Chapter 1 Personal Financial Planning in Action McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.

Personal Financial Planning Objectives Identify social and economic influences on personal financial goals and decisions Develop personal financial goals Assess personal and financial opportunity costs associated with financial decisions Implement a plan for these decisions 1-2

Financial Planning Process of managing your money to achieve personal economic satisfaction Financial Plan: Formalized report Summarizes current financial situation Analyzes financial needs Recommends future financial activities 1-3

Advantages of Financial Planning Increased effectiveness in obtaining, using, and protecting financial resources Increased control of your financial affairs Improved personal relationships Sense of freedom from financial worries 1-4

Objective 1 Identify Social and Economic Influences on Personal Financial Goals and Decisions Life situation and personal values Financial planning in our economy Domestic economic influences Global Influences Inflation Interest rates 1-5

Life Situation and Personal Values Adult life cycle Life Situation Factors: Marital status, household size, employment Exhibit 1-1 (page 5) Major events: Graduation, marriage, divorce Birth or adoption of child Career or health changes Values: The ideas and principles you consider correct, desirable, and important 1-6

Financial Planning in Our Economy Domestic Influences Economy’s influence on financial planning Business, labor & government The Federal Reserve “.. Sets the nation’s monetary policy to promote the objectives of maximum employment, stable prices and moderate long-term interest rates.” http://www.federalreserve.gov/ 1-7

Financial Planning in Our Economy Global Factors U.S economy affected by foreign investors and competition from foreign companies Level of imports/exports affects available supply of dollars Level of foreign investment affects domestic money supply Money supply affects consumer interest rates 1-8

Financial Planning in Our Economy Inflation Inflation =  in the general level of prices Reduces buying power of the dollar Most harmful to those on fixed incomes Inflation rates vary “Hidden inflation” CPI = a measure of inflation 1-9

Financial Planning in Our Economy Interest Rates Interest Rate = the cost of money Affected by supply and demand Risk premium: Length of time funds in use Expected inflation Uncertainty Major impact on financial planning 1-10

8 Basic Financial Planning Activities Obtaining Chapter 1 Planning Chapters 2, 3 Saving Chapter 4 Borrowing Chapter 5 Spending Chapter 6, 7 Managing Risk Chapter 8-10 Investing Chapter 11-13 Retirement/Estate Planning Chapter 14 1-11

Objective 2 Develop Personal Financial Goals Time Frames for Achieving Financial Goals: Short-term goals . . . . . . . . . . . w/in 1 year Intermediate goals . . . . . . . . . 2-5 years Long-term goals . . . . . . . . . . . > 5 years Financial Needs Goals: Consumable-product goals. . . Food, clothing Durable-product goals . . . . . . Car, appliances Intangible-purchase goals . . . Education, health 1-12

Goal-Setting Guidelines Effective Goals should be: Realistic Stated in specific, measurable terms Based on a time frame Action-oriented 1-13

Objective 3 Assess Personal and Financial Opportunity Costs of Financial Decisions Opportunity cost = what you give up making a choice The trade-off of a decision Not always measurable in dollars; may be time Consider lost opportunities resulting from your decisions 1-14

Opportunity Costs and Financial Trade-Offs Personal Acquisitions Opportunity Costs (car, home, college education, investments, insurance, retirement fund) (time, effort, health) Financial Opportunity Costs (Interest, liquidity, safety ) 1-15

Time Value of Money Increase in an amount of money as a result of interest earned Saving today = more money tomorrow Spending today = lost interest Saving and spending decisions involve considering the trade-offs Current needs can make spending worthwhile 1-16

Time Value of Money Interest Calculations Calculating interest earned: Principal = amount of savings Annual interest rate Length of time money on deposit (in years) Simple interest: Annual Interest Rate Amt in Svgs Time Period X = X Interest 1-17

Time Value of Money Interest Calculation Example $500 on deposit at 6% annual interest for 6 months: Principal = $500 Interest rate = 6% Time period = ½ (6/12 months) = $500 X 6% X 1/2 $15 1-18

Future Value The increased value of money from interest earned Amount to which current savings will increase Total amount available in the future “Compounding” 1-19

Original Amount in Savings Future Value Example Original Amount in Savings Future Value Interest Earned = + $100 deposited for 1 year at 6% per year Future Value = $100 + ($100 X .06 X 1) Future Value = $100 + $6 = $106 1-20

Future Value Tables Exhibit 1-3A = FV of a Single Amount Example: Multiply Table Factor by amount deposited All Future Value factors > 1.0 Example: $650 invested at 8% for 10 years Factor = 2.159 FV = $650 X 2.159 = $1,403.35 1-21

Future Value Series of Deposits Exhibit 1-3B “Annuity” = series of equal deposits at equal intervals earning a constant rate Example: Deposit $50 per year at 7% for 6 years Exhibit 1-3B factor = 7.153 Future Value = $50 x 7.153 = $357.65 1-22

Present Value The current value of a future amount based on a certain interest rate and time period The current value of an amount desired in the future How much to deposit now to obtain a desired total in the future “Discounting” 1-23

Present Value Tables Exhibit 1-3C = PV of a single amount Example: Multiply Table Factor by amount deposited All Future Value factors < 1.0 Example: You want $1,000 five years from now You can earn 5% on your money Present Value = $1,000 X 0.784 = $784 1-24

Present Value of a Series of Deposits Exhibit 1-3D Determine how much you need to deposit now in order to withdraw a specific amount for a desired number of years Example: You want to withdraw $400/year for 9 years Your money is earning 8% per year Deposit = $400 X 6.247 = $2,498.80 1-25

The 6-Step Financial Planning Process 1-26

Objective 4 Implement a Plan for Making Personal Financial and Career Decisions Determine current financial situation Develop financial goals Identify alternative courses of action Continue same course of action Expand current situation Change current situation Take a new course of action 1-27

Objective 4 Implement a Plan for Making Personal Financial and Career Decisions Evaluate alternatives Consequences of choices Evaluate risks Financial Planning information sources Create and implement financial action plan Review and revise plan 1-28

Financial Planning in Action 1-29

Career Choice and Financial Planning The life work one selects = key to financial well being and personal satisfaction Career choices have risks and opportunity costs Career choices require periodic re-evaluation of trade-offs related to personal, social and economic factors Changing personal and social factors require continuous assessment of your work situation 1-30