1.  2006 McGraw-Hill Ryerson Ltd. Kapoor Dlabay Hughes Ahmad Prepared by Cyndi Hornby, Fanshawe College Chapter 1 Personal Financial Planning: An Introduction 1-1

2.  2006 McGraw-Hill Ryerson Ltd. Learning Objectives – Chapter 1 1.Analyze the process for making personal financial decisions 2.Develop personal financial goals 3.Assess personal & economic factors that influence personal financial planning 4.Determine personal and financial opportunity costs associated with personal financial decisions 5.Identify strategies for achieving personal financial goals for different life situations 1-2

3.  2006 McGraw-Hill Ryerson Ltd. Learning Objective # 1 Analyze the process for making personal financial decisions 1-3

4.  2006 McGraw-Hill Ryerson Ltd. Financial Planning and Its Benefits Personal financial planning is the process of managing your money to achieve personal economic satisfaction Most people want to handle their finances so that they get full satisfaction from each available dollar Financial goals include such things as a new car, a larger home, advanced career training, contributions to charity, extended travel, and self- sufficiency during working and retirement years 1-4

5.  2006 McGraw-Hill Ryerson Ltd. Advantages of personal financial planning; Increased effectiveness in obtaining, using, and protecting your financial resources Increased control of your financial affairs Improved personal relationships A sense of freedom from financial worries

6.  2006 McGraw-Hill Ryerson Ltd. The Financial Planning Process

7.  2006 McGraw-Hill Ryerson Ltd. The Financial Planning Process Determine your current financial situation Develop financial goals Identify alternative courses of action Evaluate alternatives Create and implement a financial action plan Reevaluate and revise your plan 1-5

8.  2006 McGraw-Hill Ryerson Ltd. STEP 1 DETERMINE YOUR CURRENT FINANCIAL SITUATION Determine your current financial situation, regarding income, savings, living expenses, and debts Preparing a list of current asset and debt balances and amounts spent for various items gives you a foundation for financial planning activities The personal financial statements discussed will provide the information needed to match your goals with your current income and potential earning power

9.  2006 McGraw-Hill Ryerson Ltd. Step 1 Example Within the next 2 months, Kent Mullins will complete his undergraduate studies with a major in international studies He has worked part-time in various sales jobs He has a small savings fund ($1,700) and over $8,500 in student loans What additional information should Kent have available when planning his personal finances?

10.  2006 McGraw-Hill Ryerson Ltd. STEP 2 DEVELOP YOUR FINANCIAL GOALS Periodically analyze your financial values and goals Identifying how you feel about money and why you feel that way Are your feelings about money based on factual knowledge or on the influence of others? Are your financial priorities based on social pressures, household needs, or desires for luxury items? How will economic conditions affect your goals and priorities? The purpose of this analysis is to differentiate your needs from your wants

11.  2006 McGraw-Hill Ryerson Ltd. Specific financial goals are vital to financial planning Others can suggest financial goals for you. However, you must decide which goals to pursue Your financial goals can range from spending all of your current income to developing an extensive savings and investment program for your future financial security

12.  2006 McGraw-Hill Ryerson Ltd. Step 2 Example Kent Mullins has several goals Paying off his student loans Obtaining an advanced degree in global business management Working in Latin America for a multinational company What other goals might be appropriate for John?

13.  2006 McGraw-Hill Ryerson Ltd. STEP 3 IDENTIFY ALTERNATIVE COURSES OF ACTION Developing alternatives (best another way) is crucial when making decisions Many factors will influence the available alternatives, possible courses of action usually fall into 4 categories: Continue the same course of action Expand the current situation Change the current situation Take a new course of action When you decide not to take action (do nothing) which can be a dangerous alternative

14.  2006 McGraw-Hill Ryerson Ltd. Continue the same course of action You may determine that the amount you have saved each month is still appropriate Expand the current situation You may choose to save a larger amount each month Change the current situation You may decide to use a money market account instead of a regular savings account Take a new course of action You may decide to use your monthly savings budget to pay off credit card debts

15.  2006 McGraw-Hill Ryerson Ltd. Step 3 Example Kent Mullins has several options available for the near future Work full time and save for graduate school Go to graduate school full time by taking out an additional loan Go to school part time and work part time. What additional alternatives might he consider?

