Personal Finance Basics and the Time Value of Money

What Is the typical time frame for an intermediate goal?

1-5 years

Developing a Flexible Financial Plan

1. A financial plan is a formalized report that... i. Summarizes your current financial situation ii. Analyzes your financial needs iii. Recommends future financial activities 2. Your financial plan can be created by you, with assistance from a financial planner, or made using a money management software package

Which are well structured goals that follow the SMART guidelines?

1. Accumulate funds in an emergency fund equal to three months salary by the end of the next year 2. Save $200 per month for two years for a down payment on a new car

Opportunity Costs and the Time Value of Money

1. Calculate time value of money situations to analyze personal financial decisions. i. Personal Opportunity Costs (time, effort, health) ii. Financial Opportunity Costs (interest, liquidity, safety) iii. Financial Acquisitions (automobile, home, college education, investments, insurance coverage, retirement fund)

Personal Opportunity Costs

1. Every financial decision involves giving up something to obtain something else 2. Time, energy, health, abilities, knowledge 3. Personal resources like financial resources require careful management

Developing Personal Financial Goals

1. FINANCIAL GOALS i. Can be influenced by the time frame in which you want to achieve your goals ii. Can be influenced by the type of financial need that drives your goals

Financial Opportunity Costs

1. Financial choices depend on current needs, future uncertainty, and current interest rates 2. Time Value of Money i. Increases in an amount of money as a result of interest earned ii. Saving (or investing) today means more money tomorrow. Spending means lost interest iii. Saving and spending decisions involve considering the trade-offs. Current needs can make spending worthwhile

Studying Personal Finance

1. Resources i. Personal Financial Planner sheets ii. This book's library resource site in Connect iii. Practice Quizzes and end-of-chapter activities iiii. Online sources and apps for current personal finance information iv. Talk to others, experts, and friends vi. Search the Internet 2. Achieving your financial objectives requires a willingness to learn and appropriate information sources

Inflation Risk

1. Risk of falling (deflation) prices cause changes in buying power 2. Decide whether to buy something now or later. If you buy later, you may have to pay more

Select a Path to Financial Security

1. Save for emergencies and the future 2. Maintain a low level of debt 3. Have a risk management plan 4. Research to avoid investment scams 5. Communicate with others

Liquidity Risk

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

Types of Financial Goals

1. TIMING OF GOALS i. Short-term (within the next year) ii. Intermediate (one to five years) iii. Long-term goals (more than five years) - Long-term goals should be planned in coordination with short-term and intermediate goals 2. GOALS FOR DIFFERENT FINANCIAL NEEDS i. Consumable-product goals ii. Durable-product goals iii. Intangible-purchase goals

Income Risk

1. The loss of a job may result from changes in consumer spending or expanded use of technology. 2. 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.

Inflation

A rise in the general level of prices

Why is goal setting an important aspect for personal financial growth?

Goal setting assists with the financial decision making process

Goal Setting Guidelines

Goals should be S-M-A-R-T: 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

Present Value

The current value of a future amount based on a certain interest rate and a certain time period

Personal Financial Planning

The process of managing your money to achieve personal economic satisfaction

Economics

The study of how wealth is created and distributed

Influence: Economic Conditions

1. Changing economic conditions and financial decisions i. Consumer prices ii. Consumer spending iii. Interest rates iiii. Money supply iv. Unemployment vi. Housing starts vii. Gross domestic product (GDP) viii. Trade balance viii. Stock market indexes 2. Inflation 3. Rule of 72 i. Divide 72 by the annual inflation (or interest) rate ii. Example: An annual inflation rate of 4% means prices (or your savings) will double in 18 years (72/4 = 18)

Interest Rate Risk

1. Changing interest rates affect your costs (when you borrow) and your benefits (when you save or invest) 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.

