Chapter 1, Overview of a Financial Plan

What are the six key components of a financial plan?

(1) Budgeting and tax planning (2) Managing your liquidity (3) Financing your large purchases (4) Protecting your assets and income (insurance) (5) Investing your money (6) Planning your retirement and estate

What are the six steps in developing a financial plan?

(1) Establish your financial goals. (2) Consider your current financial condition. (3) Identify and evaluate alternative plans that could achieve your goals. (4) Select and implement the best plan for achieving your goals. (5) Evaluate your financial plan. (6) Revise your financial plan.

Explain why it is important to select the right university or college.

. College tuition rates vary significantly depending on a number of factors such as whether it is a public or private university. Some tuition totals for a four-year degree can reach $200,000. In addition to the cost, you need to focus on schools that have good programs for the major you have selected.

Ricardo wants a career where he can help people. He also wants to travel and see the world. He is thinking about becoming a personal care aide. What advice would you give him?

. Ricardo will need a career that generates enough income to achieve his goal of traveling. If you review Exhibit 1.7 you will see that there are several careers that will combine his interests with his personal goal and provide the income needed to travel. Ricardo might also decide to revise his personal goal of seeing the world to one that is less expensive.

What are the three elements of planning to protect your assets? Define each element.

A plan to protect your assets requires insurance planning, retirement planning, and estate planning. Insurance planning involves determining the types of insurance you need such as health, automobile, and life. Insurance reimburses you for damages to your assets, limits your exposure to potential liabilities, or protects your income. Retirement planning involves determining how much money you should set aside each year for retirement. Retirement planning must begin well before you retire so that you can accumulate sufficient money to invest and use after you retire. Estate planning is the act of planning how your estate will be distributed after you die. Effective estate planning can protect your wealth against unnecessary taxes and ensure that your wealth is distributed to your family in the manner that you desire.

How can an application of personal finance skills increase your wealth?

Applying personal finance skills can help you increase your wealth in numerous ways. For example, identifying financial goals and writing down steps needed to achieve those goals increase the likelihood that you will accomplish your goals. Understanding the time value of money and employing budgeting techniques to increase savings early on helps you amass wealth over time.

Why is it important to track your spending before creating a budget?

Budget planning is the process of forecasting future expenses and savings. It involves evaluating your current financial position by assessing your income, your expenses, your assets, and your liabilities. Until you know what money you spend on it will be impossible to forecast all of your expenses. Many of you will be surprised when you find out how much you spend on eating out or snacks.

How does each element of financial planning affect your cash flows?

Budgeting focuses on the relationship between your income (cash inflows) and spending (cash outflows). Liquidity management focuses on depositing excess cash or obtaining credit if you are short on cash. Financing focuses on obtaining cash to support large purchases. Protecting your assets focuses on using some of your cash to purchase varying types of insurance. Investing focuses on using some of your cash to build wealth. Planning your retirement and estate dictates the wealth that you will accumulate by the time you retire and its distribution before or after your death.

During a weak economy, jobs are scarce, so some individuals may consider starting their own businesses. What is the disadvantage of this idea during a weak economy?

Consumer spending is reduced during a weak economy, so the demand for the products or services produced in a new business might be limited. Thus, the business might not achieve a sufficient level of sales to survive.

How can an understanding of personal finance enhance your job marketability?

Decisions that managers make are very similar to personal finance decisions where you analyze the costs and benefits of each decision. You are practicing self-management skills when you apply personal finance techniques. You can utilize these skills whether working for others or starting your own business. You might also decide to pursue a career in finance.

How can your post-high school education decisions affect your wealth?

Different careers generate different levels of income initially, and over time. Careers also require varying types of credentials that can often take years to acquire. Post-high school education decisions need to combine your strengths and interests with an understanding of the costs and benefits.

How does your choice of major affect your financial plan?

Different careers vary widely with respect to lifetime earnings. Since one of the primary determinants of your financial plan is income, it is extremely important to select a major (i.e., career) that should generate enough income to achieve your goals.