16.  2006 McGraw-Hill Ryerson Ltd. STEP 4 EVALUATE YOUR ALTERNATIVES Evaluate possible courses of action, taking into consideration your life situation, personal values, and current economic conditions How will the ages of dependents affect your saving goals? How do you like to spend leisure time? How will changes in interest rates affect your financial situation?

17.  2006 McGraw-Hill Ryerson Ltd. CONSEQUENCES OF CHOICES Every decision closes off alternatives For ex: –A decision to invest in stock may mean you cannot take a vacation –A decision to go to school full time may mean you cannot work full time

18.  2006 McGraw-Hill Ryerson Ltd. Every Decision Has An Opportunity Cost (Trade-off) Opportunity cost is what you give up by making a choice The cost, referred to as the trade-off of a decision, cannot always be measured in dollars. Sometimes the cost is your time Consider lost opportunities that will result from your decisions. Evaluate the risks faced Refer to the money you forgo by attending school rather than working. Then the resources you give up (money or time) have a value that is lost 1-6

19.  2006 McGraw-Hill Ryerson Ltd. Decision making will be an ongoing part of your personal and financial situation Therefore, you will need to consider the lost opportunities that will result from your decisions Since decisions vary based on each person’s situation and values, opportunity costs will differ for each person

20.  2006 McGraw-Hill Ryerson Ltd. EVALUATING RISK Uncertainty is a part of every decision Selecting a college major and choosing a career field involve risk What if you don’t like working in this field or cannot obtain employment in it? Other decisions involve a very low degree of risk, such as putting money in an insured savings account or purchasing items that cost only a few dollars Your chances of losing something of great value are low in these situations

21.  2006 McGraw-Hill Ryerson Ltd. In many financial decisions, identifying and evaluating risk is difficult The best way to consider risk is to gather information based on your experience and the experiences of others and to use financial planning information sources Information is required at each stage of the decision-making process Changing personal, social, and economic conditions will require that you continually supplement and update your knowledge

22.  2006 McGraw-Hill Ryerson Ltd. Financial Planning Information Sources Printed materials Financial institutions School courses and educational seminars Computer software, World Wide Web, and on-line information sources Financial specialists 1-9

23.  2006 McGraw-Hill Ryerson Ltd. Financial Planning Information Sources

24.  2006 McGraw-Hill Ryerson Ltd. Step 4 Example As Kent Mullins evaluates his alternative courses of action, he must consider his income needs for both the short term and the long term He should also assess career opportunities with his current skills and his potential with advanced training What risks and trade-offs should Kent consider?

25.  2006 McGraw-Hill Ryerson Ltd. STEP 5 CREATE & IMPLEMENT FINANCIAL ACTION PLAN Involves developing an action plan that identifies ways to achieve your goals For ex, you can increase your savings by reducing your spending or by increasing your income through extra time on the job As you achieve your short-term/ immediate goals, the next priority goals will come to focus To implement your financial action plan, you may need assistance from others For example, you may use the services of an insurance agent to purchase property insurance or the services of an investment broker to purchase stocks, bonds, or mutual funds

26.  2006 McGraw-Hill Ryerson Ltd. Step 5 Example Kent Mullins has decided to work full time for a few years while he (1) pays off his student loans (2) saves money for graduate school (3) takes a couple of courses in the evening and on weekends What are the benefits and drawbacks of this choice?

27.  2006 McGraw-Hill Ryerson Ltd. STEP 6 REVIEW AND REVISE YOUR PLAN Financial planning is a dynamic process that does not end when you take a particular action You need to regularly assess your financial decisions You should do a complete review of your finances at least once a year Changing personal, social, and economic factors may require more frequent assessments

28.  2006 McGraw-Hill Ryerson Ltd. When life events affect your financial needs, this financial planning process will provide a vehicle for adapting to those changes Regularly reviewing this decision- making process will help you make priority adjustments that will bring your financial goals and activities in line with your current life situation

29.  2006 McGraw-Hill Ryerson Ltd. Step 6 Example Over the next 6 to 12 months Kent Mullins should reassess his financial, career, and personal situations What employment opportunities or family circumstances might affect his need or desire to take a different course of action?

