Chapter 01. The Financial Planning Process. Chapter 1 Learning Objectives. Personal Finance Basics and the Time Value of Money

Chapter 01

Personal Finance Basics and the

Time Value of Money

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

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Chapter 1

Learning Objectives

1. Analyze the process for making _________________________ 2. Develop personal financial __________ 3. Assess personal and __________factors that

influence personal financial planning 4. Calculate ________________situations

associated with personal financial decisions 5. Identify strategies for achieving personal

financial goals for different ________________ 1-2

The Financial Planning Process

personal financial decisions

What is Personal Financial Planning? …..

The process of ____________________ to achieve personal ______________________.

The Financial Planning Process

Advantages of Personal Financial Planning are:

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

2. Increased control of one’s financial affairs 3. Improved personal relationships 4. Sense of freedom from financial worries

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Six-step Procedure for Financial

Planning

Continued… _1-5

Six-step Procedure for Financial

Planning

Step 1: DETERMINE YOUR CURRENT

___________________________

• Evaluate 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

Six-step Procedure for Financial

Planning

Step 2: DEVELOP YOUR FINANCIAL

________________

• Identify feelings about money and the reasons for those feelings

• Determine the source of your feelings about money

• Determine the effects of the economy on your goals and priorities

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

Continued… _1-7

Six-step Procedure for Financial

Planning

Step 3: IDENTIFY ALTERNATIVE _________

____________________

• 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

Continued… _1-8

Six-step Procedure for Financial

Planning

Step 3: IDENTIFY ALTERNATIVE

COURSES OF ACTION (continued)

• Creativity in decision making is vital to effective choices

• “______________” can be a dangerous alternative

Six-step Procedure for Financial

Planning

Step 4: EVALUATE _________

__________________

• CONSEQUENCES OF CHOICES

– ___________________ - What you give up when you make a choice

– The cost or __________ of a decision cannot always be measured in dollars. Sometimes the cost is your time

Continued… _1-10

Six-step Procedure for Financial

Planning

Step 4: EVALUATE YOUR

ALTERNATIVES

• EVALUATING ______________

– Uncertainty is a part of every decision. – Best way to analyze and minimize risk is to

gather information from financial planning sources.

Continued… _1-11

Six-step Procedure for Financial

Planning

Step 5: CREATE AND IMPLEMENT YOUR

___________________________________

– 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

Six-step Procedure for Financial

Planning

Step 6: _________ AND _______ YOUR PLAN

• Financial planning decisions need to be assessed regularly

• Complete review should be done at least once a year

• More frequent reviews may be required for changing personal, social, and economic factors • Regular reviews of decision-making process can

help in making priority adjustments to achieve

financial goals 1-13

Developing Personal Financial Goals

Objective 2: Develop personal _____________

• TYPES OF FINANCIAL GOALScan be:

a) Influenced by the ___________ in which you want to achieve your goals

b) Influenced by the _________ need that drives your goals

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Developing Personal Financial

Goals

Objective 2: Develop personal financial goals

• TIMING OF GOALS

– Short-term, intermediate and long-term goals

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

• GOALS FOR DIFFERENT FINANCIAL NEEDS

– Consumer product goals – Durable-product goals – Intangible-purchase goals

Developing Personal Financial

Goals

GOAL-SETTING GUIDELINES • Goals should be:

– S_____: know what your goals are to create a plan – M____________: with a specific amount – A_______________: identify the personal financial

activities

– R________: utilizing your income and life situation – T_________: identify the time frame to achieve the

goal

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Influences on Personal Financial

Planning

Objective 3: Assess _________ and

___________ factors that influence personal financial planning

LIFE SITUATION AND PERSONAL VALUES

• ____________________ stage

• Marital status, household size, and employment • Major events

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

• Values influence spending and saving decisions

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Influences on Personal Financial

Planning

ECONOMIC FACTORS

• ______________ is the study of how wealth is created and distributed

• Federal Reserve Bank and it’s role in the economy

Influences on Personal Financial

Planning

GLOBAL INFLUENCES • Global marketplace influences financial

activities

• American companies compete against foreign companies for US dollars

• Balance of exports and imports

• Foreign investments and their role in the US Money Supply

• The level of Money Supply affects interest rates

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Influences on Personal Financial

Planning

•Gross domestic product (GDP) •Trade balance

•Stock market indexes

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Tools in every financial situation

• Reduce debt usage

• Reduce spending

• Review savings investments

• Evaluate insurance coverage

• Avoid financial scams

• Communicate with family

Influences on Personal Financial

Planning

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Opportunity Costs and the

Time Value of Money

• Every financial decision involves giving up something to obtain something else PERSONAL ________________________ • 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

FINANCIAL OPPORTUNITY COSTS

______________________

• 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 trade-offs. Current needs can make spending worthwhile.

Future Value Example

You deposit $100 today in a bank account that pays 3% interest per year. How much do you have in 1, 2 and 3 years?

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Opportunity Costs and the Time

Value of Money

1) _____________ OF A SINGLE AMOUNT • Future 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

2) FUTURE VALUE OF A SERIES OF DEPOSITS

• Future value can be computed for a single amount or for a series of deposits called an _______________

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Future Value of an Annuity

• You deposit $100 in each of the next 3 years (starting next year) in a bank account that pays 3% interest per year. How much do you have 3 years from now?

Future Value Formulas

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Present Value Example

You want $500 in three years. How mucg must you deposit today in a bank account that pays 3% interest per year?

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Opportunity Costs and the Time

Value of Money

3) _________________ OF A SINGLE AMOUNT

• _________________ 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.

4) PRESENT VALUE OF A SERIES OF DEPOSITS

• Present value can be computed for a single amount or for a series of deposits.

Present Value of an Annuity

• How much do you need to deposit today in a bank account that pays 3% interest per year if you plan to withdraw $250 per year for three years, starting next year?

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Present Value Formulas

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Achieving Financial Goals

personal financial goals for 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)

Achieving Financial Goals

DEVELOPING A _________ 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

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Achieving Financial Goals

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