1Aaron Stevens2 May 2011

Financial LiteracyHow to Maximize your Economic Happiness

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AgeBlood pressureCholesterolBody Mass Index (weight/height)Diet/NutritionPhysical Activity

Indicators of PhysicalHealth

3AssetsLiabilities/DebtIncomeExpensesRisk ExposureSustainable Standard of Living

Indicators ofFinancial Health

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Assets: what you ownAssets have value because they generate income (or can be sold).

Liabilities: what you oweLiabilities are a claim against your future income. Debt paymentsreduce the amount of income available for everything else.

Net Worth = Assets - Liabilities

Financial Literacy

5How do you increase your Net Worth?accumulate more assets by savingpay off debts (also saving)assets can increase in value

Financial Literacy

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Income: what you earnExpenses/Consumption: what you spend

Savings = Income - Consumption

Recall:accumulate more assets by saving

Financial Literacy

7A credit score is a report card on yourlevel of debt and payment history.

It only matters if youre going tospend your lifetime in debt. I dont care! You shouldnt either!

Credit Scoresstudents always ask

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A big problem in personal finance ishow much of your income to save.

Show: monthly spending plan

How Much To Save?

9Everyone needs:Retirement fundAn emergency fundSavings for Major Purchases

The 3 Kinds of Savings

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Joe Blow, age 22, not married, no kids.No financial assetsJoe earns $42,000 per yearJoe will work until age 66, then dropdead.(No taxes, no transfers.)

A Simple Example

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Earnings: $42,000Consumption: $42,000Savings: $0 (live to age 66)

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Conventional Net Worth = A - LWhat about human capital (HC)?

Economic Net Worth = CNW + HC

Economic Net Worth

We can value Human Capital usingthe time value of money.

Human Capital is your asset whichthrows off labor income eachyear.

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Earnings: $42,000Consumption: $42,000Savings: $0 (live to age 66)

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Joe Blow, age 22, not married, no kids.No financial assetsJoe earns $42,000 per yearJoe will work until age 66, and thenlive until age 85. How will he eat?(No taxes, no transfers.)

Saving For Retirement

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Earnings: $42,000Consumption: $36,380Savings: $5,620 (live to age 85)

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Earnings: $42,000Consumption: $36,380Savings: $5,620 (live to age 85)

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Joe Blow, age 22, not married, no kids.No financial assetsJoe earns $42,000 per yearJoe will work until age 66, and thenlive until age 100.(No taxes, no transfers.)What are some of Joes possibleconsumption paths?

Example, continued

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Earnings: $42,000Consumption: $34,204Savings: $7,796 (live to age 100)

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Its so hard to have money left overat the end of the month. Usually Ihave month left over at the end of themoney!

Saving money is incredibly hard!It requires delayed gratification!(once upon a time frugality was avirtue)

How to Save?

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The surest path to successful saving.Have a portion of your paycheck setaside for savings BEFORE it goes toyour bank account.Spend the remainder after savingfirst.

Pay Yourself First

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Uncle Barack wants you to be rich!

IRA, 401k/403b (Retirement Accounts)save pre-tax dollars now, taxdeferred until you retire, pay taxesupon withdrawalRoth IRA/401k/403kSave after-tax dollars now, no taxwhen you withdraw at retirement

Incentives for Saving

Your Emergency FundYOU NEED TO SELF-INSURE AGAINST UNEMPLOYMENT!

Set up an emergency or reserve fund of6-12 months of non-discretionary expenses.

You cannot afford to lose this money! Your emergency fund must be risk-free: put it ina Certificate of Deposit, or better yet iBonds. DO NOT use this money to buy a car, vacation,house, engagement ring, etc!

Start building your emergencyfund on day 1 of your first job!

Incentives For SavingUNCLE BARACK WANTS YOU TO BE RICH!

Series I Savings BondsRisk-free, inflation-protectedInvest after-tax moneyNo state or local taxes everMay defer taxes for up to 30 yearsNo federal tax if used for education

How to Buy I-Bonds

Set up an account at http://www.treasurydirect.gov/

ESPlannerThe only tool which uses the Life-Cycle Model

Try it free: www.esplanner.com/basic

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Borrowing involves reducing futurestandard of living to pay for pastconsumption.When you borrow, you pay interest;when you save, you earn interest.Everything costs more when borrowing.Save up in advance for majorpurchases (cars, vacations, downpayment on house).

Avoid borrowing forConsumption

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Be ware of Broker/Dealers, FinancialPlanners, Insurance Salespeople, etc.Most are looking to sell you products, butdo not have your best interest at heart.Salesmen are coin operatedTrust no-one; you alone are responsible foryour financial security.Read everything and ask questions!

Dont Trust Anyone!

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EC171 is an introduction to applied economics,which applies the life cycle model to personaleconomic decisions including: spending, saving,borrowing, insuring; matriculation; choosing careers,jobs, and locations; marrying, having children,divorcing; retiring, retirement accounts, taking SocialSecurity; buying insurance; and investing in stocksand bonds.

Offered Summer and Fall 2011 http://people.bu.edu/azs/teaching/ec171

EC 171: PersonalLifecycle Economics

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www.esplanner.com/basic: software which uses the lifecycle model todo trustworthy financial planningSpend til the end by Laurence Kotlikoff and Scott BurnsThe Only Investment Guide Youll Ever Need by Andrew TobiasThe Millionaire next Door by Thomas Stanley and William Danko

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