30.  2006 McGraw-Hill Ryerson Ltd. Economic or Product Risk Interest Rate Risk Changing interest rates affect your costs when you borrow and your benefits when you invest Inflation Risk Rising prices cause lost buying power Liquidity risk Some investments may be more difficult to convert to cash or sell without significant loss in value Product Risk Products or services flawed or not meet your expectations Retailers may not honour their obligations 1-7

31.  2006 McGraw-Hill Ryerson Ltd. Personal Risk Risk of Death Premature death causes financial hardship to family members left behind Risk of Income Loss Income stops because of job loss, illness or accident Health Risk Poor health increases medical costs May reduce working capacity or life expectancy Asset and Liability Risk Assets stolen or damaged Sued for negligence or damages caused by your actions 1-8

32.  2006 McGraw-Hill Ryerson Ltd. Learning Objective # 2 Develop personal financial goals 1-10

33.  2006 McGraw-Hill Ryerson Ltd. Developing Personal Financial Goals Financial goals are influenced by Personal values and attitudes towards money (+ or -) Time frame in which you want to achieve your goals (How long) Type of financial need that drives your goals Your life situation 1-11

34.  2006 McGraw-Hill Ryerson Ltd. Developing Personal Financial Goals Timing of goals Short-term, intermediate and long-term goals. Goals for different financial needs Consumable products goals Food, clothing Durable product goals Appliances, cars, sporting equipment 1-12

35.  2006 McGraw-Hill Ryerson Ltd. Developing Personal Financial Goals – Your Life Situation Life Situation takes into consideration personal factors Age, income, marital status, household size, personal beliefs Influences your spending and savings patterns Social Changes Married at later age More households with two incomes Single parents Living longer 1-13

36.  2006 McGraw-Hill Ryerson Ltd. Developing Personal Financial Goals – Your Life Situation Other events that influence your life situation include Graduation Engagement and marriage Birth or adoption of a child Career change or move to a new area Dependant children leaving home Changes in health Divorce Retirement Death of spouse or other family member 1-14

37.  2006 McGraw-Hill Ryerson Ltd. Developing Personal Financial Goals Financial goals should... Be realistic Be stated in specific, measurable terms Have a time frame Indicate the type of action to be taken 1-15

38.  2006 McGraw-Hill Ryerson Ltd. Learning Objective # 3 Assess personal and economic factors that influence personal financial planning 1-16

39.  2006 McGraw-Hill Ryerson Ltd. Influences on Personal Financial Planning Market Forces Supply and demand Production costs and competition Financial institutions Influence of the Bank of Canada Global Influences Level of exports, foreign investors, competition Economic conditions.... Recession, Expansion Economic factors: the study of how wealth is created and distributed 1-17

40.  2006 McGraw-Hill Ryerson Ltd. Changing Economic Conditions Consumer Prices Inflation is a rise in the general level of prices Mainly caused by increase in demand without increase in supply Harmful to people on fixed incomes Can adversely affect people who lend money Rate of inflation varies 1-18

41.  2006 McGraw-Hill Ryerson Ltd. Changing Economic Conditions Consumer Spending Demand for goods and services influences employment opportunities Reduced spending causes unemployment Interest Rates Represent the cost of money Saving and investing increase the supply of money and interest rates decrease Borrowing increases demand and interest rates rise 1-19

42.  2006 McGraw-Hill Ryerson Ltd. Learning Objective # 4 Determine personal and financial opportunity costs associated with personal financial decisions 1-20

43.  2006 McGraw-Hill Ryerson Ltd. Opportunity Costs and Financial Results Evaluated When Making Decisions Personal Opportunity Costs (time, effort, health) Financial Opportunity Costs (Interest, liquidity, safety ) Financial Acquisitions (automobile, home, college education, investments, insurance, retirement fund) 1-21

44.  2006 McGraw-Hill Ryerson Ltd. Financial Opportunity Costs (discounting) Present Amount Now Future Value (compounding) Value Amount Later 1-22 Time Value of Money Increases in an amount of money as a result of interest earned Every time you spend, save, invest or borrow money you should consider the time value of money as an opportunity cost

45.  2006 McGraw-Hill Ryerson Ltd. How Simple Interest is Computed Simple Interest: interest compounded on the principal, excluding previously earned interest $100 x 6% x 1 (1 year) 100 x.06 x 1 = $6.00 In one year you have $106 1-23 (P) (r) (T) (I) Amount x Annual x Time = Interest in Savings Interest Rate Period

