Chapter 1 Personal Financial Planning in Action McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Personal Financial Planning Chapter Learning Objectives LO1.1 Identify social and economic influences on personal financial goals and decisions LO1.2 Develop personal financial goals LO1.3 Calculate time value of money situation associated with personal financial decisions LO1.4 Implement a plan for these decisions

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

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

Learning Objective LO1.1 Identify Social and Economic Influences on Personal Financial Goals and Decisions Life situation and personal values (1.6) Financial planning in our economy Domestic economic influences (1.7) Global Influences (1.8) Inflation (1.9) Interest rates (1.10)

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

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/

Financial Planning in Our Economy Global Influences 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

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 Deflation = decline in prices

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

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

Learning Objective LO1.2 Develop Personal Financial Goals Time Frames for Achieving Financial Goals: Short-term goals . . . . . . . . . . . within 1 year Intermediate goals . . . . . . . . . 1-5 years Long-term goals . . . . . . . . . . . > 5 years Financial Needs Goals: Consumable-product goals. . . Food, clothing Durable-product goals . . . . . . Car, appliances Intangible-purchase goals . . . Education, health

Goal-Setting Guidelines The “SMART” Approach A “goal” that is not written down is a dream! Effective Goals should be: S = Specific M = Measurable A = Action-oriented R = Realistic T = Time-based

Learning Objective LO1.3 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

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 )

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 Skip to slide 30

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

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

Time Value of Money Types of TVM Calculations Future Value = Amount that will be available at a later date Present Value = Current value of an amount desired in the future

Time Value of Money Calculation Methods Formula calculation Time value of money tables Financial calculator Spreadsheet software Websites and apps

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

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

Future Value Tables Appendix Exhibit 1-A = FV of a Single Amount 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

Time Value of Money Calculation Methods

Time Value of Money TVM Websites www.moneychimp.com/calculator www.dinkytown.net

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

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”

Present Value Tables Appendix Exhibit 1-C = PV of a single amount 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

Present Value of a Series of Deposits Appendix Exhibit 1-D 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

The 6-Step Financial Planning Process

Learning Objective LO1.4 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 (change vehicle) Take a new course of action

Learning Objective LO1.4 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

Financial Planning in Action

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

Chapter Summary Learning Objective LO1.1 Financial decisions are affected by: Life situation Personal values Economic factors Major elements of Financial Planning: 1. Obtaining 5. Spending 2. Planning 6. Managing Risk 3. Saving 7. Investing 4. Borrowing 8. Retirement & Estate planning

Chapter Summary Learning Objective LO1.2 Financial Goals should be: S = Specific M = Measurable A = Action-oriented R = Realistic T = Time-based

Chapter Summary Learning Objective LO1.3 Every decision involves a trade-off Personal opportunity costs: Time Effort Health Financial opportunity costs Based on the time value of money

Chapter Summary Learning Objective LO1.4 Personal financial planning involves: Determine financial situation Develop financial goals Identify alternative courses of action Evaluate alternatives Create and implement a financial action plan Review and revise the financial plan