chapter 1 notes

Chapter 1Personal Finance

Basics and the Time Value of

Money

09/01/09

Chapter 1Personal Finance

Basics and the Time Value of

Money

09/01/09

Why Important

Nobody can avoid dealing with personal

finance

People do claim bankruptcy

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Chapter 1 Learning Objectives

1. Analyze the process for making personal financial decisions

2. Develop personal financial goals

3. Assess personal and economic factors that influence personal financial planning

4. Determine the personal and financial opportunity costs associated with personal financial decisions

5. Identify strategies for achieving personal financial goals for different life situations

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The Financial Planning ProcessObjective 1: Analyze the process for

making personal financial decisions

Personal Financial Planning is the process of managing your money to achieve personal economic satisfaction

Advantages of Personal Financial Planning are:

1. Increased effectiveness in obtaining, using and protecting financial resources

2. Increase control of one’s financial affairs

3. Sense of freedom from financial worries

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The Financial Planning Process (continued)

Six-step procedure for Financial Planning Determine your current financial situation. Develop your financial goals. Identify alternative courses of action. Evaluate your alternatives. Create and implement your financial action

plan. Review and revise your plan.

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Step 1: DETERMINE YOUR CURRENT FINANCIAL SITUATION

Determine current financial situation regarding income, savings, living expenses, and debts

Prepare a list of current asset and debt balances and amount spent for various items

Match financial goals to current income and potential earning power

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Step 2: DEVELOP YOUR FINANCIAL GOALS

Identify feelings about money and the reasons for those feelings

Determine the source of your feelings about money

Determine the effects of economy on your goals and priorities

Make sure that your goals are your own and are specific to your situation

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Step 3: IDENTIFY ALTERNATIVE COURSES OF ACTION

Possible courses of action can be:

Continue the same course of action

Expand the current situation

Change the current situation

Take a new course of action

Creativity in decision making is vital to effective choices 8


Step 4: EVALUATE YOUR ALTERNATIVES

CONSEQUENCES OF CHOICESOpportunity cost - What you give up when you make a choice The cost or trade-off of a decision cannot always

be measured in dollars. Sometimes the cost is your time

EVALUATING RISKUncertainty is a part of every decision.Best way to analyze and minimize risk is to gather

information from financial planning sources. (Exhibit 1-3)

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Step 5: CREATE AND IMPLEMENT YOUR FINANCIAL ACTION PLAN

Develop an action plan that identifies ways to achieve financial goals

Possible action plans can be increasing savings, reducing spending, or making provisions for taxes

To implement action plans you may need assistance from others

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Step 6: REVIEW AND REVISE YOUR PLAN

Financial planning decisions need to be assessed regularly

Complete review should be done at least once a year

Regular reviews of decision-making process can help in making priority adjustments to achieve financial goals

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Developing Personal Financial GoalsObjective 2: Develop personal financial goalsTYPES OF FINANCIAL GOALS can be:

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

Influenced by the financial need that drives your goals

TIMING OF GOALSShort-term, intermediate and long-term goals

Long term goals should be planned in coordination with short-term and intermediate goals

GOALS FOR DIFFERENT FINANCIAL NEEDSConsumer product goalsDurable-produce goalsIntangible-purchase goals

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Developing Personal Financial Goals (continued)

GOAL-SETTING GUIDELINES

Goals should be realistic

Goals should be stated in specific terms

Goals should have a time frame

Goals should indicate the action to be taken

Discuss some of your goals

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Developing Personal Financial Goals (continued)

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Influences on Personal Financial Planning

Objective 3: Assess personal and economic factors that influence personal financial planning

LIFE SITUATION AND PERSONAL VALUESAdult life cycle stageMarital status, household size, and employmentMajor events

Graduation, marriage, career change, children, retirement, etc

ValuesWhat values are important to you?

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Influences on Personal Financial Planning (continued)

ECONOMIC FACTORS

Forces of Supply and Demand and prices

Federal Reserve Bank and it’s role in the economy

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GLOBAL INFLUENCES

Global marketplace influences financial activities

Balance of exports and imports

Foreign investments and their role in the US Money Supply

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ECONOMIC CONDITIONS

Consumer The value of the dollarprices changes in inflation

Consumer The demand for goods and spending services by individuals and households

Interest rates The cost of money; cost ofcredit when you borrow; returnon your money when you saveor invest

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Opportunity Costs and the Time Value of MoneyObject 4: Every financial decision involves

giving up something to obtain something else

PERSONAL OPPORTUNITY COSTS

Time

Other personal opportunity costs can be related to health, leisure etc.

Personal resources like financial resources require careful management

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Opportunity Costs and the Time Value of Money (continued)

FINANCIAL OPPORTUNITY COSTS

Time Value of Money Increases in an amount of money as a result

of interest earned. Saving today means more money tomorrow.

Spending means lost interest. Saving and spending decisions involve

considering the trade-offs. Current needs can make spending worthwhile.

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INTEREST CALCULATIONS

Three amounts are required to calculate the time value of money

Principal

Interest rates

Time

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COMPUTING SIMPLE INTEREST(Amount in savings) x (annual interest rate) x (time period) = (interest)

For Example:$100 x 5% x 1 (1 year) 100 x .05 x 1 = $5.00

In one year you have $100 in principle plus $5.00 in interest for a total of $105 at the end of the year

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FUTURE VALUE OF A SINGLE AMOUNTFuture value is the amount to which current

savings will increase based on a certain interest rate and a certain time period

Future value is also call compounding - earning interest on previously earned interest

FUTURE VALUE OF A SERIES OF DEPOSITSFuture value can be computed for a single

amount or for a series of deposits called annuities

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PRESENT VALUE OF A SINGLE AMOUNTPresent Value is the current value of a future

amount based on a certain interest rate and a certain time period

Present value calculations are also called discounting

The present value of the amount you want in the future will always be less than the future value (See Exhibit 1-8C)

PRESENT VALUE OF A SERIES OF DEPOSITSPresent value can be computed for a single

amount or for a series of deposits (See Exhibit 1-8D) 25

Achieving Financial GoalsObjective 5: Identify strategies for achieving

personal financial goals different life situations

COMPONENTS OF PERSONAL FINANCIAL PLANNING

Obtaining (chapter 2) Planning (chapters 3, 4) Saving (chapter 5) Borrowing (chapters 6, 7) Spending (chapters 8, 9) Managing risk (chapters 10-12) Investing (chapters 13-17) Retirement and estate planning (chapters 18, 19) 26

Achieving Financial Goals (continued)

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, with assistance from a financial planner, or made using a money management software package 27

Achieving Financial Goals (continued)

IMPLEMENTING YOUR FINANCIAL PLAN

Develop 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

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Economy & Finance

chapter 1 notes