1

Summer 2014, BUS-121Financial Planning & Money Management

Frank Paiano – “Paco”Professor, School of Social Studies, Business, and Humanities

Financial Planning and Money Management

Welcome, Everyone!

2

First – A Perspective

“It is a gloomy moment in history. Never has the future seemed so dark and incalculable. The United States is beset with racial, industrial and commercial chaos, drifting we know not where. Of our troubles, no one can see the end.”

Harper’s Magazine, 1847

3

CHAPTER 1Personal Financial Planning in Action

“It is not money that brings happiness, it is lots of money.” – Old Russian Proverb

4

Financial Planning, Definition Personal financial planning is the process of

managing your money to achieve personal economic satisfaction (our book’s definition)

Other definitions: The ability to use knowledge and skills to manage one's

financial resources effectively for lifetime financial security The process of realizing more enjoyment from income and

improving one’s standard of living while making adequate arrangements for a secure and comfortable retirement

The process of identifying assets, determining the classification of those assets in regard to both current and future needs, analyzing debt, expenses, and consumption patterns, reviewing tax status, and addressing a host of other issues and concerns

How would you define personal financial planning?

5

The Benefits of Financial Planning There are several advantages of effective

personal financial planning Increased effectiveness in obtaining, using, and

protecting your financial resources Increased control of your financial affairs A sense of freedom from financial worries obtained

by being able to look optimistically toward the future

Improved personal relationships What is the number 1 reason for divorce in America?

6

Developing a Flexible 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, done with assistance from a financial planner, or made using a money management software package

7

The Financial Planning Process

1. Determine your current financial situation2. Develop your financial goals3. Identify alternative courses of action4. Evaluate your alternatives

Keep in mind opportunity costs and risks5. Create and implement a financial action plan

Write it down!6. Reevaluate and revise your plan

“My Goodness! Does anybody really do all this?!”

8 What is a More Realistic and TypicalFinancial Planning Process?

1. Make money2. Spend it3. Make some more money4. Spend that …

… and then spend some more5. Go into debt6. Panic! 7. Take BUS-121, Financial Planning and

Money Management“Lots of anybodies have done this!”

9 Simply Put, It All Comes Down to the Choices We Make!

Opportunity cost What you give up by making a choice

The opportunity cost is sometimes referred to as the trade-off of a decision

It cannot always be measured in dollars. Sometimes the cost is your time or your health

Consider the lost opportunities that will invariably result from your decisions

Example/Discussion: “There is no such thing as a free lunch!”

What are the opportunity costs of attending college?

10 Opportunity Costs and Financial Results Evaluated When Making Decisions

PersonalOpportunity Costs

(time, effort, health)

FinancialOpportunity Costs(interest, liquidity,

safety)

FinancialAcquisitions

(automobile, home, college education,

investments, insurance,

retirement fund, lifestyle)

versus

Your Money or Your Life, Joe Dominguez & Vicki Robinwww.simplelivingforum.net

11 Every Financial DecisionInvolves Evaluating Types of Risk Inflation risk

Rising prices cause lost buying power Interest-rate risk

Affect costs of borrowing and rate of return Income risk

The loss of a job Personal risk

Health or safety Liquidity risk

Higher return may mean less liquidity Culture of Consumerism risk

a.k.a. Die-Working-and-in-Debt-Up-to-Your-Eyeballs risk

Discussion:Can you guard

against all risks?Should you try?

12

Implementing Your Financial Plan Developing good financial habits

Use a well-conceived spending plan to help 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 tax and investment alternatives

Achieving your financial objectives requires… A willingness to learn, and Appropriate information sources

13

Financial Planning Information Sources

Printed materialsBooks, magazines

Financial institutionsCredit unions, banks, brokerages, etc.

School courses and educational seminars Computer software and on-line information

sourcesThe Internet is an inexhaustible supply

Sometimes useful, sometimes not… Financial specialists

Taking this course is a great start!

14

Influences on Personal Financial Planning

Marital status, household size, and employment Major events

Marriage, Birth or adoption of child, Divorce!, Bankruptcy Values

What are the ideas and principles you consider correct, desirable and important?

Where are you in the Adult Life Cycle stage? “Traditionalist / Mature” – Pre 1946 – 62 million “Baby Boomer” – 1946 to 1964 – 78 million “Gen Xer” – 1965 to 1981 – 59 million “Millennial” – 1981 to 2000 – 78 million

(a.k.a. Digital Generation, Gen Y) The next generation? – 2001+

Life situation and personal values

15

Millennial tee-shirt worn by an SDSU student.

Influences on Personal Financial Planning(continued)

16

Market Forces Supply and demand Production costs and competition

Financial institutions Influence of the Federal Reserve Bank and the

global financial markets Global influences

Level of exports and imports Economic conditions....

Economic factors:

Influences on Personal Financial Planning(continued)

17

Changing Economic Conditions Consumer Prices and Inflation Consumer Spending Interest Rates Money Supply Unemployment Housing Starts GDP: Gross Domestic Product Trade Balance (a.k.a. Trade Inbalance!) Budget Deficit Financial Markets

But since none of us has much, if any, control over these matters, we will focus on the things that we can and do have control over.

