Transcript Chapter 1

Chapter 1
Introduction to Personal
Financial Planning
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Chapter Goals
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Understand what personal financial planning (PFP)
is and how it works.
Place goals at the head of the PFP process.
Develop familiarity with PFP’s financial and personal
frameworks.
Understand the specific role of financial planning and
the financial plan as comprehensive integrated
processes.
Why Is Financial Planning Important?
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Many financial alternatives are available.
Extensive information is available to help decide
which alternative to choose.
Wise decisions enable the achievement of financial
goals.
Financial planning assists in making wise decisions.
The History of Personal Financial
Planning
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Before the 1970s, PFP services were generally
provided to only the very wealthy.
Services began expanding to a larger population,
due to:
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A middle class with increased discretionary income.
The growing complexity of financial instruments and
services.
The development of PFP professionals.
Increased media awareness of PFP.
Characteristics of Finance
 Finance is concerned with the following variables:
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Markets
Capital
Market structure
Market value
5. Fair value
6. Cash flow
7. Risk
8. Investments
 Let’s define each of these terms:
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Characteristics of Finance, cont.
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Markets: Places where tangible goods and
financial instruments are bought and sold.
Capital: Real, financial and human related assets
that are generated by individuals and organizations
or bought and sold in the marketplace.
Market structures: The economic operations of the
business, the government, and the household that
facilitate the purchase and sale of items.
Market Value: The market-established worth of a
product or a financial instrument.
Characteristics of Finance, cont.
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Fair Value: The inherent worth of nonmarketable
assets based on cash flow, risk, and the time value
of money principles.
Cash Flow: The economic operation of the
organization based on the cash it generates.
Risk: The uncertainty of outcomes.
Investments: Placing cash flow into assets designed
to improve an organization or to provide future
funds for consumption.
Finance Tools
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Basic finance tools used when making finance
decisions include:
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Time value of money
Cash flow analysis
Optimization
Market pricing
Analysis of risk
Investment models of behavior
Personal Finance
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Personal finance: The study of how people develop
the cash flows necessary to support their operations
and provide for their well-being.
Household finance: The study of how a household
and the people in it develop the cash flows
necessary to support operations and provide for the
well-being of its members.
Personal Finance cont.
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Personal finance issues can be placed into one of
the following categories:
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Consumption and savings
Investments
Financing
Risk management
Personal Finance cont.
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For example:
Personal Finance Issue
Inability to save properly
Debt problem
Desire to improve investment returns
Desire to retire comfortably
Discomfort with risk profile
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Principal Category
Consumption and savings
Financing
Investing
Multiple categories
Risk management
Other Disciplines
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Other disciplines are used in the practice of personal
finance. These include:
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Microeconomics
Macroeconomics
Accounting
Law and taxation
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Let’s consider each of these disciplines:
5. Mathematics and statistics
6. Business and government
7. Psychology and sociology
Other Disciplines, cont.
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3.
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Microeconomics: Helps us understand how people
and households allocate scarce resources.
Macroeconomics: Macroeconomic conditions often
have a strong influence on household actions.
Accounting: Provides some of the analysis and
record-keeping structures.
Law and taxation: Presents the rules and regulations
in general, and in relation to taxation in particular.
Other Disciplines, cont.
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Mathematics and statistics: Yields logical thinking and
appropriate measurement of household operations.
Business and government: Business provides a
benchmark for selected household activities.
Government can change the planning environment
Psychology and sociology: Help in understanding how
people act as distinct from how they should act.
Personal Financial Planning
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Personal financial planning (PFP): The method by
which people anticipate and plot their future actions to
reach their goals.
When we engage in PFP, it is usually to solve a
problem or to structure a plan for the future.
Personal Financial Planning, cont.
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PFP is implemented through the following six-step
decision making process:
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Establish the scope of the activity
Gather the data and identify goals
Compile and analyze the data
Develop solutions and present the plan
Implement
Monitor and review periodically
Let’s consider each of these steps:
Personal Financial Planning, cont.
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Establish the scope of the activity
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Gather the data and identify goals
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Defines the specific services that will be provided.
Accumulates data on household financial assets,
income and expenditures, health, time available, and
tolerance for risk.
The underlying goal is to have the highest standard of
living possible.
Personal Financial Planning, cont.
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Compile and analyze the data
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Develop solutions and present the plan
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Data is placed on the balance sheet, the cash flow
statement, and any other statements that are relevant.
Analysis of the statements is performed and the client’s
overall financial position is established.
Financial planner chooses the products, services, and
practices that solve the client’s problem.
