Chapter 1

Personal Financial Planning in Action

McGraw-Hill/Irwin

Copyright 2010 by The McGraw-Hill Companies, Inc. All rights reserved.

Personal Financial Planning Objectives

1. Identify social and economic influences on personal financial goals and decisions 2. Develop personal financial goals 3. Assess personal and financial opportunity costs associated with financial decisions 4. Implement a plan for these decisions
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Financial Planning
Process of managing your money to achieve personal economic satisfaction Financial Plan:
Formalized report Summarizes current financial situation Analyzes financial needs Recommends future financial activities

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Advantages of Financial Planning

Increased effectiveness in obtaining, using, and protecting financial resources Increased control of your financial affairs Improved personal relationships Sense of freedom from financial worries
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Identify Social and Economic Influences on Personal Financial Goals and Decisions Life situation and personal values Financial planning in our economy
Domestic economic influences Global Influences Inflation Interest rates

Objective 1

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Life Situation and Personal Values

Adult life cycle Life Situation Factors:
Marital status, household size, employment

Major events:
Graduation, marriage, divorce Birth or adoption of child Career or health changes

Values:
The ideas and principles you consider correct, desirable, and important
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Financial Planning in Our Economy

Domestic Influences

Economys influence on financial planning

Business, labor & government

The Central Bank

Monetary & Fiscal Policy impact on interest rates, inflation, currency value

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Financial Planning in Our Economy Global Factors

TT economy affected by commodity prices of major exports Level of imports/exports affects available supply of dollars Level of foreign investment affects domestic money supply Money supply affects consumer interest rates

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Financial Planning in Our Economy Inflation

Inflation = in the general level of prices

Reduces buying power of the dollar Most harmful to those on fixed incomes Inflation rates vary Hidden inflation CPI = a measure of inflation

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Financial Planning in Our Economy Interest Rates Interest Rate = the cost of money Affected by supply and demand Risk premium:
Length of time funds in use Expected inflation Uncertainty

Major impact on financial planning

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8 Basic Financial Planning Activities

Obtaining Planning 2, 3 Saving Borrowing Spending 7 Managing Risk 10 Investing 11-13 Retirement/Estate Chapter 1 Chapters Chapter 4 Chapter 5 Chapter 6, Chapter 8Chapter
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Develop Personal Financial Goals

Time Frames for Achieving Financial Goals:
Short-term goals . . . . . . . . . . . Intermediate goals . . . . . . . . . Long-term goals . . . . . . . . . . . w/in 1 year 2-5 years > 5 years

Objective 2

Financial Needs Goals:

Consumable-product goals. . . Durable-product goals . . . . . . appliances Intangible-purchase goals . . . health Food, clothing Car, Education,

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Goal-Setting Guidelines
Effective Goals should be:
Realistic
Stated

in specific, measurable

terms Based on a time frame Action-oriented

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Assess Personal and Financial Opportunity Costs of Financial Decisions

Opportunity cost = what you give up making a choice The trade-off of a decision Not always measurable in dollars; may be time

Objective 3

Consider lost opportunities resulting from your decisions

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Opportunity Costs and Financial Trade-Offs

Personal
Opportunity Costs (time, effort, health)

Financial Acquisitions
(car, home, college education, investments, insurance, retirement fund)

Financial
Opportunity Costs (Interest, liquidity, safety )

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Time Value of Money

Increase in an amount of money as a result of interest earned
Saving today = more money tomorrow Spending today = lost interest

Saving and spending decisions involve considering the trade-offs

Current needs can make spending worthwhile
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Time Value of Money

Interest Calculations Calculating interest earned:
Principal = amount of savings Annual interest rate Length of time money on deposit (in years)

Simple interest:
Amt in Svgs

Annual Interest Rate

Time Period

Interest

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Time Value of Money

Interest Calculation Example
$500 on deposit at 6% annual interest for 6 months: Principal = $500 Interest rate = 6% Time period = (6/12 months)

$500

6%

1/2

$15

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Future Value
The increased value of money from interest earned Amount to which current savings will increase Total amount available in the future Compounding

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Future Value
Example
Future Value
Original Amount in Savings

Interest Earned

$100 deposited for 1 year at 6% per year Future Value = $100 + ($100 X .06 X 1) Future Value = $100 + $6 = $106

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Present Value
The current value of a future amount based on a certain interest rate and time period The current value of an amount desired in the future How much to deposit now to obtain a desired total in the future Discounting
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The 6-Step Financial Planning Process

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Implement a Plan for Making Personal Financial and Career Decisions

Objective 4

1. Determine current financial situation 2. Develop financial goals 3. Identify alternative courses of action Continue same course of action Expand current situation Change current situation Take a new course of action
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Implement a Plan for Making Personal Financial and Career Decisions 4. Evaluate alternatives Consequences of choices Evaluate risks Financial Planning information sources 5. Create and implement financial action plan 6. Review and revise plan
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Objective 4

Financial Planning in Action

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Career Choice and Financial Planning

1.

2.

3.

4.

The life work one selects = key to financial well being and personal satisfaction Career choices have risks and opportunity costs Career choices require periodic reevaluation of trade-offs related to personal, social and economic factors Changing personal and social factors require continuous assessment of your work situation
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