Kapoor

Dlabay

Hughes

6e

©The McGraw-Hill Companies, Inc.,2001. All Rights Reserved.

PE

RS

ON

AL

FIN

AN

CE

Irwin/McGraw-Hill

© The McGraw-Hill Companies, Inc., 2001. All Rights Reserved.

Irwin/McGraw-Hill

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CHAPTER 1

Personal Finance

Personal Financial Planning: An Introduction

Kapoor Dlabay Hughes

6e

Irwin/McGraw-Hill

© The McGraw-Hill Companies, Inc., 2001. All Rights Reserved.

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Financial Planning and Its Benefits

Personal financial planning is the process of managing your money to achieve personal economic satisfaction. There are several advantages of personal financial planning.

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

Increased control of your financial affairs. Improved personal relationships. A sense of freedom from financial worries

obtained by looking to the future. 1-2

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The Financial Planning Process

Determine your current financial situation. Develop financial goals. Identify alternative courses of action. Evaluate alternatives. Create and implement a financial action plan. Reevaluate and revise your plan.

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Every Decision Has An Opportunity Cost (trade-off)Opportunity cost is what you give up by making a choice.

The cost, referred to as the trade-off of a decision, cannot always be measured in dollars. Sometimes the cost is your time.

Consider lost opportunities that will result from your decisions.

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Every Financial DecisionInvolves Evaluating Types of Risk Inflation risk.

Rising prices cause lost buying power. Interest-rate risk.

Effect costs of borrowing and rate of return. Income risk.

The loss of a job. Personal risk.

Health, safety, or costs. Liquidity risk.

Higher return may mean less liquidity.1-5

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Financial Planning Information Sources

Printed materials. Financial institutions. School courses and educational seminars. Computer software, World Wide Web, and on-line information sources. Financial specialists.

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Developing Personal Financial Goals Types of financial goals include those...

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

Influenced by the financial need that drives your goals.

Timing of goals. Short-term, intermediate and long-term goals.

Goals for different financial needs. Financial goals should...

Be realistic, be stated in specific, measurable terms, have a time frame, and indicate the type of action to be taken.

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Influences on Personal Financial Planning

Adult life cycle stage. Marital status, household

size, and employment. Major events.

Marriage. Birth or adoption of child. Divorce.

Values. What are the ideas and principles you consider

correct, desirable and important?

Life situation and personal values

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Influences on Personal Financial Planning (continued)

Market Forces. Supply and demand. Production costs and competition.

Financial institutions. Influence of the Federal Reserve.

Global influences. Level of exports.

Economic conditions....

Economic factors:

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Changing Economic Conditions

Consumer The value of the dollarprices changes in inflation.

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

Interest rates The cost of money; cost of credit when you borrow; return on your money when you save or invest.

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Changing Economic Conditions (continued)

Money Supply The dollars available for spending in our economy.

Unemployment The number of individuals without employment who are willing and able to work.

Housing starts Number of new homes being built.

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Changing Economic Conditions (continued)

GDP: Gross Total value of goods and services Domestic Product produced in a country.

Trade balance Difference between a country’s exports and imports.

Market indexes The relative value of stocks as represented by the index, such as the Dow Jones Average or theS&P 500.

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Opportunity Costs and Financial Results Evaluated When Making Decisions

PersonalOpportunity Costs

(time, effort, health)

FinancialOpportunity Costs(Interest, liquidity,

safety )

Financial

Acquisitions

(automobile, home, college education, investments, insurance, retirement fund)

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Time Value of Money

(discounting)

Present

AmountNow

Future

Value(compounding)

ValueAmount

Later

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Increases in an amount of money as a result of interest earned

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How Simple Interest is Computed

Simple Interest.Amount in savings x annual interest rate x time period equals the interest.

$100 x 6% x 1 (1 year) 100 x .06 x 1 = $6.00

In one year you have $106.

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Future Value of Money

Future value is also call compounding. The amount to which a sum you invest

now will increase based on a specified interest rate and time period.

Future value can be computed for a single amount.

Future value can also be determined for a series of deposits.

Start investing now to take advantage of the future value of money.

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Present Value The current value for a future amount

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

Present value calculations are also called discounting.

Present value of a single amount. Present value of a series of deposits.

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Components of 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) 1-18

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Developing a Flexible Financial Plan

A financial plan is formalized report that... Summarizes your current financial situation. Analyzes your financial needs. Recommends future financial activities.

You financial plan can be created by you, done with assistance from a financial planner, or made using a money management software package.

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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.

Achieving your financial objectives requires.. A willingness to learn. Appropriate information sources.

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