Pesonal finance 6th madura chapter 01 overview of a financial plan

All Rights ReservedDefinitions • Personal finance: the process of planning your spending, financing, and investing to optimize your financial situation • Personal financial plan: a pla

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Personal Finance

SIXTH EDITION

Chapter 1

Overview of a Financial Plan

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Definitions

• Personal finance: the process of planning your

spending, financing, and investing to optimize

your financial situation

• Personal financial plan: a plan that specifies your

financial goals and describes the spending,

financing, and investing plans that are intended to achieve those goals

• Opportunity cost: what you give up as a result of a

decision

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How You Benefit from an Understanding

of Personal Finance

• Make your own financial decisions

– Every spending decision has an opportunity

cost

• Judge the advice of financial advisors

– Make informed decisions

• Become a financial advisor

– Many career opportunities available

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Components of a Financial Plan

• Budgeting and tax planning

• Managing your liquidity

• Financing your large purchases

• Protecting your assets and income (insurance)

• Investing your money

• Planning your retirement and estate

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A Plan for Your Budgeting and Tax

Planning

• Budget planning: The process of forecasting

future expenses and savings

– Evaluate your current financial position

 Assets: what you own

 Liabilities: what you owe

 Net worth: the value of what you own minus the value of what you owe

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Budget and Tax Planning

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A Plan to Manage Your Liquidity (1 of 2)

• Liquidity: access to funds to cover any short-term

cash deficiencies

• Money management: decisions regarding how

much money to retain in a liquid form and how to allocate the funds among short-term investment instruments

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A Plan to Manage Your Liquidity (2 of 2)

• Credit management: decisions regarding how

much credit to obtain to support your spending and which sources of credit to use

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Managing Your Liquidity

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A Plan for Your Financing

 How much can you afford to borrow?

 Determining maturity of the loan

 Selecting a loan with a competitive interest rate

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Financing Your Large Purchases

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A Plan for Protecting Your Assets and Income

• Insurance planning: Determining the types and amount of insurance needed to protect your

assets

– Health insurance limits potential medical expenses

– Disability and life insurance protect your income

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A Plan for Your Investing

• Any funds beyond what you need to maintain

liquidity should be invested

– Primary objective to earn a high return

– Potential investments include stocks, bonds, mutual

funds and real estate

– Risk: uncertainty surrounding the potential return on an

investment

– Manage investments to keep risk at a tolerable level

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A Plan for Your Retirement and Estate

• This includes insurance planning, retirement

planning, and estate planning

should be set aside each year for retirement and how you should invest those funds

– Estate planning: determining how your wealth will be distributed before or upon your death

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Building Your Own Financial Plan

• Enhances your net worth

• Builds your wealth

• All components of your financial plan affect your

cash inflows and outflows and how much cash you have available

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How Financial Plan Decisions Affect Your Cash Flows (1 of 13)

• How the components relate to your cash flows

– Cash inflows are cash that you receive

– Cash outflows are cash that you spend

– Liquidity deals with cash excesses or shortages

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How Financial Plan Decisions Affect

Your Cash Flows (2 of 13)

• Part 1 – Tools for Financial Planning College

tuition, car, house

– Budgeting allows you to plan how you will use the cash

you receive in a given period

 How much should you work this month (if your employer allows flexibility)?

the amount of your cash outflows each month

 What products or services should you purchase this month?

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• Part 2 – Managing Your Liquidity

– If you have excess cash this month, how much cash should you add to your checking or saving account?

– If you have a cash deficiency this month, how much

cash should you withdraw from your checking or savings account?

– If you have a cash deficiency this month, how much credit should you use from credit cards or other

sources?

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• Part 3 – Personal Financing

– Should you lease a car?

– How long a period will you need to borrow funds? – What is the ideal source from which you will borrow

funds?

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• Part 4 – Protecting Your Wealth

– What types of insurance do you need?

– How much insurance should you purchase to protect

your assets?

– How much insurance should you purchase to protect

your income?

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• Part 5 – Personal Investing

– How much risk should you tolerate when making

investments?

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• Part 6 – Retirement and Estate Planning

retirement each month?

– What types of investments should you make for your

retirement accounts?

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Summary of Financial Plan Components (1 of 3)

• Notice how the financial plan components are

integrated

• Each component can be a source of cash or a use

of cash

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• Summary of sources of cash from each

component

– Attempt to work more hours (Part 1)

– Withdraw cash from savings (Part 2)

– Obtain a loan (Part 3)

– Cash in an insurance policy (Part 4)

– Sell some of your investments (Part 5)

– Withdraw funds from your retirement account (Part 6)

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• Summary of uses of cash

– Purchase products and services (Part 1)

– Deposit cash in your checking or savings account (Part 2) – Pay interest payments on a loan or pay off a loan (Part 3) – Make insurance payments (Part 4)

– Make new investments (Part 5)

– Contribute toward your retirement account (Part 6)

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How Financial Planning Relates to Cash Flow

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Integration of the Financial Plan

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Integration of the Financial Plan

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How Psychology Affects Your Financial Plan (1 of 3)

• Psychology has a major impact on human behavior

and decision making

• Psychology has a major impact on spending

behavior and ability to implement an effective

financial plan

• Consider two different types of spending behavior

– Focus on immediate satisfaction and peer pressure

– Focus on the future

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• Assess your own spending behavior

– Do you pay rent for a single apartment rather than share

an apartment?

