Transcript Section 4 - personal finance

Part IV
The 12 Key Elements of Practical
Personal Finance!
1
Overview
• Personal finance IQ quiz
• Financial insecurity in America
• The 12 key elements of practical personal
finance
• Budgeting Exercise
• Meeting with an investment representative
2
Personal Finance IQ Quiz!
What do you know about personal finance?
3
Financial Insecurity in America
Why is there so much financial insecurity in
America?
Is it because our income is so low?
4
Not Really!
Real Disposable Income Per Capita
35000
Billions of 2000 Chained Dollars
30000
25000
20000
15000
10000
5000
0
1970
1975
1980
1985
1990
1995
2000
2005
5
Consumption per person has also
been growing!
Real Disposible and Consumption Per Capita
30000
Billions of 2000 Chained Dollars
25000
20000
15000
10000
5000
0
1970
1975
1980
1985
1990
1995
2000
2005
Year
Real Personal Disposible Income Per Capita (2000 Dollars)
Real Personal Consumption Per Capita (2000 dollars)
6
More Consuming + Less Saving =
More Debt
As a Percentage of Real Disposable Income
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
1970
1975
1980
1985
Savings Rate
1990
1995
2000
2005
Consumption Rates
7
Debt Per Household
8
Who needs money when we have
credit!
Real Unpaid Credit Card Balance Per U.S. Household
(2007 Dollars)
$10,000
$8,000
$6,000
$4,000
$2,000
$0
1970
1975
1980
1985
1990
1995
2000
2005
9
Credit Card Debt!
10
Interest on household debt as a
percentage of income
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Is America in Trouble?
Real income per person is rising, but:
• Savings rate is falling
• Debt is increasing
What can we do?
Is there any escape?
12
Planning for Financial Success!
The bad news:
• Failure to save regularly, conserve wisely,
invest strategically, and use credit cards
prudently is the major cause of financial
insecurity in America
The good news:
• Every one of these things is fixable!
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The importance of financial security
Financial security leads to:
•
•
•
•
Less conflict in marriage
Better health
Retirement
A greater ability to achieve personal goals
14
The Millionaire Mind!
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The 12 Key Elements of Personal
Finance
The following is a list of fundamental steps
that are necessary for achieving wealth
and financial security into the future
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#1 Discover your Comparative
Advantage
• Discover what you can produce at a lower
opportunity cost than other people.
• Don’t just think about money, your
opportunity cost includes your personal
satisfaction as well!
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#1 Discover your Comparative Advantage
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#1 Discover your Comparative
Advantage
Start looking for your comparative
advantage now!
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#2 Be Entrepreneurial
• Remember, in market economy, people
get rich by helping others and discovering
better ways of doing things
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#2 Be Entrepreneurial
Entrepreneurial talent involves the ability to
discover:
a. New products that are highly valued
relative to their costs.
The possibilities are endless!
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#2 Be Entrepreneurial
Entrepreneurial talent involves the ability to
discover:
b. Cost-reducing production methods
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#2 Be Entrepreneurial
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#2 Be Entrepreneurial
Entrepreneurial talent involves the ability to
discover:
c. Profitable opportunities that others over
look
Its hard to know what will work….
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#2 Be Entrepreneurial
Ken Olson, chairman/founder of Digital Equipment Corp.,
1977: "There is no reason anyone would want a
computer in their home."
Fred Smith’s (FedEx) Yale University Senior Project Grade
Remark: "The concept is interesting and well-formed,
but in order to earn better than a 'C,' the idea must be
feasible."
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#2 Be Entrepreneurial
Would you have invested?
26
#2 Be Entrepreneurial
Who would have thought….
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#2 Be Entrepreneurial
Requires the tolerance for risk:
• Entrepreneurial activity and selfemployment are riskier than being
employed by someone else
• This greater risk can translate into higher
income and wealth
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#2 Be Entrepreneurial
Entrepreneurs tend to:
a. Have high savings rates: they are often
reinvesting in their businesses
b. Work long hours and work more
strategically
A free market economy tends to promote
entrepreneurship….
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#2 Be Entrepreneurial
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#3 Spend less than you earn
Savings and Investment is the most likely
way that you will become rich
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#3 Spend less than you earn
Start Saving Now!
1. If you don’t exert the willpower to save
now, it is unlikely that you will start later.
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#3 Spend less than you earn
Start Saving Now!
2. The longer you wait to start saving, the
more potential wealth you give up!
You only have to save a little!
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#3 Spend less than you earn
Start out saving small amounts and then
build up to larger amounts:
“A journey of a thousand miles begins with a
single step” – Chinese proverb, most
commonly attributed to Lao Tzu
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#3 Spend less than you earn
Save Automatically:
• You can have money automatically deducted
from your paycheck or bank account for savings
• Include a plan to save in your budget
Save Strategically: Tax Deferred Savings
• 401 (k)
• Traditional IRA’s
• Roth IRA’s
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#4 Don’t Finance Anything Longer
Than Its Useful Life
You don’t want to be paying for things long after
your done consuming them.
