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Chapter 1:Learning Objectives

1. Use the building blocks to achieve financial success.

2. Understand how the economy affects your personal financial success.

3. Apply economic principles when making financial decisions.

4. Perform time value of money calculations.

5. Make smart decisions about your employee benefits.

6. Identify the professional qualifications of providers of financial advice.

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Living with Economic Turbulence

YOUR MONEY: Making good decisions is difficult in amidst the ups & downs!

Pg 4

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Personal Finance– How you spend, save, protect,

invest your financial resources

Financial Literacy– Your knowledge of facts and tools that help you be smart

about money– It empowers you!– Helps you face challenges, avoid mistakes, and take

advantage of opportunities

Financial Responsibility– WHO is accountable for your

future financial well-being?– WHO controls your financial destiny?

“The biggest barrier to achieving

financial success is to live like you are

rich before you are!”

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Building Blocks to Achieving Financial Success

• Is being wealthy a result of how much you earn or inherit?

• Reality: NO! Your wealth (or lack of!) is due to the trade-offs and decisions you make every day of your life.

• Personal Finance is not Rocket Science!– Spend less, so you can save and invest more

– Sacrifice current consumption to achieve financial goals

GOOD MONEY HABITS => ACHIEVE GOALS =>

FINANCIALLY HAPPY

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What is FINANCIAL HAPPINESS?

What is FINANCIAL SECURITY?

People who are happy about their finances are likely to

• have a budget• set reasonable goals

• live within their means

“This happiness spills over in a positive way to feelings about their

overall enjoyment of life.”

Financial Powerpoint

Pg. 5Building Blocks to Success

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The Economy Affects Your Financial Success

Economic Growth: – Increasing production & consumption in the economy

Business Cycle:– Our economy grows & contracts over time [6 yrs]– A wavelike pattern of rising and falling economic activity

What is the preferred stage of the

economic cycle?

• production = high• retail sales = high• unemployment =

low• interest rates = low

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What is a Recession? Consumers are pessimistic

Average 10 month decline in economic activity

Average unemployment rate of 6%+

The Great Recession: 2007 – 2009

• Worst recession since Great Depression

• Lasted 18 months

• Unemployment => 10%+

• Decline in stock market => 50%+

• Real estate values plunged 35%+

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Using INDICATORS to predict the future direction of the economy…

Unemployment, GDP, Production, Sales

The Stock Market is a LEADING INDICATOR

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Inflation, Prices, & Interest Rates

INFLATION:Steady rise in the general level of prices

Interest rates move in same direction

How does inflation affect us as consumers?

DEFLATION:Decline in prices due to consumers not spending

What can the Fed do to “pump up” the economy?

CPI: measures changes in prices of goods

***Does your income keep up with inflation?***

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Think Like an Economist When Making Financial Decisions

A basic economic principle:

OPPORTUNITY COST

******Every decision we make involves a trade-off…

Personal Opportunity Costs• Time• Sleep• Health

Financial Opportunity Costs• Interest• Safety

• Liquidity

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• Marginal Utility: The extra satisfaction we enjoy from “1 more”

• Marginal Cost:The added cost we incur from “1 more”

We tend to seek “1 more” if the ______ exceeds the ______.

When considering trade-offs,we ask ourselves… “is it worth it?”

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Consider Income Taxes When Making Financial Decisions…

Marginal Tax Rate: the rate at which your last dollar of earnings is taxed

Legally Avoid Paying Taxes?

Tax-exempt income

Tax-deferred income

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Why Tax-Sheltered Returns are Better than Taxable Returns

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The Time Value of Money

“A dollar today is worth more than a

dollar received 5 years from now!”

2 Common Questions about money:

1)What will an investment be worth after a certain period of time?

2)How much should be invested now to provide some dollar amount in the future?

PRESENT VALUE = DISCOUNTING

FUTURE VALUE = COMPOUNDING

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Therefore, TVM calculations take into consideration

INTEREST THAT IS EARNED OVER A PERIOD OF TIME

A simple way of calculating interest:

I = P * R * T

Ex: $1000 put into an account that earns 5% annually:

At end of year one: INTERST = $1000 x .05 x 1 = $50At end of year two: INTEREST = $1050 x .05 X 1 = $52.50At end of year three:

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“The way to build wealth is to make money on your money, not simply to put money away. Compounding over time is

what really builds wealth.”

COMPOUNDING

When we keep our saved money AND the interest it has earned in an account, it grows faster:

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Future Value = Compounding: Finding the value of an asset at some time in the future

Ex: What is the future value of $1000 invested for 4 years earning 8% interest?

FV SINGLE AMOUNT

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TheFuture Value

of $10,000

The effects of compounding are greatest over time!

This chart shows the importance of higher rates and more time! Pg. 19

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A SHORT-CUT WORTH REMEMBERING!

How long will it take for my initial investment to double?

The RULE of 72:

72 ÷ the interest rate

the money will be earning

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The Future Value of $2000

Invested Annually(EACH YEAR)

What if we ADD to our savings each year?

FV SERIES

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2ND TYPE OF TVM QUESTION:

I know the amount I need in the future… what do I have to

put away now to reach that goal?

Ex: What do I need to invest now in order to reach my desired goal of $20,000 in

10 years if my interest rate is 7% ?

0.5083 (factor) x 20,000 (principal) = $10,166

PV SINGLE AMOUNT

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In retirement, we WITHDRAW money each year from our “nestegg” to live off of…

Ex: When I retire, I need to have $30,000 per year for the next 20 years. If I can earn 7% on my investment, what amount should be put away now in order to achieve this?

10.5940 (factor) x 30,000 = $317,820

How large does our nestegg

need to be?

PV OF AN

ANNUITY

Present Value = Discounting:

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Make Smart Decisions at Work

Employee Benefit: non-monetary compensation• Ex: Paid holidays, health insurance, retirement plans

• Value can be 30%+ of your salary

Some benefits are TAX-SHELTERED• You do not pay income taxes on the value of the benefit

– Cafeteria Plan (Flex-Spending Plan)

– Health Savings Account (HSA)

Tax advantage: paying with pre-tax dollars

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Participating in your Employer’s Retirement Plan

1. Tax-Deductible Contributions2. Employer’s Matching Contributions3. Tax-Deferred Growth4. Starting Early is a must! See example pg. 25

So Many Advantages!

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Where to Seek Expert Financial Advice

• Financial advisors• Tend to focus on specific areas of your finances

(tax preparer, insurance agent, stock broker, etc.)

• Financial planners• Analyze your total needs; recommend long-term

financial strategies • taxes• insurance• education goals• retirement investments

How are they paid?

Fee-Based Commission-Based

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HOMEWORK:

Reading chapter one

Preview chapter three

PG 31 #3 (a) through (g)

Due next Thursday