18

Components of Financial Planning Planning (chapters 1, 2) Taxes (chapter 3) Saving (chapter 4) Borrowing (chapter 5) Spending (chapters 6, 7) Managing risk (chapters 8, 9, 10) Investing (chapters 11, 12, 13) Retirement and estate planning (chapter 14)

19

Developing Personal Financial Goals Types of financial goals include those...

Influenced by the time frame in which you want to achieve your goals

Influenced by the financial need that drives your goals

Timing of goals must be identified Short-term, intermediate-term and long-term goals

Financial goals should... Be realistic, be stated in specific, measurable

terms, have a time frame, have a priority, and indicate the action or actions to be taken

20

Timing of Financial Goals

Short-term – up to 1 year “or so” Intermediate-term – 2 to 5 yearsLong-term – more than 5 years

The above are the book’s time frames. Here are mine: Short-term – 1 to 3 years Intermediate-term – 3 to 5, 6 or even 7 years Long-term – 7 years or longer (10 to 30 years)

The book’s time frames are more in line with the general consensus within the financial industry (brokerage firms, mutual funds, etc.)

My time frames are more common in the life insurance industry.

21

Financial Goal: Example Pay off VISA

Balance: $3,500 Time frame: Within 12 months Actions to be taken

Reduce dating and clubbing to twice a month Cancel cable service and mobile phone Stop buying coffee at FiveBuck$ Pay extra $300 per month

Priority: HighWhich time frame does this belong to?

How would you measure the success of the goal?Is the goal reasonable?

22

Financial Goal: Example Save up for a Home Theater system

Amount needed: $2,000 Time frame: Within 12 months Actions to be taken

Take part-time job at Home Cheapo Put $150 per month into a special savings

account at the bank Priority: Medium

23

Financial Goal: Example Save for down payment on a condo

Amount needed: $15,000 Time frame: 5 years Actions to be taken

Set up $200 automatic investment per month to be taken from our checking account

Expected rate of return: 7% Priority: High

Will $200 per month at 7% be enough to reach this goal?We are going to learn how to calculate the future value of

this stream of investments.

24

Non-Financial Goal: Example Be able to do 15 “good” push-ups

Can currently only do 7 “good” push-ups Time frame: Within 3 months Actions to be taken

Start with 7 push-ups, three times a day Increase by 2 or 3 push-ups every three to four

weeks Work up to 15 push-ups within 3 months

Priority: Medium

Is this goal reasonable?

25

Goal Setting

Which of the following goals would be the easiest to implement and measure its accomplishment?

A. Spend less so we can save more each monthB. Save $10,000 for a down payment on a condoC. Save $100 each month to create a $4,000

emergency fund in 40 months by canceling the cable service

D. Save enough for a $4,000 vacation next year

The correct answer is (C).

26

The Financial Goal of Most Americans

Spend everything that you earn!And then spend some more!

Most Americans Live Beyond Their Means

Discussion: How do we do it? Why do we do it?

“Honey, Can We Make It to the Next Paycheck?”

27

The Most Important Financial Goal!

Spend less than you earn!

“MAKE L VE, NOT LOAN$!”

“Pay Yourself First” – 10%?

“Live Beneath Your Means”

28

Is 10% a reasonable goal?

The Most Important Financial Goal!(continued)

Pay Yourself First By having the money come out of your

paycheck or checking account automatically, most individuals easily adjust to investing

Works like a pay raise, only in reverse The 10% Solution

Many financial planners recommend saving at least 10% of your income for long-term, compounded growth

The Wealthy Barber, David Chilton

29

The Wealthy Barber, David Chilton

“The magic of compound interest. Thirty dollars a month, a dollar a day, can magically turn into over a million dollars. And do you know what is even more impressive? You know someone who has done it,” Roy, our barber, said proudly.“Thirty-five years ago, I started my savings with thirty dollars a month, approximately 10% of my earnings. I have achieved just under 13% return per year. In addition, as my income rose, my savings rose accordingly. Thirty dollars a month became sixty dollars, then a hundred, and eventually hundreds of dollars a month.”“You three are looking at a very wealthy man.”

The Most Important Financial Goal!(continued)

30

The Wealthy Barber, David Chilton

“One of my early students only followed the ‘Pay Yourself 10% First’ lesson. He bought the wrong life insurance, abused credit cards, overpaid for his mortgage, did not take advantage of his 401(k) at work, and lost all $15,000 of an inheritance playing the commodities market.” “This is a real upbeat, encouraging story, Roy,” said Tom.“Today, his net worth is $850,000, Tom. $300,000 of it is the equity in his house but the rest is his 10% savings.”“He did everything else wrong but –” Cathy started.“Because he had saved 10% of each paycheck and invested it for long-term, compounded growth, today he is in great shape,” Roy finished.

