The Financial Planning Process Professor Payne, Finance 4100 Chapter 1 The Financial Planning Process Professor Payne, Finance 4100

Learning Objectives Explain why personal financial planning is so important. Describe the five basic steps of personal financial planning. Set your financial goals.

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. Learn ten principles of personal finance. 7. Understand that achieving financial security is more difficult for women.

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.

Importance of Personal Financial Planning Accumulate wealth for special expenses Save for retirement “Cover your assets” Invest intelligently Minimize payments to Uncle Sam

Five basic steps to personal financial planning Evaluate your financial health Define your financial goals Develop a plan of action Implement your plan Review your progress, reevaluate, and revise your plan

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.

Step 2: Define Your Financial Goals Write or formalize your goals. Attach a financial cost to each one. When will you need the money to achieve the goal? Analyze and revise your goals.

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.

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.

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.

Figure 1.1 The Budgeting and Planning Process

ESTABLISHING YOUR FINANCIAL GOALS Short-term—within 1 year Intermediate-term—1 to 10 years Long-term—more than 10 years

Examples of 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

Examples of Intermediate-Term Goals Save for Older Child’s College Save for a Down Payment on a House Pay Off Major Debt Finance Large Items (Weddings) Purchase a Vacation Home

Examples of 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

Figure 1.2 Personal Financial Goals Worksheet

Figure 1.3 A Typical Individual’s Financial Life Cycle

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

Table 1.1 The Cost of Raising a Child

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.

Stage 3 The Retirement Years After age 65, live off savings Retirement age depends on savings. Less risky investment strategy Consider long-term care protection. Estate planning decisions and documents are critical.

Thinking About Your Career A series of positions to show your skills. Is the job important, enjoyable, and satisfying? Does it provide for your desired lifestyle?

Figure 1.4 Job Search Worksheet

Figure 1.4 Job Search Worksheet (cont.)

Figure 1.4 Job Search Worksheet (cont.)

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 http://www.bls.gov/oco/cg

Table 1.2 What Different College Majors Earn

Getting a Job Start early Prepare and practice for interviews Research the company Dress appropriately, be confident, and follow-up

Table 1.3 Most Common Interview Questions Tell me a little about yourself. What do your know about our company and this position? What are your short-term and long-term goals? What is your greatest strength and your greatest weakness? What is the hardest thing you have ever had to do? Describe a time you worked with a difficult person, perhaps a fellow student, professor, co-worker. How did you handle it then and how would you handle it now? How would you rate your performance under pressure? How did you choose your major and what was your most rewarding college experience? Did you participate in extracurricular activities or clubs while in school? What did you like the most/least about your last job(s)? What motivates you and how do you motivate others? Describe a project you have worked on and your contribution. Why should we hire you? What can you do for our company? Are your grades a good indicator of your professional potential? Is there anything else that we should know about you?

Being Successful in Your Career Do good work. Project the right image. Understand and work within the power structure. Gain visibility.

Being Successful in Your Career Take new assignments. Acquire new skills and keep up with technology. Develop a strong network. Be ethical.

What Determines Your Income? Skills Education Marriage

Figure 1.5 Education and Earnings

Money Isn’t Everything Money doesn’t necessarily bring happiness But, not having money can bring anxiety

Lessons Learned from the Recent Economic Downturn The crisis of 2008 led to high rates of unemployment and a disruption of financial markets Not understanding the past could lead to a repeat of events

Lessons Learned Prepare an adequate emergency fund Plan for retirement early…it will come sooner than you think Avoid excessive debt Maintain adequate health insurance

Ten Principles of Personal Finance 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.

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.

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

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.

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

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

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.

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.

Figure 1.7 The Risk-Return Trade-Off

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.

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.

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 independence is more difficult for them than it is for men.

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.

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.

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.

Figure 1.6 How Long Households Go Without Income Before Hardship Sets In

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