Three things worth financing:
• House
• Education
• Automobiles (in some cases)
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#4 Don’t Finance Anything Longer
Than Its Useful Life
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#4 Don’t Finance Anything Longer
Than Its Useful Life
Things you don’t want to finance:
• Food
• Clothing
• Entertainment
• Vacations
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#5 Get More Out of Your Money
A. Avoid credit card debt!
a. Interest rates on credit cards are very
high (usually higher than savings and
investment return rates).
b. Always pay your credit card in full and
on time
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#5 Get More Out of Your Money
B. Consider purchasing used items
a. New cars lose substantial value as
soon as they are driven off of the lot.
b. Used cars have higher maintenance costs,
but depreciation costs are much lower
40
#5 Get More Out of Your Money
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#6 Begin paying into a real-world
savings account every month
• Things are going to go wrong, its just a
matter of when!
• Make contributions to an emergency
savings account a regular part of your
budget.
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#7 Harness the Power of
Compound Interest
“Mr. Einstein, what is the most powerful
force in the Universe?”
“Compound Interest!”
43
#7 Harness the Power of
Compound Interest
The Rule of 70: Divide 70 by the expected
rate of return and you will see how long it
takes for your investment to double
Again, its all about saving early!
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#8 Diversify
Don’t put all of your eggs in one basket:
Investment involves risk, especially in the
short run. Mitigate this risk by building a
diversified portfolio.
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#8 Diversify
Historically, long term returns on stocks have
been really good. Just make sure you:
• Hold a large number of unrelated stocks
• Hold stocks for a lengthy period of time.
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#8 Diversify
The Law of Large Numbers: The tendency, over
an increasing number of observations, for the
sample average to approach the population
average (the expected value).
If you hold a diversified set of stocks, some will do
poorly while others will do well so that the rate of
return will converge toward the historic average
of the stock market
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#8 Diversify
Avoid Double Jeopardy:
If your company offers you a stock-based
retirement program then you may want sell your
company’s shares as soon as you are permitted
If you don’t, and the company goes under, then
you have lost your job and your investment!
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#8 Diversify
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#9 Indexed Equity Funds Can Help You Beat the
Experts Without Taking Excessive Risk
Random Walk Theory: Current stock prices
reflect all known information about the
company, so unforeseeable events is what
drives changes in stock prices.
No one person, group of people, or
company can predict changes in the stock
market.
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#9 Indexed Equity Funds Can Help You Beat the
Experts Without Taking Excessive Risk
Mutual Funds: a professionally managed
collective investment scheme that pools
money from many investors and channels
this money into alternative investments
Many types: money market, equity funds,
bonds, etc.
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#9 Indexed Equity Funds Can Help You Beat the
Experts Without Taking Excessive Risk
• Managed equity funds are administered by
professionals who research and select
stocks in an effort to maximize your return
• Indexed equity funds reflect the holdings
of broad indexes such as the Dow Jones
and the S&P 500
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#9 Indexed Equity Funds Can Help You Beat the
Experts Without Taking Excessive Risk
Go with indexed funds:
1. The administrative costs of indexed
funds are lower than managed funds
2. Historically, the average long-term yield
of indexed equity funds has been higher
than managed funds
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#10 For the long-run, invest in stocks; for the
short-run, switch to bonds
Historically, the real return from stocks has
been higher than that for bonds.
• Over the long-run, your investment in
stocks will be able to ride out the bad
times in the market.
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#10 For the long-run, invest in stocks; for the
short-run, switch to bonds
• However, over short time horizons, stocks
are risky. As you get older, you should
switch a higher proportion of your
investment over to bonds which is less
risky.
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#10 For the long-run, invest in stocks; for the
short-run, switch to bonds
Bonds do carry some risk:
1. Inflation Risk: Unexpected inflation
erodes the purchasing power of the face
value of the bond and interest earned
2. Interest Rate Risk: Unexpected
increases in interest rates reduce the
value of outstanding bonds
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#10 For the long-run, invest in stocks; for the
short-run, switch to bonds
As your time horizon gets shorter, switch to
bonds that will mature as you need the
money
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#11 Beware of Investment Schemes Promising
High Returns with Little or No Risk
• Remember, there is no such thing as a
free lunch!
Principle-Agent Problem:
The incentive problem that occurs when the
buyer of services (investor) lacks full
information about the circumstances faced
by the seller of circumstances (investee).
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#11 Beware of Investment Schemes Promising
High Returns with Little or No Risk
Tips for avoiding investment fraud:
1.
2.
3.
4.
5.
6.
Only deal with reputable parties
Never purchase an investment by phone or email
Do not allow yourself to be forced into a quick (or any)
decision.
Do not allow friendship to influence an investment
decision
Avoid investments that use high pressured marketing
techniques.
If it looks too good to be true than it probably is
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#12 Teach Your Children About
Money
• Teach your children the value of a dollar
• Help your children develop a good work
ethic and savings habit (teach them to
save early)
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#12 Teach Your Children About
Money
• Save for your retirement over your
children’s education
• Children make bad retirement investments
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Review
•
•
•
Understand the causes of the financial
insecurity in America
Know how to effectively budget your money
and the importance of saving now for your
future.
Know the 12 Key Elements of Personal
Finance:
1. Discover your comparative advantage
2. Be entrepreneurial
3. Spend less than you earn (Save Now!)
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Review
Know the 12 Key Elements of Personal Finance (continued):
Don’t finance anything for longer than its useful life.
Get more out of your money (avoid credit card debt
and buy used)
6. Establish a real-world savings account
7. Harness the power of compound interest
8. Diversify
9. Indexed equity funds can help you beat the market
10. Invest in stocks for the long run and bonds for the
short run
11. Beware of investment schemes promising high returns
and little to no risk
12. Teach your children about money (earning and saving)
4.
5.
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