46.  2006 McGraw-Hill Ryerson Ltd. How Compound Interest is Computed Compound Interest: Interest that is earned on previously earned interest Each time interest is added to the principal, the next interest is computed on the new balance 1-24 1 st year: $100 x 6% x 1(year) = $106.00 2 nd year: ($100 + $6) x 6% x 1(year) = $112.36 3 rd year: ($106 + $6.36) x 6% x 1(year) =$119.10

47.  2006 McGraw-Hill Ryerson Ltd. Future Value of Money Is the amount to which current savings will increase based on certain interest rate and certain time period Calculations involve compounding since interest is earned on previously earned interest Can be computed for a single amount or a series of deposits Start investing now to take advantage of the future value of money 1-25

48.  2006 McGraw-Hill Ryerson Ltd. Present Value The current value of a future amount based on a certain interest rate and a certain time period Present value calculations are also called discounting Allows you to determine how much to deposit now to obtain desired future amount Can be computed for a single amount or a series of deposits 1-26

49.  2006 McGraw-Hill Ryerson Ltd. Learning Objective # 5 Identify strategies for achieving personal financial goals for different life situations 1-27

50.  2006 McGraw-Hill Ryerson Ltd. Components of Financial Planning Obtaining (chapter 1) Planning (chapters 2,3) Saving (chapter 4) Borrowing (chapters 5,6) Spending (chapter 7) Managing Risk (chapters 8,9) Investing (chapters 10-13) Retirement and Estate Planning (chapters 14,15) 1-28

51.  2006 McGraw-Hill Ryerson Ltd. Developing a Flexible Financial Plan A financial plan is formalized report that Summarizes your current financial situation Analyzes your financial needs Recommends future financial activities You financial plan can be created by you, done with assistance from a financial planner, or made using a money management software package 1-29

52.  2006 McGraw-Hill Ryerson Ltd. Implementing Your Financial Plan Develop good financial habits Use a spending plan to stay within your income, allowing you to save and invest for the future Have appropriate insurance protection to prevent financial disasters Become informed about tax and investment alternatives Achieving your financial objectives requires A willingness to learn Appropriate information sources 1-30

53.  2006 McGraw-Hill Ryerson Ltd. Chapter 1 - Appendix Financial Planners and Other Financial Planning Information Sources Current Periodicals Financial Institutions Courses & Seminars Personal Finance Software Spreadsheets Money Management & Financial Planning Programs Tax Software Investment Analysis Programs The Internet 1-31

54.  2006 McGraw-Hill Ryerson Ltd. Chapter 1 - Appendix Financial Planning Specialists Accountants Bankers Credit counselors Certified Financial Planners Insurance agents/brokers Investment Brokers Lawyers Real Estate Agents Tax Preparers 1-32

55.  2006 McGraw-Hill Ryerson Ltd. Chapter 1 - Appendix Financial planners are categorized based on the method of compensation 1. Fee-only planners 2. Fee-and-commission planners 3. Commission-only planners Do you need a financial planner? Your income Your willingness to make independent decisions 1-33

56.  2006 McGraw-Hill Ryerson Ltd. Summary of Learning Objectives Analyze the process for making personal financial decisions Determine current financial situation Develop financial goals Identify alternative courses of action Evaluate alternatives Create and implement a financial plan Re-evaluate and revise the financial plan 1-34

57.  2006 McGraw-Hill Ryerson Ltd. Summary of Learning Objectives Develop personal financial goals Goals should be realistic Be stated in specific, measurable terms Have a time frame Indicate the type of action to be taken Affected by person’s values, attitudes towards money and life situation 1-35

58.  2006 McGraw-Hill Ryerson Ltd. Summary of Learning Objectives Assess economic factors that influence personal financial planning Consumer prices Interest rates Employment opportunities 1-36

59.  2006 McGraw-Hill Ryerson Ltd. Summary of Learning Objectives Determine personal and financial opportunity costs associated with personal financial decisions Every decision involves a trade off Personal opportunity costs include time, effort and health Financial opportunity costs based on time value of money Future and present value calculations measure increased value or lost interest from saving, investing, borrowing or purchasing decisions 1-37

60.  2006 McGraw-Hill Ryerson Ltd. Summary of Learning Objectives Identify strategies for achieving personal financial goals for different life situations Requires specific goals combined with spending, saving, investing and borrowing strategies Based on your personal life situation and various social and economic factors 1-38