Personal Finance Chapter 1

Step 4 in the Financial Planning Process

EVALUATE YOUR ALTERNATIVES. CONSEQUENCES OF CHOICES. Opportunity cost: What you give up by making a choice. -The cost, or trade-off of a decision, cannot always be measured in dollars. -May refer to the value of money or time that you give up. -Decision-making will be an ongoing part of one's life. -Consider the lost opportunities that will result from each decision.

Goal Frequency

Some goals (like vacations) may occur annually, while other goals like tuition fees occur less frequently

Consumer Spending

Total demand for goods and services in the economy influences employment opportunities and the potential for income.

Risk Premium

The rate of return that financial investors require to hold risky assets minus the rate of return on safe assets

Investing

current income: pay regular dividends or interest long-term growth: stocks, mutual funds, real estate investment diversification can be shown in a portfolio

Personal Financial Planning

the process of managing your money to achieve personal economic satisfaction

Time Value of Money

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

Debt Securities

Represent money borrowed by companies or the government (such as bonds)

Security

financial instrument that represents debt or equity

Interest Rate Risk

(1) changing interest rates affect your costs (when you borrow) and your benefits (when you save or invest); and (2) borrowing at a low interest rate when interest rates are rising can be to your advantage. Variable rate loans may increase, resulting in higher payments. If you save when interest rates are dropping, you will earn a lower return with a six-month savings certificate than with a certificate having a longer maturity.

Inflation Risk

(1) rising or falling (deflation) prices cause changes in buying power; and (2) deciding whether to buy something now or later. If you buy later, you may have to pay more.

Income Risk

(1) the loss of a job may that results from changes in consumer spending or expanded use of technology; and (2) how individuals who face the risk of unemployment need to save while employed or acquire skills they can use to obtain a different type of work.

Financial Plan

A financial plan is a formalized report that... -Summarizes your current financial situation. -Analyzes your financial needs. -Recommends future financial activities. -Your financial plan can be created by you, with assistance from a financial planner, or made using a money management software package.

Step 5 in the Financial Planning Process

CREATE AND IMPLEMENT YOUR FINANCIAL ACTION PLAN. -Develop an action plan that identifies ways to achieve financial goals. -Possible action plans can be increasing savings, reducing spending, increasing income by working extra hours, or making provisions for taxes. -To implement action plans you may need assistance from others (like insurance agents)

Step 1 in the Financial Planning Process

DETERMINE YOUR CURRENT FINANCIAL SITUATION. -Evaluate income, savings, living expenses, and debts. -Prepare a list of current asset and debt balances and amounts spent for various items. -Match financial goals to current income and potential earning power.

Rule of 72

Divide 72 by the annual inflation (or interest) rate. Example: An annual inflation rate of 4% means prices (or your savings) will double in 18 years (72/4 = 18).

Personal Opportunity Costs

Every financial decision involves giving up something to obtain something you consider more desirable. Personal resources, like financial resources, require careful management. Example time, energy, health, abilities, knowledge.

Personal Inflation

Everyone has their own weighting of spending so for example someone who spends on something that's price has increased will see their inflation ^ and vice versa

Annuity

Future value can be computed for a single amount or for a series of deposits (or payments) called an annuity.

Step 3 in the Financial Planning Process

IDENTIFY ALTERNATIVE COURSES OF ACTION. Common courses of action include: -Continue the same course of action. -Expand the current situation. -Change the current situation. -Take a new course of action. Creativity in decision making is vital for effective choices. Electing to "do nothing" can be a dangerous alternative.

Values

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

The Financial System and Economic Factors

In the financial system, providers (that is, savers, investors) of funds include individuals, businesses, governments, and foreign entities. Funds flow from them to either financial intermediaries or financial markets, between which funds also move in both directions. Financial intermediaries include banks, credit unions, insurance companies, investment companies, and other financial institutions. Funds then move on from financial intermediaries and financial markets to users (i.e., borrowers and spenders) of funds, which include individuals, businesses, governments, and foreign entities. The financial system is regulated by the Federal Reserve System, Federal Deposit Insurance Corporation, National Credit Union Administration, Office of the Comptroller of the Currency, Consumer Financial Protection Bureau, Securities and Exchange Commission, state banking agencies, and state insurance agencies.

Components of Personal Financial Planning

Obtaining (Chapter 2, employment, investments, ownership of business, this is the foundation of financial planning). Planning (Chapters 3, 4 anticipate expenses and financial decisions). Saving (Chapter 5, save regularly first and then make other investments). Borrowing (Chapters 6, 7, be wise with spending and borrowing). Spending (Chapters 8, 9, spend less than you earn). Managing risk (Chapters 10 to 12, you need adequate insurance). Investing (Chapters 13 to 17). Retirement and estate planning (Chapters 18, 19, transfer of money or property to others should be timed).

