conservative or aggressive Step 4. Select and Implement the Best Plan for Achieving Your Goals –The Internet has valuable financial planning information

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved Using the Internet to Facilitate Financial Planning (1 of 2) Provides updated information on all parts of your financial plan –Current tax rates and regulations –Investment performances –New retirement plan rules

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved Using the Internet to Facilitate Financial Planning (2 of 2) Online calculators –Estimating taxes –Determining how your savings will grow over time –Determining whether buying or leasing a car is more appropriate

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved Developing the Financial Plan (9 of 15) Focus on Ethics: Personal Financial Advice –Your objective is to get the best advice appropriate to your needs –Be wary of unethical behavior  Difficult to discern –Be wary of incompetent advice  Be alert, ask questions, carefully consider advice

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved Developing the Financial Plan (10 of 15) Step 5. Evaluate Your Financial Plan –Keep plan in an accessible place and monitor your progress Step 6. Revise Your Financial Plan –Change plan as financial condition and financial goals change

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved Developing the Financial Plan (11 of 15) EXHIBIT 1.8 Summary of Steps Used to Develop a Financial Plan 1. Establish your financial goals.  What are your short-term financial goals?  What are your intermediate-term financial goals?  What are your long-term financial goals? 2. Consider your current financial position.  How much money do you have in savings?  What is the value of your investments?  What is your net worth? 3. Identify and evaluate alternative plans that could achieve your goals.  How can you obtain the necessary funds to achieve your financial goals?  Will you need to reduce your spending to save more money each month?  Will you need to make investments that generate a higher rate of return? 4. Select and implement the best plan for achieving your goals.  What are the advantages and disadvantages of each alternative plan that could be used to achieve your goals? 5. Evaluate your financial plan.  Is your financial plan working properly? That is, will it enable you to achieve your financial goals? 6. Revise your financial plan.  Have your financial goals changed?  Should parts of your financial plan be revised to achieve your financial goals? If so, how?

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved Developing the Financial Plan (12 of 15) EXHIBIT 1.9 Summary of Steps Used to Develop a Financial Plan Step 1. Financial Goals: I would like to:  buy a new car within a year,  buy a home within two years,  make investments that will allow my wealth to grow over time, and  build a large amount of savings for retirement in 20 to 40 years. Step 2. Current Financial Position: I have very little savings at this time and own an old car. My income, which is about $30,000 a year after taxes, should increase over time.

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved Developing the Financial Plan (13 of 15) EXHIBIT 1.9 Summary of Steps Used to Develop a Financial Plan Step 3. Plans to Achieve the Goals: Since my current financial position does not provide me with sufficient funds to achieve these financial goals, I need to develop a financial plan for achieving these goals. I want to save enough money to make a down payment on the car and home and to obtain financing to cover the rest of the cost. This plan allows me to allocate some of my income toward investments. My financing decisions will determine the type of car and home that I will purchase and the amount of funds I will have left to make other investments so that I can build my wealth over time.

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved Developing the Financial Plan (14 of 15) EXHIBIT 1.9 Summary of Steps Used to Develop a Financial Plan Step 4. Selecting and Implementing the Best Plan: Financing the purchase of a car and a home is a more appropriate plan for me. I will prepare a budget so that over time I can accumulate savings that will be used to make a down payment on a new car. Then, I will attempt to accumulate savings to make a down payment on a new home. I need to make sure that I can afford financing payments on any money that I borrow. Step 5. Evaluating the Plan: Once I establish a budget, I will monitor it over time to determine whether I am achieving the desired amount of savings each month.

Copyright © 2017, 2014, 2011 Pearson Education, Inc. All Rights Reserved Developing the Financial Plan (15 of 15) EXHIBIT 1.9 Summary of Steps Used to Develop a Financial Plan Step 6. Revising the Plan: If I cannot save as much money as I desire, I may have to delay my plans for purchasing a car and a home until I can accumulate enough funds to make the down payments. If I am able to exceed my savings goal, I may be able to purchase the car and the home sooner than I had originally expected.