5 Reasons for Financial Planning
- manage the unplanned
- accumulate wealth for special expenses
- save for retirement
- "cover your assets"
- to invest intelligently
- minimize taxes owed
Basics of Personal Finance
- it's easier to spend than save
- it's an ongoing process that changes with financial situation and position in life
- managing and controlling your finances with a personal plan always has positive effects
- it helps one achieve financial goals
5 basic steps to personal financial planning
1) evaluate your financial health
2) define you financial goals
3) develop a plan of action to get there
4) implement the plan you make
5) review and revise your plan as you progress in it and see how it plays out in reality
evaluating your financial health
- how much money do you make?
- how are you spending your money?
defining financial goals
- figure them out and place a dollar amount on them
- figure out at what point in time you want to reach each goal
- analyze and revise as you go
developing a plan of action
- remember that all plans need to be flexible
- take into account liquidity
- make protection a priority (preparing for the unexpected)
- seek to minimize taxes and keep more of what you earn
implementing your plan
- often the toughest part
- stick to it as best you can
review, reevaluate, revise
- it's about making sure that the road map you've made is actually guiding you to the right places
- be prepared to make changes because it's rarely a one way ticket
short-term goals
- includes those that a year or less in duration
- examples include: accumulating a 3 month's income back-up fund, paying off bills and credit cards, purchasing insurance, purchasing a major item, financing a vacation
- immediate and significant impact on
intermediate-term goals
- time frame of 2-10 years
- examples include saving for older child's education, saving for a down payment on a major item, paying off a major debt, financing larger items, purchasing a vacation home, planning for children
- more time to save so less of
long-term goals
- time frame greater than 10 years
- example include saving for a younger child's education, purchasing a retirement home, creating a retirement fund to maintain the current standard of living, taking care of elderly parents or grand parents, starting a p
estate planning
planning for your eventual death and passage of your wealth to your heirs
inflation
an economic condition in which rising prices reduce the purchasing power of money
ten principles of personal finance
1) the best protection is knowledge(if you don't understand the system, it's difficult to reach your goals)
2) nothing happens without a plan
3) time value of money matters (gives you an understanding of how investment truly grow over time and to compare
diversification
acquisitions of a variety of different investments instead of just one to reduce the risk
personal balance sheet
a statement of you financial position on a given date that includes the assets you own, the debt and liabilities you have incurred, and you level of wealth
assets
what you own
- monetary assets: your most liquid form of money ranging from cash to checking/savings accounts, and money market funds
- investments: common stocks, mutual funds, or bonds
- retirement plans
- housing, cars, personal property
- other (money
liabilities
something that is owed or borrowing money
- only includes unpaid balances
- current debt: immediate unpaid bills
- long-term debt: cars, houses, etc.
net worth/equity
a measure of the level of you wealth determined by subtracting your level of borrowing and debt from the value of your assets
- if liabilities outnumber assets, you are considered insolvent (the condition in which you owe more than you are worth)
- this i
fair market value
what an asset could be sold for rather than what it cost or what it will be worth sometime in the future (this is what you need to use when estimating net worth
income statement
a statement that tells you where your money has come from and where it has also gone in a given period of time
more of a moving picture or flow
- based on cash in and out flows
- essential for any sort of financial planning
income
where your money comes from
- wages, salary, bonuses, commissions, etc. after taxes
- family gifts, pensions, gov. payments, investment earnings, etc.
