1. © Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc. Fifth Edition Personal Finance An Integrated Planning Approach Bernard J. Winger Ralph R. Frasca

2. © Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc. Chapter 1: Financial Planning-- Why It’s Important l Increased Emphasis on Self Reliance –Less From Government; e.g. Social Security –Less From Employer; e.g. Reduced Role of Traditional Retirement Plans l Achieving Financial Independence l Coping with Economic Uncertainties and Shocks

3. © Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc. Financial Success and Financial Independence l Financial Success: Obtaining Maximum Benefits from Limited Financial Resources l Financial Independence: Having Sufficient Income or Financial Resources To Be Self Reliant

4. © Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc. What Are Your Goals in Life? l Nonfinancial Goals l Financial Goals –Current Consumption –Future Consumption –Savings

5. © Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc. The Principle of Diminishing Marginal Satisfaction l Current consumption is limited by diminishing marginal satisfaction. l Example: Would you rather drink 7 soft drinks right now, or have 1 a day for the next 7 days? Most people prefer the latter choice because each additional bottle after the first one (or two) provides much less satisfaction. Indeed, the 7th bottle right now might make you sick!

6. © Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc. Important Economic Trends l Continuing Inflation--How High? 3-4%? l Persistent Business Cycles –Is Your Job Safe? –Do You Have Cash Reserves to Weather a Storm? l A Perplexing Tax System –High Tax Rates –Selectively Rewarding

7. © Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc. A Planning Approach l Define a Broad Goal l Break it Down To Manageable Sub-goals l Create an Action Plan to Achieve Sub-goals l Periodically Evaluate the Action Plan –If Successful, Keep Up Good Work –If Not, Find New Action Plan or New Goal

8. © Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc. Planning Areas l Consumption and savings planning l Debt Planning l Insurance Planning l Investment Planning l Retirement Planning l Estate Planning l Income Tax Planning

9. © Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc. Marginal Analysis l Looks at changes in important variables l Considers whether a decision’s added benefits are worth its added costs l Example: you choose not be buy whole life insurance because the cash build-up in the policy is less than what you could earn by buying term insurance and investing the saved premiums.

10. © Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc. Opportunity Costs l Opportunity costs are benefits that you give up when you choose one alternative over another l Example: the opportunity cost of taking a course in personal finance is the knowledge you could have gained by taking another course in its place

11. © Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc. What Is Meant by the “Time Value of Money?” l Having a dollar today is worth more than receiving a dollar sometime in the future. l Conversely, paying a dollar at a later date is more desirable than paying it now. l The above statements make sense because any sum of money today can be invested to earn interest and thereby grow to a larger amount.

12. © Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc. Time Value of Money: Compounding l Must Know: –Interest Rate –Number of Periods Investment is Held l Assumes Interest Earned Is Reinvested l Can Find the Future Value of: –A Single Payment –An Ordinary Annuity –An Annuity Due

13. © Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc. Coumpounding Illustrated You invest $1,000 today, hold the investment for 3 years, and earn 10% each year. How much will you accumulate at the end of 3 years? __________________________________________ Year Beginning-of- Interest End-of-Year Year Amount Earned Amount 1 $1,000 $100 $1,100 2 1,100 110 1,210 3 1,210 121 1,331 Answer

14. © Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc. Portion of a Future-Value-of- $1- Table Number of Interest Rate ( i ) Periods (n) 6% 8% 10% 1 1.0600 1.0800 1.1000 3 1.1910 1.2597 1.3310 10 1.7908 2.1589 2.5937 20 3.2071 4.6610 6.7275 30 5.7435 10.0620 17.4490 40 10.2850 21.7240 45.2590

15. © Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc. Easy Way to Find An FV l Use FV of $1 Table to find the FV value for your problem l Multiply by the number of $s invested l Example: How much will you accumulate over 10 years by investing $4,000 today and earning 8% a year? Answer: Find FVof $1 for n = 10, i = 8: it is 2.1589. Then 2.1589 x $4,000 = $8,635.60

16. © Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc. What Is an Annuity? l An annuity is a series of equal payments l An ordinary annuity (OA) assumes the payments occur at the end of periods. Most future-value-of-$1-annuity tables show ordinary annuities l An annuity due assumes the payments occur at the beginning of periods l Annuities are found in many investments, such as bonds

17. © Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc. FV of an Ordinary Annuity An investment of $1,000 is made at the end of each of the next 3 years and earns 10%. How much is accumulated at the end of 3 years? –First payment earns interest for 2 years; so, $1,000 x 1.1 x 1.1 = $1,210 –Second payment earns interest for one year; so, $1,000 x 1.1 = $1,100 –Third payment earns no interest; so, $1,000 X 1.0 = $1,000 –Add: $1,210 + $1,100 + $1,000 = $3,310

18. © Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc. Portion of a Future-Value-of- $1- Annuity Table Number of Interest Rate ( i ) Periods (n) 6% 8% 10% 1 1.0000 1.0000 1.0000 3 3.1836 3.2464 3.3100 10 13.1800 14.4860 15.9370 20 36.7850 45.7620 57.2750 30 79.0580 113.2800 164.4900 40 154.7600 259.0500 442.5900

19. © Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc. Converting an Ordinary Annuity (OA) Into An Annuity Due (AD) l The conversion formula is: FVAD = (1 + i ) x FVOA where i = the interest rate earned l Previous example calculated an OA of $73,570. If payments were made at the beginning of periods, then FVAD = (1.06) x $73,570 = $77,984

20. © Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc. Time Value of Money: Discounting l Must Know: –Interest Rate –When Money is Received in the Future l Assumes Interest Earned Is Reinvested l Can Find the Present Value of: –A Single Payment –An Ordinary Annuity –An Annuity Due

21. © Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc. Portion of a Present -Value-of- $1-Table Number of Interest Rate ( i ) Periods (n) 6% 8% 10% 1 0.9434 0.9259 0.9091 3 0.8396 0.7938 0.7513 10 0.5584 0.4632 0.3855 20 0.3118 0.2145 0.1486 30 0.1741 0.0994 0.0573 40 0.0972 0.0460 0.0221

22. © Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc. Portion of a Present -Value-of-a- $1 Annuity-Table Number of Interest Rate ( i ) Periods (n) 6% 8% 10% 1 0.9434 0.9259 0.9091 3 2.6730 2.5571 2.4869 10 7.3601 6.7101 6.1446 20 11.4699 9.8181 8.5136 30 13.7648 11.2578 9.4268 40 15.0463 11.9246 9.7791

23. © Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc. Finding Present Values l Easiest method is to use the tables l Problem 1: What is the present value of $1,331 to be received at the end of 3 years, assuming a 10% discount rate? (1) Find the PV of $1 for n = 3 and i = 10%; it is 0.7513 (2) Multiply by $1,331 to find answer: 0.7513 x $1,331 = $1,000

24. © Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc. Finding Present Values l Problem 2: What is the present value of $800 to be received at the end of each of the next 20 years, assuming a 6% interest rate? (1) Find the PV of $1 annuity for n = 20 and i = 6%; it is 11.4699 (2) Multiply $800 by 11.4699 = $9,175.92 l If payments were at beginning of periods: PVAD = (1 + i) x PVOA = 1.06 x $9,175.92 = $9,726.48

25. © Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc. Meet the Steele Family l Typical suburban family consisting of Arnold (h) and Sharon (w) and two kids-- Nancy and John l Enjoying the “good life” associated with an above-average income l Doing virtually no financial planning –to educate the children –to enjoy retirement

26. © Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc. Building Blocks of Success--The Foundation l Developing Your Career l Acquiring Adequate Insurance l Finding Suitable Housing l Saving to Build Adequate Cash Reserves

27. © Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc. Building Blocks of Success-- Going Up the Ladder l First Floor: Invest in Very Secure Instruments; e.g. Bank CDs l Second Floor: Gradually Increase Risks to Earn Higher Returns; e.g. High Quality Stocks l Top Floor: Invest in All Types of Assets to Maximize Wealth; e.g. Risky Growth Stocks

28. © Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc. Next Chapter 2 Financial Statements and Budgets