The best solution is usually the one that solves the
problem at the lowest cost.
Personal Financial Planning, cont.
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Implement
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Monitor and review periodically
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The best solution is chosen and put into practice.
Often difficult to accomplish due to either inertia or
difficulty.
All planning procedures are subject to change, due to
factors such as income, financial environment, and life
situation changes.
Individual goals may also change as the client ages.
The Financial Plan
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Financial plan: The structure through which you can
establish and integrate all goals and needs.
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Comprehensive financial plan: a detailed written
financial plan, typically prepared by a personal
financial planner.
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The financial plan is the practical embodiment of the
financial planning process and the tool to assist in its
implementation.
Most people come to a financial planner for a solution to
individuals problems and not for a comprehensive plan.
The Financial Plan, cont.
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The financial plan is composed of the following parts:
1. Establishing goals
2. Analysis of financial
statements
3. Cash flow planning
4. Tax planning
5. Investment planning
6. Risk management
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7. Retirement planning
8. Estate planning
9. Special circumstances
planning
10. Employee benefits
11. Educational planning
Let’s consider each of these parts:
The Financial Plan, cont.
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Establishing goals: Decide on priorities, both today
and the future.
Analysis of financial statements: Present a current
picture of the financial condition.
Cash flow planning: Plan income and expense flows
so that work, cost of living, savings and investment
and financing issues interact in an optimal way to
provide the highest returns possible.
Tax planning: minimize payments to the government
through allowable tax deductions, credits, and other
forms of tax benefits.
The Financial Plan, cont.
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Investment planning: enable our net cash flows to
grow as rapidly as possible, subject to our tolerance
for risk.
Risk management: Control the level of risk and
consequently of loss for each significant household
asset and for the entire portfolio of assets.
Retirement planning: Focus on household saving and
investing decisions that allow individuals to retire at
the age and lifestyle that they desire.’
The Financial Plan, cont.
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Estate planning: Planning for yourself and others while
you are alive and for current and former members of
your household and other people or institutions upon
your death.
Special circumstances planning: A miscellaneous
category to handle other goals and activities.
Employee benefits: planning and integrating forms of
compensation other than salary.
Educational planning: Preparing financially for the
outlays for educating adult and children members of
the household.
The Financial Plan, cont.
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Financial planning is more than the sum total of
individual goals for each section.
Integration looks at goals and resources as a whole
and at how actions in one part of the plan can affect
other areas.
For example, money saved in a pension plan can
increase investment sums, reduce retirement
planning, and estate planning needs, and results in
fewer resources available for spending today.
The Financial Plan, cont.
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Summary:
Establishing goals
Analysis of financial statements
Cash flow planning, tax planning, investment planning, retirement
planning, estate planning, special circumstances planning, education
planning, risk management, and employee benefits
Financial integration
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Financial plan
Financial planning as a career
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Financial planners: people with designations,
education, and experience, who are trained to practice
personal financial planning. Designations include:
Certified Financial Planner™ (CFP®)
– NAPFA-Registered Financial Advisors
– Chartered Financial Consultant (ChFC)
– Personal Financial Specialist (PFS)
– Chartered Financial Analyst (CFA)
Let’s consider each designation:
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Financial planning as a career, cont.
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Certified Financial Planner™ (CFP®):
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NAPFA-Registered Financial Advisors:
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Offered by the Financial Planning Association.
Must take at least five courses in financial planning.
Must pass a comprehensive examination.
Must have at least three years of practical financial
experience.
Offered by the National Association of Personal
Financial Advisors for fee-only advisors.
Financial planning as a career, cont.
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Chartered Financial Consultant (ChFC):
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Personal Financial Specialist (PFS):
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Offered by the American Institute of Certified Public
Accountants.
For CPAs.
Chartered Financial Analyst (CFA):
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Offered by the American College.
For insurance agents.
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Offered by CFA Institute
Specializes in investments.
Financial planning as a career, cont.
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Examples of the activities of financial planners:
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Constructing a comprehensive financial plan.
Selecting an overall asset allocation and investments.
Implementing risk management and insurance.
Structuring and planning household cash flows.
Eliminating debt difficulties.
Helping plan for retirement.
Setting up an estate plan.
Developing goals.
Reducing taxes through planning, products and structures.
Chapter Summary
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PFP is the method by which people anticipate and
schedule their future activities to reach their goals.
PFP is a six step process that begins with establishing
the scope of the activity and ends with monitoring and
reviewing the plan as set out.
The financial plan is a practical structure for achieving
the goals set out.
Financial planning is a growing career opportunity that
helps people in a wide variety of their financial
pursuits.