Planning Your Financial Future, 4e by: Boone, Kurtz & Hearth An Overview of Personal Finance Chapter 1

2 The Meaning and Importance of Personal Finance  Can improve your standard of living  Today’s environment has impacted personal finance over the years Sluggish growth in personal income  After adjusting for inflation and taxes, personal income growth has only been about 2% a year for the last two decades Changes in the labor market  Most people starting jobs today will work at numerous companies during their career(s) More options  Many more options available today in investments, retirement planning, banking, etc.

3 Personal Financial Planning—A Lifelong Activity  No matter how old you are, you’ll have financial goals  What works when you’re 20, won’t necessarily work when you’re 40 In your 20s, your goals may be paying off student loans or buying your first house In your 70s, your goal may be making sure your retirement funds last your lifetime

4 Personal Financial Toolbox  Once you graduate from college (and now have a ‘real’ job) Figure out your current financial standing  How much do you owe?  What assets do you have? Prepare an income statement and balance sheet Put yourself on a budget Insure yourself against financial ruin  Life, health, property

5 Personal Financial Toolbox  Get your debts under control (if they’re not already) Pay off high-rate loans (or roll over into lower-rate loans)  Start saving for retirement  Set up a regular savings program (pay yourself) Have money automatically transferred from checking to savings Treat this like a fixed expense

6 Getting Professional Help  Many colleges & universities offer credit counseling  May use services of a CPA or professional investment advisor  Dozens of financial self-help books  Online financial information is available  If you use a financial planner, make sure they are qualified

7 Web Links   

8 A Personal Financial Management Model  A financial plan is a guide to help you reach your targeted future goals Step 1: Develop short and long-term goals  Influenced by your personal values & current financial situation Step 2: Establish financial strategies Step 3: Put plan in action & monitor performance

9 General Themes Common to All Financial Plans  Maximizing income and wealth The amount of money you earn is a vital part of any plan  Using money more effectively Spend (and save) your money wisely  Little things add up  Monitoring expenditures Use a budget to help control expenditures The more you know about loans, investments, etc., the more likely you are to make a good decision

10 Pitfalls of Poor Financial Planning  Missed or late payments will be noticed Creditors may:  Repossess your property  Garnish your wages  Force you to file for personal bankruptcy A bad credit record can last for years

11 Setting Personal Goals  Your values will influence your financial goals What things in life are important to you?  Your financial goals are influenced by your current financial situation Prepare current financial statements  Review them to determine what you own, what you owe, & where you’re spending your money Prepare a budget Prepare a list of short- and long-term goals  Make sure they are realistic and obtainable Write down your goals and periodically review them

12 Your Personal Financial Decisions  Career choice Most of your income comes from salaries/wages – determines your lifestyle  Basic money management Prepare a budget Select the right bank Establish a regular savings plan  Credit management Don’t bite off more than you can chew Find a good credit card Learn how to compute interest charges/monthly payments Find out your credit history (report) Learn what to do if you get into trouble

13 Your Personal Financial Decisions  Tax planning How can you reduce your taxes?  Effective buying Real estate, cars, etc.  Renting vs. owning  Insurance How much insurance should you have (if any)?  Life  Health  Property  Disability  Liability

14 Your Personal Financial Decisions  Investment management Invest to increase your future wealth  Difficult to substantially increase future wealth without investing Investments are risky, choices include:  Mutual funds  Stocks  Bonds  Options and futures  Real estate  Art  Coins  Metals (gold, silver, etc.)

15 Financial Planning for Tomorrow  Planning for your children’s college education Becoming more and more expensive  Retirement planning How do you want to live your retirement? How much (if any) do you want to pass along to your heirs? How long remains until you retire? Will Social Security be enough?

16 External Factors  Government policy Changes to federal student loan programs  Will costs of student loans increase due to loan consolidation limits? Social Security reform  Will it be privatized?  Will benefits be reduced?

17 External Factors  Economic conditions The business cycle  Shorter-term sequences of expansions and contractions (recession) Typical business cycle has four stages: prosperity, decline, recession, and recovery Gross domestic product  Represents the total value of goods and services produced by a nation’s economy Important determinant of personal income Disposable personal income – what remains after income taxes Discretionary personal income – what remains after all necessary living expenses have been paid

18 External Factors Unemployment rate  The percentage of the workforce currently looking for a job Inversely related to economic activity Inflation  Inflation decreases the purchasing power of the dollar  Inflation has been about 3% in recent years  Income sources with cost-of-living increases are tied to inflation Interest rates  If you think interest rates are going to rise sharply, buy that house/car now instead of waiting  Interest rates are tied to inflation  Nominal interest rates are those that you pay or receive, whereas real interest rates are nominal rates less the rate of inflation For instance, if a six-month CD pays a 5% nominal rate, but inflation is 2%, then you are earning a real rate of 3%

19 External Factors Government policy and economic activity  Government influences economy If taxes increase and government spending remains unchanged, economic growth will slow Federal Reserve Board can increase or decrease the supply of money Impacts interest rates, inflation, and economic growth Recession/Expansion  If you think a recession is in the near future, save more now (in case you get laid off)

20 Figure 1.5: Change in Real GDP Source: Based on data from the Federal Reserve Board and the Statistical Abstract of the United States.

21 Figure 1.6: Breakdown of Personal Income Source: Based on data from the Federal Reserve Board and the Statistical Abstract of the United States.

22 The Time Value of Money  Why money has time value Risk of not getting your money back Risk of inflation Opportunity cost  You have to give up something when you invest (you can’t use the money for something else)  Because money has time value you should expect to earn interest on an investment

23 Future Value  Value at some point in the future of a current sum of money If you invest $1,000 in an account and it earns 6%, after one year you will have $1,060  $1,000 × 0.06 = $60 interest + $1,000 beginning amount After two years, the $1,000 investment would be worth  $1,060 × 0.06 = $63.60 interest + $1,060 = $1,  Or, $1,000 × = $1,123.60

24 Future Value  Compound interest Payment of interest on interest  Simple interest Interest on the original deposit only  Multiple cash flows An annuity is a series of cash payments or receipts

25 Present Value  The value today of a future sum of money A dollar received tomorrow is worth less than a dollar today Finding present value is called discounting