Personal Finance: Chapter 1
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 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 plan 6) revise your plan
Why do most people need access to financing at some point in their life?
Most people don't have the savings available to purchase big ticket items such as a house or a car. Therefore in order to acquire some of these items they must borrow money or finance the purchase.
Define personal financial planning. What types of decisions are involved in 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.
What is the primary objective of investing? What else must be considered? What potential investment vehicles are available?
The primary objective to 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 is the next step after your financial plan has been implemented?
You must monitor your plan to ensure you are following the plan
How is your net worth calculated? Why is it important?
Your net worth is your assets minus your liabilities. You can measure your wealth by your net worth, and budgeting strategies can help you increase your net worth and thereby your wealth.
credit management
decisions regarding how much credit to obtain to support your spending and which sources of credit to use
money management
decisions regarding how much money to retain in a liquid form and how to allocate the funds among short-term investment instruments
retirement planning
determining how much money you should 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
insurance planning
determining the types and amount of insurance needed to protect your assets
What is an opportunity cost? What might be some of the opportunity costs of spending $10 each week on the lottery?
An opportunity cost is what you forgo as a result of a decision. Some of the opportunity costs of spending $10 on lottery tickets might be not eating out for lunch once a week, reducing debt an additional $40 per month, or having $520 in savings at the end of the year.
How can an understanding of personal finance benefit you?
An understanding of personal finance enables you to make more informed decisions about your financial situation. You would be able to better judge the advice of financial advisers. You might even pursue a career as a financial adviser.
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 you spend money on it will be impossible to forecast all of your expenses.
How does each element of financial planning affect your cash flow?
Budgeting focuses on cash inflows and 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. Investing focuses on using cash to build wealth.
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.
What are three elements of planning to protect your assets?
Insurance, retirement, and estate
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.
Personal financial plan
a plan that specifies your financial goals and describe the spending, financing, and investing plans that are intended to achieve those goals
liquidity
access to funds to cover any short-term cash deficiencies
Factors that affect your current financial position?
level of debt, marital status, family responsibility, age, career, and level of education
budget planning
the process of forecasting future expenses and savings
Personal finance
the process of planning your spending, financing, and investing to optimize your financial situation
net worth
the value of what you own minus the value of what you owe
risk
uncertainty surrounding the potential return on an investment
liabilities
what you owe; your debt
assets
what you own
Opportunity cost
whatever must be given up to obtain some item