variable expenditures
expenditure over which you have control so it varies month to month in most cases
fixed expenditure
expenditure over which you have not control and you are obligated to make at a consistent amount each moth
budget
a plan for controlling cash inflows and outflows based on your goals and financial obligations
trends with cash outflow
- other 37-44%
- housing 26-29%
- food 10-15%
- education 1.5-4%
current ratio
monetary assets/current liabilities
- answers whether or not you have enough liquidity to meet emergencies
- should be greater than 1 and ideally above 2
month's living expenses cover ratio
monetary assets/(annual living expenditures/12)
- ideally have between 3 and 6 months worth on this
debt ratio
total debt or liabilities/total assets
tells you what percentage of your assets can be financed by borrowing
-greater than 1.0 raises red flag
long-term debt-coverage ratio
(total income available for living expenses)/(total long-term debt payments)
- divisor would include car payments, mortgage payments, and long-term credit obligations
- anything less than 2.5 should raise a red flag
savings ratio
(income available for savings and investment)/(income available for living expenses)
- gives you a percent measure
- obviously the higher the better
time value of money
concept that a dollar received today is worth more than a dollar received in the future
compound interest
the effect of earning interest on interest resulting from reinvestment
principle
face value of a deposit or investment (p)
present value
the current value in today's dollars of a future sum of money (PV)
annual interest rate
the rate charged or paid for the of money on an annual basis (i)
future value
the values of an investment at some future point (FV)
TVM formula
FV = PV (1+i) ^n
interest earned
i earned = P (1 +i)
rule of 72
# yrs to double = 72/i
discount rate
interest rate used to bring future dollars back to the present
PV = FV/(1+i)^n
present value interest factor
[1/(1+i)^n]
annuity
a series of payments coming at the end of each time period for a specific number of time periods
compound annuity
an investment that involves depositing an equal sum of money at the end of each year for a certain number of years and allowing it to grow
amortized loans
a loan paid off in equal installments
perpetuity
an annuity that continues forever
PV = PP/i
deposit-type financial institutions
provide traditional checking and savings accounts; commonly referred to as banks
- also includes savings and loans and credit unions
- insured by FDIC
checking
- money is liquid, safe
- little to no min balance required
savings
- liquid and safe
- higher
non d-t financial institutions
don't provide checking and savings accounts, rather have options like mutual funds, stock brokerage, and insurance companies
- insured by FCUA
demand deposit
- a type of checking account on which no interest is paid
- customer pays had to pay some fees if they below min balance
NOW
negotiable order of withdrawal account
- min balance required
- monthly fee
money market deposit account
- MMDA
- provides a rate of interest that varies with the current market value
- safe (fed insured)
- interest earning
- check writing abilities
- high min balance and penalties
- lower interest rate than alternatives
certificate of deposit
- CD
- savings alternative that pay fixed rate of interest while keeping your funds on deposit for a set period of time (min 30 days to several years)
- safe (fed insured)
- fixed interest
- convenient
- penalties for early withdrawal
- min deposit requir
money market mutual funds
- MMMFs
- invest in short term notes (usually <90 days) of very high denominations
- high rates of return
- check writing available
- limited risk
- convenient
- administrative fees
- min investment required
- no fed insurance
- min check amount required
asset management accounts
comprehensive financial service packages offed by brokerage firms, which can include a checking account; credit/debit cards; an MMMF; loans; automatic payments; direct system of payout
- comes with monthly statements
- automatically coordinates money mana
t-bills
short-term notes issued by the fed gov. with maturities ranging from 4 week to 12 months
- risk free
- tax free
- low rate of return
US savings bonds
type of security that's actually a loan on which you receive interest, generally every 6 months for the life of the bond
- safe
- affordable
- tax free except fed if used for education
- convenient
- universal
- no commission or fees
- low liquidity
long
APY
annual percentage yield is what converts interest rates compounded for different periods into comparable annual rates
- institutions required to share this with their customers by law since Truth in Savings Act of 1993
after tax return
(1 - marginal tax rate) + nontaxable return
choosing a financial institution
Cost
- minimum balance required?
- monthly fees?
- charge per check?
Convenience
- direct deposit?
- safety- deposit boxes?
- overdraft protection?
- ATMs large in number and near customer
- top payment function
Consideration
- staff is personable and kno
types of checks
cashier's: drawn from a bank or financial institution
certified: drawn like the above, but after it's amount and legitimacy is verified by that institution
money order: like a cashier's check, but from non-banking institution
traveler's check: from large
smart cards
like debit cards, but actually magnetically store their own accounts so that when the funds deplete, the card is useless