Step 4: Evaluate Your Alternatives

1. Consequences of choices i. Opportunity cost: what you give up by making a choice ii. The cost, or trade-off of a decision, may refer to the value of money or time that you give up 2. Evaluating risk i. Uncertainty is a part of every decision ii. Consider inflation risk, interest rate risk, income risk, personal risk, and liquidity risk 3. Financial planning information sources i. To minimize risk, gather relevant information from print and media sources, digital sources, financial experts and financial institutions

Influence: The Financial System

1. Describes the flow of money i. Providers of funds (savers and investors) ii. Financial Intermediaries (banks, insurance companies, etc.) iii. Financial Markets (stock markets, bond markets, etc.) iiii. Users of funds (borrowers and spenders)

The Financial Planning Process

1. Determine current financial situation 2. Develop your financial goals 3. Identify alternative courses of action 4. Evaluate alternatives -Consider i. Life situation ii. Personal values iii. Economic factors -Assess i. Risk ii. Time value of money (opportunity cost) 5. Create and implement your financial action plan 6. Review and revise the financial plan

Step 5: Create and Implement your Financial Action Plan

1. Develop an action plan that identifies ways to achieve financial goals 2. Possible action plans can be increasing savings, reducing spending, increasing income by working extra hours, or making provisions for taxes 3. To implement action plans you may need assistance from others

Implementing Your Financial Plan

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

Step 1: Determine your current financial situation

1. Evaluate income, savings, living expenses, and debts 2. Prepare a list of current asset and debt balances and amounts spent for various items 3. Match financial goals to current income and potential earning power

Step 6: Review and Revise Your Plan

1. Financial planning decisions need to be assessed regularly 2. A complete review should be done at least once a year 3. More frequent reviews may be required for changing personal, social, and economic factors 4. Regular reviews of decision-making process can help in making priority adjustments to achieve financial goals

Influence: Economic Factors

1. Forces of Supply and Demand on setting prices 2. The economic environment includes various institutions 2. Federal Reserve Bank and its role in the economy to maintain an adequate money supply

Methods for Calculating Time Value of Money

1. Formula calculation 2. Time value of money tables 3. Financial calculator 4. Spreadsheet software 5. Websites and Apps

Time Value of Money: Future Value

1. Future value is the amount to which current savings will increase based on a certain interest rate and a certain time period 2. Future value is also called compounding — earning interest on previously earned interest 3. Future value can be computed for a single amount or for a series of deposits (or payments) called an annuity i. FUTURE VALUE OF A SINGLE AMOUNT ii. FUTURE VALUE OF A SERIES OF DEPOSITS

Influence: Global Influences

1. Global economy influences personal finance 2. American companies compete against foreign companies for US dollars 3. Balance of exports and imports 4. Foreign investments and their role in the US money supply 5. The level of money supply affects interest rates

Time Value of Money

1. INTEREST CALCULATIONS Three amounts are required to calculate the time value of money i. Principal (the amount of savings) ii. Interest rate (annual) iii. Time period 2. 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 =$15.00In 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: Develop Financial Goals

1. Identify feelings about money and the reasons for those feelings 2. Determine the source of your feelings about money (facts or influence of others) 3. Determine the basis of your financial priorities (social pressures, household needs, or desires) 4. Determine the effects of the economy on your goals and priorities 5. Decide on specific financial goals to pursue for your situation

Advantages of Personal Financial Planning

1. Increased effectiveness in obtaining, using, and protecting financial resources 2. Increased control of one's financial affairs by avoiding excessive debt, bankruptcy, and dependence on others 3. Improved personal relationships 4. Sense of freedom from financial worries

Influences on Personal Financial Planning

1. Life situation and personal values i. Adult life cycle are the stages in the family and financial needs of an adult ii. Marital status, household size, and employment iii. Major events iiii. Graduation, engagement, career change, children, retirement, etc. iv. Values influence spending and saving decisions

Personal Risk

1. Many factors can create a less than desirable situation. Purchasing a certain brand or from a certain store may create the risk of having to obtain repairs at an inconvenient location. 2. Personal risk may also take the form of health risks, safety risks, or additional costs associated with various purchases of financial decisions.

Step 3: Identify Alternative Courses of Action

1. Possible courses of action can be: i. Continue the same course of action ii. Expand the current situation iii. Change the current situation iiii. Take a new course of action 2. Creativity in decision making is vital for effective choices 3.Electing to "do nothing" can be a dangerous alternative

Time Value of Money: Present Value

1. Present value calculations are also called discounting 2. The present value of the amount you want in the future will always be less than the future value 3. Present value can be computed for a single amount or for a series of deposits i. PRESENT VALUE OF A SINGLE AMOUNT ii. PRESENT VALUE OF A SERIES OF DEPOSITS