Achieving Financial Goals

Part 1 covers planning your personal finances with obtaining (Chapter 2) and planning your finances (Chapters 3 and 4); part 2 covers managing your personal finances with chapters on saving (Chapter 5) and borrowing (Chapters 6 and 7); part 3 covers making your purchasing decisions, that is, by spending (Chapters 8 and 9); part 4 covers insuring your resources by managing risk (Chapters 10 through 12); part 5 covers investing your financial resources (Chapters 13 through 17); and part 6, controlling your financial future with retirement and estate planning (Chapters 18 and 19).

Opportunity Costs and the Time Value

Personal opportunity costs (that is, time, effort, health) and financial opportunity costs (that is, interest, liquidity, safety) should be assessed before making financial assessments (for example, automobile, home, college education, investments, insurance coverage, or retirement fund).

Step 6 in the Financial Planning Process

REVIEW AND REVISE YOUR PLAN. -Financial planning decisions need to be assessed regularly. -A complete review should be done at least once a year. -More frequent reviews may be required for changing personal, social, and economic factors. -Regular reviews of decision-making process can help in making priority adjustments to achieve financial goals.

Equity Securities (stock)

Represent ownership in a corporation

Interest Rates

Represent the cost of money.

Trade Deficit

Situation in which a country imports more than it exports

Liquidity

The ability to readily convert financial resources into cash without a loss in value

Bankruptcy

The legal status of a person who is not able to pay debts owed

Interest Calculations

Three amounts are required to calculate the time value of money: -Principal (the amount of savings). -Interest rate (annual). -Time period.

Opportunity Cost

What you give up by making a choice

Deflation

a decline in prices, can also have damaging economic effects.

Consumer Price Index

the measure of average change in the prices urban consumers pay for a fixed "basket" of goods and services

Economics

the study of how wealth is created and distributed. -Forces of supply and demand on setting prices. -The economic environment includes various institutions (businesses, labor, government) -Federal Reserve Bank has significant economic responsibility (they influence borrowing, interest rates, and the buying/selling of government securities). They make adequate funds available for consumer spending and business expansion while keeping interest rates and consumer prices at appropriate levels.

Three Main Decision Areas

1. Spending (daily expenses, leisure) 2. Saving (for emergencies, long term) 3. Sharing (for donating)

Financial Planning Information Sources

To minimize risk, gather relevant information from print media sources, financial institutions, and financial specialists. 1. Media 2. Financial Institutions (banks, credit unions, etc.) 3. Financial Specialists (financial planners, bankers, etc.)

Personal Risk

many factors that can create a less than desirable situation. For example, purchasing a certain brand or from a certain store may create the risk of having to obtain repairs at an inconvenient location. Personal risk may also take the form of health risks, safety risks, or additional costs associated with various purchases or financial decisions.

Financial Goals

-Can be influenced by the time frame in which you want to achieve your goals -Can be influenced by the type of financial need that drives your goals.

Goals for Different Financial Needs

-Consumable-product goals (items used up relatively quickly like food, clothing, or entertainment) -Durable-product goals (infrequently purchased but more expensive items like appliances) -Intangible-purchase goals (personal relationships, health, etc.)

Path to Financial Security

-Do something. -Save for emergencies and the future. -Maintain a low level of debt. -Have a risk management plan. -Avoid excuses. Rate your current situation. -Set your mission. -Develop a personal finance mission statement.

Financial Opportunity Costs

-Financial choices depend on current needs, future uncertainty, and current interest rates. -Time Value of Money: Increases in an amount of money as a result of interest earned. -Saving (or investing) today means more money tomorrow. Spending means lost interest. -Saving and spending decisions involve considering the trade-offs. Current needs can make spending worthwhile.

Methods for Calculating Time Value of Money

-Formula calculation. -Time value of money tables. -Financial calculator. -Spreadsheet software. -Websites and apps.

Future Value

The amount to which current savings will increase based on a certain interest rate and a certain time period.

Hidden Inflation

The cost of necessities (food, gas, health care) may rise at a higher rate than the cost of nonessential items.

Advantages of Personal Financial Planning

-Increased effectiveness in obtaining, using, and protecting financial resources. -Increased control of one's financial affairs by avoiding excessive debt, bankruptcy, and dependence on others. -Improved personal relationships. -Enhanced freedom from financial worries obtained by looking to the future, anticipating expenses, and achieving personal economic goals.

Present Value

-Present value is 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. -The present value of the amount you want in the future will always be less than the future value. -Present value can be computed for a single amount or for a series of deposits.

