MGT 12 - Midterm 1 - Ch. 1: Personal Finance Basics and the Time Value of Money
- Interest Calculations
*3 amounts are required to calculate the time value of money: 1) Principal of Amount Invested 2) Interest rate 3) Time
- Influences on Personal Financial Planning: Life-situation and Personal Values are influential
- *Adult life cycle* stage: remember each stage will have different goals - Marital status, household size, and employment - Major events: graduation, marriage, career change, children, college, weddings, retirement, etc. - Personal values influence spending and saving decisions
- 3) Present Value of a Single Amount
- *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 - This is the opposite of compounding! - The present value of the amount you want in the future will always be less than the future value - One Starbucks x years in the future is worth how much money today?
- (3) Time Element
- Can calculate FUTURE values, in other words, how much will money be worth x years from now - Can calculate PRESENT values, in other words, given a future amount, what is it worth today?
- (2) Timing of Goals/Stages of Life
- Each stage of life will have different short-term, intermediate and long-term goals and different financial focus: - 20s Post Graduation - single - 30s Early Career - single/married - 40s Mid Career - single/married/family - 50s/60s Late Career - pre-retirement/college expenses/empty nest - 60s/70s + Retirement - living off of investments/part time work
- 2) Future Value of a Series of Deposits
- Future value can be computed for a single amount or for a series of deposits called an *annuity* (even payment stream over time) - How much money is a Starbucks per day for 5 years worth, assuming one invested the money instead?
- 1) Future Value of a Single Amount
- Future value is the amount to which current savings will increase based on a certain interest rate and a certain time period - Future value benefits from compounding - earning interest on previously earned interest - How much is today's Starbucks worth x years from now, assuming one invested the money instead?
What is Personal Financial Planning?
- Managing your money to achieve personal economic satisfaction - Being proactive and prepared for the future
- Influences on Personal Financial Planning: Economic Factors
- Market Forces: Supply & Demand and impact on prices and markets - Key Global Players: the economic environment is global and includes many different institutions (corporations, governments, financial system) - Key US Player: Federal Reserve Bank and its role in the economy and regulating interest rates in the US; interest rates have an impact on large financial decisions
Time Value of Money (*see LS)
- Money increases and grows as a result of interest earned; the continual effect of this is compounding: - Compound interest means Interest on Interest! --> $100 earning 10% compounded over 7 years = $100 x (1 + 10%)^7 or $100 x (1.1)^7 = $200 - Saving today means *exponentially* more money tomorrow; spending means lost interest and lost interest on interest; huge lost opportunity - Saving and spending decisions involve considering the trade-offs b/w now and later and much later
- 4) Present Value of a Series of Deposits
- Present value can be computed for a single amount or for a series of deposits - Many Starbucks over a period of time is worth what amount of money today?
- (2) Timing of Goals
- Short-term, intermediate (int.) and long-term goals - One can have concurrent financial goals - Long-term goals should be planned in coordination w/ short-term and intermediate goals Short-term = 0-1 years Shorter Int. = 1-5 yrs Longer Int. = 5-10 yrs Long-term = 10+ yrs
6 step procedure for Financial Planning
1. Determine your current financial situation 2. Develop your financial goals 3. Identify alternative courses of action 4. Evaluate alternatives 5. Create and implement financial action plan 6. Review and revise financial plan as needed
Time Value of Money: Rule of 72
72/x% = Y years for $ to double in value, where x% rate of return is a whole number Example: at 10% rate of return, money will double in approximately 7 years --> 72/10 ~ 7
Who is Janet Yellen?
An American economist. *She is the Chair of the Board of Governors of the Federal Reserve System, previously serving as Vice Chair from 2010 to 2014. Previously, she was President and Chief Executive Officer of the Federal Reserve Bank of San Francisco*; Chair of the White House Council of Economic Advisers under President Bill Clinton; and business professor at the University of California, Berkeley, Haas School of Business.
- Consequences of Choices
Examples of trade-offs (opportunity cost) and potential consequences of decisions: - Buying vs. renting a home - Paying off debt - Buying a nice car vs. a functional car
- (2) Developing Personal Financial Goals
Goals should be S-M-A-R-T: - Specific: know what your goals are to create a plan - Measurable: w/ a specific amount - Action-orientated: identify the personal financial activities - Realistic: utilizing your income and life situation - Time-based: identify the time frame to achieve the goal --> Example actionable, measurable and time-bound plans: a) I want to go to Grad School in 3 years and save up to $30K, $10K per year b) I want to buy a home in 5 years and save for a $75K downpayment, $15K per year
Retirement Planning: The Importance of Starting Early can't be Overemphasized (*see LS, etc.)
To take advantage of the time value of money: - If from age 25-65 you invest $300 a month (10% return), at age 65 you'll have a nest egg of approx. = $1.9 million - Wait 10 years until age 35 to start and you'll have approx. $684,000 at age 65 = or ~65% less than starting at 25 - Wait 20 years until age 45 to start and you'll have approx. $230,000 at age 65 = or ~88% less than starting at 25 - By the way, if you stop at 35 after saving for 10 years, you would accumulate = $1.2 million