Chapter 1

Personal FinancialPlanning in Action

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

Personal Financial Planning Objectives

1. Identify social and economic influences on personal financial goals and decisions

2. Develop personal financial goals3. Assess personal and financial

opportunity costs associated with financial decisions

4. Implement a plan for these decisions

1-2

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

1-3

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

1-4

• Life situation and personal values

• Financial planning in our economy– Domestic economic influences– Global Influences– Inflation– Interest rates

Objective 1Identify Social and Economic

Influences on Personal Financial Goals and Decisions

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Life Situation and Personal Values

• Adult life cycle• Life Situation Factors:

– Marital status, household size, employment

– Exhibit 1-1 (page 5)

• 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

• Economy’s influence on financial

planning

– Business, labor & government

• The Federal Reserve – “.. Sets the nation’s monetary policy to promote

the objectives of maximum employment, stable

prices and moderate long-term interest rates.”

– http://www.federalreserve.gov/1-7

Financial Planning in Our Economy

Global Factors• U.S economy affected by foreign

investors and competition from foreign companies

• Level of imports/exports affects available supply of dollars

• Level of foreign investment affects domestic money supply

• Money supply affects consumer interest rates

1-8

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

1-9

Financial Planning in Our Economy

Interest RatesInterest 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 Chapter 1• Planning Chapters 2, 3• Saving Chapter 4• Borrowing Chapter 5• Spending Chapter 6, 7• Managing Risk Chapter 8-10• Investing Chapter 11-13• Retirement/Estate Planning Chapter 14

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

• Financial Needs Goals:– Consumable-product goals. . . Food, clothing– Durable-product goals . . . . . . Car,

appliances– Intangible-purchase goals . . . Education,

health

Objective 2Develop Personal Financial

Goals

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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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Objective 3Assess 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

– Consider lost opportunities resulting from your decisions

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Opportunity Costs and Financial Trade-Offs

PersonalOpportunity Costs

(time, effort, health)

FinancialOpportunity Costs(Interest, liquidity,

safety )

FinancialAcquisitions(car, home, college education, investments, insurance, retirement fund)

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

• Simple interest:

Time Value of MoneyInterest Calculations

Amt in Amt in SvgsSvgs X

Annual Interest

Rate

Time Period InterestX =

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$500 on deposit at 6% annual interest for 6 months:

Principal = $500

Interest rate = 6%

Time period = ½ (6/12 months)

Time Value of MoneyInterest Calculation Example

$500 X 6% 1/2 $15X =

1-18

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 ValueExample

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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Future Value Tables

• Exhibit 1-3A = FV of a Single Amount– Multiply Table Factor by amount deposited– All Future Value factors > 1.0

• Example:– $650 invested at 8% for 10 years– Factor = 2.159– FV = $650 X 2.159 = $1,403.35

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Future ValueSeries of Deposits

• Exhibit 1-3B

• “Annuity” = series of equal deposits at equal intervals earning a constant rate

• Example:– Deposit $50 per year at 7% for 6 years– Exhibit 1-3B factor = 7.153– Future Value = $50 x 7.153 = $357.65

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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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Present Value Tables

• Exhibit 1-3C = PV of a single amount– Multiply Table Factor by amount deposited– All Future Value factors < 1.0

• Example:– You want $1,000 five years from now– You can earn 5% on your money– Present Value = $1,000 X 0.784 = $784

1-24

Present Valueof a Series of Deposits

• Exhibit 1-3D• Determine how much you need to deposit

now in order to withdraw a specific amount for a desired number of years

• Example:– You want to withdraw $400/year for 9 years– Your money is earning 8% per year– Deposit = $400 X 6.247 = $2,498.80

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The 6-Step Financial Planning Process

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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

Objective 4Implement a Plan for Making Personal Financial and Career

Decisions

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4. Evaluate alternatives• Consequences of choices• Evaluate risks• Financial Planning information

sources5. Create and implement financial action

plan6. Review and revise plan

Objective 4Implement a Plan for Making Personal Financial and Career

Decisions

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Financial Planning in Action

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Career Choice and Financial Planning

1. The life work one selects = key to financial well being and personal satisfaction

2. Career choices have risks and opportunity costs

3. Career choices require periodic re-evaluation of trade-offs related to personal, social and economic factors

4. Changing personal and social factors require continuous assessment of your work situation

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