What factors influence income? Why is an accurate estimate of expenses important in budget planning? How do tax laws affect the budgeting process?

Income is influenced by education and career decisions. If expenses are not accurately estimated, it may be difficult to reach savings goals. Many financial decisions are affected by tax laws, such as certain types of income being taxed at a higher rate than others. Knowledge of tax laws allows you to make more favorable choices.

What is liquidity? What two factors are considered in managing liquidity? How are they used?

Liquidity means having sufficient funds to cover short-term cash deficiencies. In managing your liquidity, you consider money management and credit management. Money management means deciding how much money to retain in liquid form and how much to invest. Credit management deals with the decisions you make on the amount of credit to use to support your spending.

Why do most people need access to financing at some point in their lives?

Most people do not have the saving available to purchase big ticket items such as a house or a car. Therefore, in order to acquire these items they must borrow money, or finance these items, and repay it over time.

Once your financial plan has been implemented, what is the next step? Why is it important?

Once you have developed and implemented a plan, you must monitor it. Monitoring the plan will ensure that you are following the plan and that the plan is working as intended.

What are some possible disadvantages of using online sources of personal finance information?

Online resources may be from credible sources or they may present false or misleading information. Also, you need to understand that free personal finance advice found online does not necessarily apply to everyone's personal situation.

How can peer pressure affect your spending habits?

Peer pressure can cause you to make impulse purchases and spend beyond your means. This in turn impacts your ability to save and invest for future needs.

Define personal financial planning. What types of decisions are involved in a personal financial plan?

Personal financial planning is the process of planning your spending, financing, and investing in order to optimize your financial situation. A personal financial plan involves decisions about financial goals and describes the spending, financing, and investing plans necessary to achieve those goals.

Name some factors that might affect your current financial position.

Some factors that might affect your current financial position are: your level of debt, your marital status and family responsibility, your age and level of wealth accumulated, your career choice, and your level of education.

What is the primary objective of investing? What else must be considered? What potential investment vehicles are available?

The primary objective of investing is to use funds not needed for liquidity purposes to earn a high return. Most investments also carry an amount of risk. Potential investments include stocks, bonds, mutual funds, and real estate.

What are some ways you can lower the cost of a college education?

You can opt to live at home and attend a nearby university or college, attend a public school instead of a private school, or attend a two-year community college and then transfer to another institution to finish your degree after earning an associate's degree.

Why might you need to revise your financial plan?

You may find you need to revise the plan to make it more realistic. In addition, your life circumstances and financial condition may change. As your financial conditions change, your goals may change, especially as the result of specific events such as graduating college, getting married,or the birth of a child.

Assume that you have established a plan to achieve a particular level of wealth in three years, but economic conditions suddenly cause both your existing income and the value of your existing assets to decline. Should you leave your financial plan as it is, or adjust it?

You should change your plan because your goals may be unrealistic due to the weaker economic conditions

Jill has decided to save 50% of her income for retirement. Her father told her she needed to set a different goal. Why do you think he gave her this advice?

Your goals are where you want to be, and your current financial position is where you are. Your alternative financial plans will "map" how to get from one position to the other. However, for goals to be effective they must be realistic. In most cases saving 50% of your income is not a realistic goal.

How do your financial goals fit into your financial plan? Why should goals be realistic? What are three time frames for goals? Give an example of a goal for each time frame.

Your goals will influence the amount of money and the timing you need to achieve the goals. If goals are not realistic, they will be very difficult to accomplish, and you will become discouraged and lose interest in planning. Short-term goals are those to be accomplished in less than a year such as saving $500 for Christmas gifts. An intermediate goal takes from one to five years to accomplish, such as paying off a three-year note. A long-term goal takes more than five years to accomplish;an example is saving for retirement in a set number of years.

How is your net worth calculated? Why is it important?

Your net worth is your assets (what your own) minus your liabilities (what you owe). You can measure your wealth by your net worth, and budgeting strategies can help you increase your net worth and thereby your wealth. For example, you can build your net worth by setting aside part of your income to invest in additional assets or reduce your liabilities.