The Most Important Financial Goal!(continued)

31

The Rule of 72

But let us get more precise…

A Quick ‘n’ Dirty Method for Calculating Compound Interest (or Inflation) Divide the interest (or inflation) rate into 72 That is approximately how long it will take the

amount to double Example: 10% Interest Rate

72 / 10 = 7.2 years – It will take about 7 years for your investment to double if you earn 10%

Example: 3% Consumer Price Index (inflation) 72 / 3 = 24 years – It will take about 24 years for

prices to double if inflation runs about 3%

32

Simple versus Compound Interest

Simple InterestInterest = Principal * Rate * TimeInterest = $100 * 6% * 1 year = $6.00In one year you have $106 ($100 + $6.00)

Compound InterestBut the next year, you will earn interest on your interest…$106 x 6% x 1 = $6.36After the next year, you will have $112.36

I know what you are thinking, “Big Deal, Paiano!”

33

Time Value of Money

(discounting)

Present

AmountNow

FutureValue(compounding)

ValueAmount

Later

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

34

Future Value of Money The amount to which a sum you invest now

will increase based on a specified interest rate and time period Future value is also called compounding Future value can be computed for a single

amount – a.k.a. a lump sum or principal Future value can also be determined for a series

of deposits – a.k.a. stream of investments, “annuity”

Start investing now to take advantage of the future value of money.

35

Future value formula for Lump Sum Principal

(continued)

Future Value = Principal * (1 + Rate)Time

Future value formula for Series of Deposits (1+Rate)Time - 1Future Value = Deposit * ──────────

Rate

Do not worry about the math. We use the future value of money tables.

Future Value of Money

36

Present Value of Money The current value for a future amount

based on a certain interest rate and a certain time period Present value is also called discounting Present value of a single lump sum Present value of a series of withdrawals

Not only is present value harder to comprehend, it is also not as important for

personal finance. (We use present value extensively in the BUS-123, Introduction to

Investments, class.)

37

Present value formula for Lump Sum

(continued)

Lump SumPresent Value = ───────────

(1 + Rate)Time

Present value formula for Series of Withdrawals 1

1- ───────

(1+Rate)Time

Present Value = Deposit * ─────────── Rate

Please do not drop the class. We are not going to do any present value calculations.

Present Value of Money

38

Future Value of Money

Okay, let us do some exercises…

Future value handouts

39

Hope For Your Future

As of December 31, 2013

40

Financial Aspects of Career Planning

A Job – An employment position obtained mainly to

earn money, without regard for interests or opportunities for advancement

A Career – A commitment to a profession that requires

continued training and offers a clear path for occupational growth

Do you have a Job or a Career?

“A job is something you do for a paycheck. A career is something you do regardless of the paycheck.”

41

How Education Relates to Income

Source: U.S. Census Bureau, 2010http://www.census.gov/hhes/www/cpstables/032011/perinc/new03_028.htm

Level of Education Annual Lifetime

High School Graduate $35,035 $1,401,400

Associate’s Degree $42,419 $1,696,760

Bachelor’s Degree $55,864 $2,234,560

Master’s Degree $68,879 $2,755,160

Doctorate Degree $91,492 $3,659,680

Professional Degree $101,737 $4,069,480

42 Service Industries Expected to Havethe Greatest Employment Potential

Computer Technology Health Care Business Services Social Services Sales and Retailing Hospitality and Food Services Management and Human Resources Education Financial Services

“Biotechnology.”

43

But What Is Your Career Goal? Most people believe you must become a

doctor or lawyer or high-powered executive to become wealthy But what if you want to be a writer or a teacher

or an artist or a janitor or mechanic or plumber? Can you become wealthy while doing what

you love... Even if it does not command a large salary?

As we saw, the answer is, “Yes!”The key is to set a goal for yourself & start investing early.

In fact, your career is not your most important financial decision.But if your career is not your most important decision, what is?

44 What is Your Most Important Financial Decision?

Who You Marry!

And then subsequently divorce …

“Marriage is grand. Divorce is more like $100 grand.” – Anonymous

45

The Millenials Go To Work

“They are ambitious, they are demanding and they question everything, so if there is not a good reason for that long commute or late night, do not expect them to do it. When it comes to loyalty, the companies they work for are last on their list – behind their families, their friends, their communities, their co-workers and, of course, themselves.

But there are a whole lot of them. And as the baby-boomers begin to retire, triggering a … worker shortage, businesses are realizing that they may have no choice but to accommodate these curious Gen Y creatures. Especially because if they do not, the creatures will simply go home to their parents, who in all likelihood will welcome them back.”

http://money.cnn.com/magazines/fortune/fortune_archive/2007/05/28/100033934/index.htm

Fortune says…

46

The March of Civilization

Hunting & GatheringAgrarian

SimpleAdvanced

IndustrialInformation (?)

60 to 80 hours per

week

40 hours per week

25 hours per week?

25 hours per week

47

Our Secret Weapons!

48

“Choose a job you love, and you will never have to work a day in your life.”

Confucious

Could not have said it better myself…