Timing of Goals

-Short-term (within the next year). -Intermediate (one to five years). -Long-term (more than five years). -Long-term goals should be planned in coordination with short-term and intermediate goals.

SMART Goals

-Specific: know exactly what your goals are to create a plan. -Measurable: with a specific amount. -Action-oriented: identify the personal financial activities you will undertake. -Realistic: utilizing your income and life situation. -Time-based: identify the time frame to achieve the goal.

Consumer Prices

-The buying power of a dollar; inflation. -If consumer prices increase faster than income, you are not able to purchase the same amount of goods and services; higher consumer prices often cause higher interest rates.

Interest Rates

-The cost of money; the cost of credit when you borrow; the return on your money when you save or invest. -Higher interest rates make buying on credit more expensive; higher interest rates make saving and investing more attractive and may discourage borrowing. -less borrowing means less interest, while more borrowing means high interest

Consumer Spending

-The demand for goods and services by individuals and households. -Increased consumer spending usually creates more jobs and higher wages; high levels of consumer spending and borrowing may push up consumer prices and interest rates.

Trade Balance

-The difference between a country's exports and its imports. -If a country has more exports than imports, the balance of trade deficit can result in price changes for foreign goods.

Money Supply

-The dollars available for spending in our economy. -Interest rates tend to decline as more people save and invest; but higher saving (and lower spending) may also reduce job opportunities.

Housing Starts

-The number of new homes being built. -Increased home building creates jobs, higher wages, more consumer spending, and overall economic expansion.

Unemployment

-The number of people without employment who are willing and able to work. -Unemployed people should reduce their debt level and have an emergency fund; high unemployment reduces consumer spending and job opportunities.

Dow Jones Average, S&P 500, other stock market indexes

-The relative value of stocks represented by the index. -These indexes provide an indication of the general movement of stock prices.

Adult Life Cycle

-The stages in the family and financial needs of an adult -Marital status, household size, and employment, as well as major events such as graduation, engagement, career change, children, retirement, etc.

Gross Domestic Product

-The total value of goods and services produced within a country's borders, including items produced with foreign resources. -GDP is an indication of a nation's economic viability, resulting in jobs and opportunities for increased personal wealth.

Evaluating Risk

-Uncertainty is a part of every decision. Some decisions have high risks and some have low. -Consider inflation risk, interest rate risk, income risk, personal risk, and liquidity risk.

Inflation

-a rise in the general level of prices -the buying power of the dollar decreases -harmful to people living in fixed incomes (such as retired people) -it negatively affects lenders in that the dollars you pay the lender has less buying power

Compounding

-earning interest on previously earned interest -Compounding allows for the future value of a deposit to grow faster than it would if interest were paid only on the original deposit. -For example: $100 deposited in a 6 percent account for one year will grow to $106. This amount is computed as follows: Future value (FV) = ($100 × 0.06 × 1 year) = $106

Liquidity Risk

Although some savings and investments have potential for higher earnings, they may be more difficult to convert to cash or to sell without significant loss in value.

Computing Simple Interest

Amount in savings × annual interest rate × time period = interest amount. For Example: $500 × 6% × 6 months/12 months = $500 × .06 × ½ year = $15.00 In six months, a $500 deposit (principal) will earn $15.00 interest. Therefore, you will have a total of $515 at the end of six months.

Step 2 in the Financial Planning Process

DEVELOP FINANCIAL GOALS. -Identify feelings about money and the reasons for those feelings. -Determine the source of your feelings about money (facts or influence of others). -Determine the basis of your financial priorities (social pressures, household needs, or desires). -Decide on specific financial goals to pursue for your situation. -Separate needs from wants

Implementing Your Financial Plan

Develop good financial habits. -Use a well-conceived spending plan that helps you stay within your income while allowing you to save and invest for the future. -Have appropriate insurance protection to prevent financial disasters. -Become informed about taxes and investments to expand your financial resources.

Global Influences

Global economy influences personal finance. -American companies compete against foreign companies for US dollars. -Balance of exports and imports. -Foreign investments and their role in the US money supply. -A trade deficit also affects the value of a nation's money and the cost of items being purchased by consumers.

Learning Standards

LO1-1 Analyze the process for making personal financial decisions. LO1-2 Assess personal and economic factors that influence personal financial planning. LO1-3 Develop personal financial goals. LO1-4 Calculate time value of money to analyze personal financial decisions. LO1-5 Identify strategies for achieving personal financial goals for different life situations.

Opportunity Costs and the Time Value of Money

Personal opportunity costs (that is, time, effort, health) and financial opportunity costs (that is, interest, liquidity, safety) should be assessed before making financial assessments (for example, automobile, home, college education, investments, insurance coverage, or retirement fund).