Chapter 1: personal finance

Financial Planning process

1. Determine current financial situation 2. Develop financial goals 3. Identify alternative courses of action 4. Evaluate alternatives 5. Create and Implement financial action plan 6. Review and revise plan

Financial plan

A formalized report that summarizes your current financial situation, analyzes your financial needs, and recommends future financial activities

Inflation

A rise in the general level of prices

Bankruptcy

A set of federal laws allowing you to either restructure your debts or remove certain debts

What personal and economic factors commonly affect personal financial decisions?

Age; Martial Status; Number and Age of Household members; Employment situation

4. Evaluate alternatives

Assess: risk and time value of money (opportunity cost) Consider: life situation, personal values, and economic factors

2. Develop financial goals

Differentiate needs from wants

Values

Ideas and principles that a person considers correct, desirable, and important

Time value of money

Increase in an amount of money as a result of interest earned

Common risks

Inflation risk- rise or fall of prices Interest rate risk- changes in cost of money Income risk- loss of job or illness Personal risk- tangible and intangible factors Liquidity risk- savings and investments have potential for higher earnings difficult to convert or sell

What are the eight main components of personal finance planning?

Obtaining; Planning; Saving; Borrowing; Spending; Managing Risk; Investing; Retirement and Estate Planning

Opportunity cost

What a person gives up by making a choice

3. Identify alternative courses of action

continue the same course of action (ex: amount saved each month is still appropriate) expand current situation (ex: save larger amount each month) change the current situation (ex: use money market account instead of savings account) take a new course of action (ex: use monthly saving budge to pay off bills)

Examples of personal opportunity cost

time; energy; health, abilities; knowledge

1. Determine current financial situation

Regarding income, savings, living expenses, and debts Prepare a list of current assets and debt balances and amounts spent for various items

What are the main characteristics of useful financial goals?

S- specific M- measurable (ex: Accumulate $5,000 in an investment fund within 3 years) A- action-oriented (ex: Reduce credit card debt) R- realistic (goals based on income and life situation) T- time-based (ex: 3 years)

Types of financial goals

Short-term goals: within next year Intermediate goals: two to five years Long-term goals: more than five years

Future value

The amount to which current savings will increase based on a certain interest rate and a certain time period; also referred to as compounding

Present value

The current value for a future amount based on a certain interest rate and a certain time period; also referred to as discounting

Personal financial planning

The process of managing your money to achieve personal economic satisfaction

Adult life cycle

The stages in the family situation and financial needs of an adult

Economics

The study of how wealth is created and distributed