– Do you have credit card bills that you only make the

minimum monthly payment toward each month?

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– Do you spend all of your income that is not needed for

rent or car loans payments within the first day or two of receiving your paycheck?

– Do you always find a reason each month to spend all of

your income?

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Developing the Financial Plan (1 of 15)

• Step 1 Establish Your Financial Goals

– Types of financial goals

 Car, home, college, wealth, charity – Set realistic goals

 Stronger likelihood of reaching goals – Timing of goals

 Short term (within one year)

 Intermediate (between 1–5 years)

 Long term (beyond five years)

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• Step 2 Consider Your Current Financial Position

– How your future financial position is tied to your education

 Consider your skills, interests, and career paths – How your future financial position is tied to your career

choice

 Choose a career that will be enjoyable and suit your skills

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– How your future financial position is tied to the economy

 Economic conditions affect types of jobs available, salaries offered, price of services, value of assets

 Financial crisis of 2008-2009 affected financial positions in many ways

– Reduction in new job opportunities

– Elimination of some jobs

– Lower salaries for existing jobs – Value of many assets declined

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EXHIBIT 1.7 Fastest-Growing Occupations

Occupation Growth Rate Over the 2012–2022 Period Annual Median Pay

Industrial organizational psychologist 53% $83,580

Personal care aides 49% $19,190

Interpreters and translators 46% $45,430

Diagnostic medical sonographers 46% $65,860

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EXHIBIT 1.7 Fastest-Growing Occupations

Occupation Growth Rate Over the 2012–2022 Period Annual Median Pay

Physical therapy aides 40% $23,880

Skincare specialists 40% $28,640

Physician assistants 38% $90,930

Helpers for electricians 38% $27,670

Information security analysts 37% $86,170

Occupational therapy aides 36% $26,850

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• Step 3 Identify and Evaluate Alternative Plans That Could Achieve Your Goals

– Plans could be conservative or aggressive

• Step 4 Select and Implement the Best Plan for

Achieving Your Goals

– The Internet has valuable financial planning information

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Using the Internet to Facilitate Financial Planning (1 of 2)

• Provides updated information on all parts of your

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Using the Internet to Facilitate Financial Planning (2 of 2)

• Online calculators

– Estimating taxes

– Determining how your savings will grow over time

– Determining whether buying or leasing a car is more

appropriate

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• Focus on Ethics: Personal Financial Advice

– Your objective is to get the best advice appropriate to your needs

– Be wary of unethical behavior

 Difficult to discern – Be wary of incompetent advice

 Be alert, ask questions, carefully consider advice

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• Step 5 Evaluate Your Financial Plan

– Keep plan in an accessible place and monitor your

progress

• Step 6 Revise Your Financial Plan

– Change plan as financial condition and financial goals

change

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EXHIBIT 1.8 Summary of Steps Used to Develop a Financial Plan

1 Establish your financial goals

 What are your short-term financial goals?

 What are your intermediate-term financial goals?

 What are your long-term financial goals?

2 Consider your current financial position

 How much money do you have in savings?

 What is the value of your investments?

 What is your net worth?

3 Identify and evaluate alternative plans that could achieve your goals

 How can you obtain the necessary funds to achieve your financial goals?

 Will you need to reduce your spending to save more money each month?

 Will you need to make investments that generate a higher rate of return?

4 Select and implement the best plan for achieving your goals

 What are the advantages and disadvantages of each alternative plan that could be used to achieve your goals?

5 Evaluate your financial plan

 Is your financial plan working properly? That is, will it enable you to achieve your financial goals?

6 Revise your financial plan

 Have your financial goals changed?

 Should parts of your financial plan be revised to achieve your financial goals? If so, how?

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Step 1 Financial Goals:

I would like to:

 buy a new car within a year,

 buy a home within two years,

 make investments that will allow my wealth to grow over time, and

 build a large amount of savings for retirement in 20 to 40 years.

Step 2 Current Financial Position:

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Step 3 Plans to Achieve the Goals:

Since my current financial position does not provide me with sufficient funds to achieve these financial goals, I need to develop a financial plan for achieving these goals I want to save enough money to make a down payment on the car and home and to obtain financing to cover the rest of the cost This plan allows me to allocate some of my income toward

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Step 4 Selecting and Implementing the Best Plan:

Financing the purchase of a car and a home is a more appropriate plan for me I will prepare a budget so that over time I can accumulate

savings that will be used to make a down payment on a new car Then, I will attempt to accumulate savings to make a down payment on a new home I need to make sure that I can afford financing payments on any money that I borrow.

Step 5 Evaluating the Plan:

Once I establish a budget, I will monitor it over time to determine whether

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Step 6 Revising the Plan:

If I cannot save as much money as I desire, I may have to delay my

plans for purchasing a car and a home until I can accumulate enough funds to make the down payments If I am able to exceed my savings goal, I may be able to purchase the car and the home sooner than I had originally expected.

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