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Copyright ©2004 Pearson Education, Inc. All rights reserved. Chapter 1 Overview of a Financial Plan

Madura 16816 x_ppt01

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Page 1: Madura 16816 x_ppt01

Copyright ©2004 Pearson Education, Inc. All rights reserved.

Chapter 1

Overview of a Financial Plan

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Chapter Objectives

• Introduce the subject of personal finance

• Identify the key components of a financial plan

• Outline the steps involved in developing your financial plan

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Definitions

• Personal finance: the process of planning your spending, financing, and investing so as to optimize your financial situation

• Personal financial plan: a plan that specifies your financial goals and describes the spending, financing, and investing plans that are intended to achieve those goals

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Definitions

• Opportunity cost: what you give up as a result of a decision

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How You Benefit From An Understanding of Personal Finance

• Make your own financial decisions– Every spending decision has an

opportunity cost

• Judge the advice of financial advisors– Make informed decisions

• Become a financial advisor– Many career opportunities available

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Components of a Financial Plan

• Budgeting and tax planning

• Managing your liquidity

• Financing your large purchases

• Protecting your assets and income (insurance)

• Investing your money

• Planning your retirement and estate

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A Plan for Your Budgeting and Tax Planning

• Budget planning: The process of forecasting future expenses and savings

• Evaluate your current financial position– Assets: what you own– Liabilities: what you owe– Net worth: the value of what you own

minus the value of what you owe

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Budgeting and Tax Planning

Exhibit 1.1: How a Budget Affects Savings

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A Plan to Manage Your Liquidity

• Liquidity: access to funds to cover any short-term cash deficiencies

• Money management: decisions regarding how much money to retain in a liquid form and how to allocate the funds among short-term investment instruments

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A Plan to Manage Your Liquidity

• Credit management: decisions

regarding how much credit to obtain to

support your spending and which

sources of credit to use

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Managing Your Liquidity

Exhibit 1.2: Managing Your Liquidity

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A Plan for Your Financing

• Loans often needed for large expenditures– College tuition, car, house

• Managing loans– How much can you afford to borrow?

– Determining maturity of the loan

– Selecting a loan with a competitive interest rate

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Financing Your Large Purchases

Exhibit 1.3: Financing Process

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A Plan for Your Investing

• Funds not needed for liquidity can be invested

– Stocks, bonds, mutual funds, real estate

• All investments have some level of risk

• Risk: uncertainty surrounding the potential return on an investment

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A Plan for Your Retirement and Estate• This includes insurance planning, retirement

planning, and estate planning

– Retirement planning: determining how much money should be set aside each year for retirement and how those funds should be invested

– Estate planning: determining how your wealth will be distributed before or upon your death

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Exhibit 1.4: Components of Your Financial Plan

Components of Your Financial Plan

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How the Text Organization Relates to the Financial Plan’s Components

• Each of the six parts of the text covers one specific component of the financial plan

• An effective financial plan enhances net worth and builds wealth

• Follow the steps to a complete financial plan at the end of the school term

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How the Text Organization Relates to the Financial Plan’s Components

• How the components relate to your cash flows

– Cash inflows are cash that you receive

– Cash outflows are cash that you spend

– Budgeting balances income and spending

– Liquidity deals with cash excesses or shortages

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How the Text Organization Relates to the Financial Plan’s Components

– Financing focuses on obtaining cash for large purchases or repaying loans

– Protect assets and income by using cash for insurance and retirement

– Investing uses cash to build wealth

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How Financial Planning Relates to Cash Flow

Exhibit 1.6: How Financial Planning Affects Your Cash Flows

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Developing the Financial Plan

• Step 1. Establish Your Financial Goals– Types of goals

• Car, home, college, wealth, charity

– Set realistic goals• Stronger likelihood of reaching goals

– Timing of goals• Short term (within one year)• Intermediate (between 1–5 years)• Long term (beyond five years)

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Developing the Financial Plan

• Step 2. Consider Your Current Financial Position– How your future financial position is tied to

your education• Consider your skills, interests, and career paths

– How your future financial position is tied to your career choice

• Choose a career that will be enjoyable and suit your skills

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Developing the Financial Plan

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Developing the Financial Plan

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Developing the Financial Plan

• Step 3. Identify and Evaluate Alternative Plans That Could Achieve Your Goals– Plans could be conservative or aggressive

• Step 4. Select and Implement the Best Plan for Achieving Your Goals– The Internet has valuable financial

planning information

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Developing the Financial Plan

• Focus on Ethics: Personal Financial Advice– Your objective is to get the best advice

appropriate to your needs

– Be wary of unethical behavior• Difficult to discern

– Be wary of incompetent advice• Be alert, ask questions, carefully consider advice

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Developing the Financial Plan

• Step 5. Evaluate Your Financial Plan– Keep plan in an accessible place and

monitor your progress

• Step 6. Revise Your Financial Plan– Change plan as financial condition and

financial goals change

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How the Internet Facilitates Financial Planning

• The Internet provides information on all aspects of financial planning– Bank deposit rates

– Prices of cars and homes

– Financing rates

– Prices of investments

– Insurance premiums

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How the Internet Facilitates Financial Planning

• Provides updated information on all parts of your financial plan

– Current tax rates and regulations

– Investment performances

– Online calculators

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How the Internet Facilitates Financial Planning

1.1 Financial Planning Online: Should You Pursue a Career in Financial Planning?

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Financial Planning Online: Financial Planning Tools for You

• Go to http://finance.yahoo.com

• This website provides much information and many tools that can be used for all aspects of financial planning.

• It also provides information for creating retirement plans and wills.

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Integrating Key Concepts

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Looking Ahead

• Part 1: Financial Planning Tools– Chapter 1 showed an overview of a financial plan

– Chapter 2 teaches personal financial statements

– Chapter 3 teaches time value of money

– Chapter 4 teaches tax planning

• Part 2: Liquidity Management• Part 3: Financing• Part 4: Protecting Your Wealth• Part 5: Investing• Part 6: Retirement and Estate Planning