Transcript chapter 1 notes

Chapter 1
Personal Finance Basics
and the Time Value of
Money
09/01/09
Why Important

Nobody can avoid dealing with personal finance

People do claim bankruptcy
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Chapter 1
Learning Objectives
1.
Analyze the process for making personal financial
decisions
2.
Develop personal financial goals
3.
Assess personal and economic factors that
influence personal financial planning
4.
Determine the personal and financial
opportunity costs associated with personal
financial decisions
5.
Identify strategies for achieving personal
financial goals for different life situations
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The Financial Planning Process
Objective 1: Analyze the process for making
personal financial decisions
Personal Financial Planning is the process of managing
your money to achieve personal economic satisfaction
Advantages of Personal Financial Planning are:
1.
Increased effectiveness in obtaining, using and
protecting financial resources
2.
Increase control of one’s financial affairs
3.
Sense of freedom from financial worries
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The Financial Planning Process
(continued)
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Six-step procedure for Financial Planning
Determine your current financial situation.
Develop your financial goals.
Identify alternative courses of action.
Evaluate your alternatives.
Create and implement your financial action plan.
Review and revise your plan.
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The Financial Planning Process
(continued)
Step 1: DETERMINE YOUR CURRENT
FINANCIAL SITUATION

Determine current financial situation regarding
income, savings, living expenses, and debts
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Prepare a list of current asset and debt balances
and amount spent for various items
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Match financial goals to current income and
potential earning power
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The Financial Planning Process
(continued)
Step 2: DEVELOP YOUR FINANCIAL GOALS
 Identify feelings about money and the reasons for
those feelings
 Determine the source of your feelings about money
 Determine the effects of economy on your goals and
priorities
 Make sure that your goals are your own and are specific
to your situation
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The Financial Planning Process
(continued)
Step 3: IDENTIFY ALTERNATIVE COURSES OF
ACTION
 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
 Creativity in decision making is vital to effective choices
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The Financial Planning Process
(continued)
Step 4: EVALUATE YOUR ALTERNATIVES
 CONSEQUENCES OF CHOICES
 Opportunity cost - What you give up
when you make a choice
 The cost or trade-off of a decision cannot always be
measured in dollars. Sometimes the cost is your time
 EVALUATING RISK
 Uncertainty is a part of every decision.
 Best way to analyze and minimize risk is to gather
information from financial planning sources. (Exhibit 13)
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The Financial Planning Process
(continued)
Step 5: CREATE AND IMPLEMENT YOUR
FINANCIAL ACTION PLAN
 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
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The Financial Planning Process
(continued)
Step 6: REVIEW AND REVISE YOUR PLAN
 Financial planning decisions need to be assessed
regularly
 Complete review should be done at least once a year
 Regular reviews of decision-making process can help
in making priority adjustments to achieve financial
goals
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Developing Personal Financial Goals
Objective 2: Develop personal financial goals
 TYPES OF FINANCIAL GOALS can be:
 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
 Long term goals should be planned in coordination
with short-term and intermediate goals
 GOALS FOR DIFFERENT FINANCIAL NEEDS
 Consumer product goals
 Durable-produce goals
 Intangible-purchase goals
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Developing Personal Financial Goals
(continued)
GOAL-SETTING GUIDELINES
 Goals should be realistic
 Goals should be stated in specific terms
 Goals should have a time frame
 Goals should indicate the action to be taken
 Discuss some of your goals
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Developing Personal Financial Goals
(continued)
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Influences on Personal Financial Planning
Objective 3: Assess personal and economic
factors that influence personal financial
planning
LIFE SITUATION AND PERSONAL VALUES
 Adult life cycle stage
 Marital status, household size, and employment
 Major events
 Graduation, marriage, career change, children, retirement,
etc
 Values
 What values are important to you?
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Influences on Personal Financial Planning
(continued)
ECONOMIC FACTORS
 Forces of Supply and Demand and prices
 Federal Reserve Bank and it’s role in the economy
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Influences on Personal Financial Planning
(continued)
GLOBAL INFLUENCES
 Global marketplace influences financial activities
 Balance of exports and imports
 Foreign investments and their role in the US Money
Supply
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Influences on Personal Financial Planning
(continued)
ECONOMIC CONDITIONS
Consumer
prices
The value of the dollar
changes in inflation
Consumer
spending
The demand for goods and
services 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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Opportunity Costs and the Time Value of
Money
 Object 4: Every financial decision involves giving up
something to obtain something else
PERSONAL OPPORTUNITY COSTS
 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 (continued)
FINANCIAL OPPORTUNITY COSTS
Time Value of Money
 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 considering
the trade-offs. Current needs can make spending
worthwhile.
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Opportunity Costs and the Time Value of
Money (continued)
INTEREST CALCULATIONS
 Three amounts are required to calculate the time value
of money
 Principal
 Interest rates
 Time
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Opportunity Costs and the Time Value of
Money (continued)
COMPUTING SIMPLE INTEREST
(Amount in savings) x (annual interest rate) x
(time period) = (interest)
For Example:
$100 x 5% x 1 (1 year)
100 x .05 x 1 = $5.00
In one year you have $100 in principle plus $5.00 in
interest for a total of $105 at the end of the year
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Opportunity Costs and the Time Value of
Money (continued)
FUTURE VALUE 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
FUTURE VALUE OF A SERIES OF DEPOSITS
 Future value can be computed for a single amount
or for a series of deposits called annuities
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Opportunity Costs and the Time Value of
Money (continued)
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Opportunity Costs and the Time Value of
Money (continued)
PRESENT VALUE OF A SINGLE AMOUNT
 Present Value 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 (See Exhibit 18C)
PRESENT VALUE OF A SERIES OF DEPOSITS
 Present value can be computed for a single amount or for
a series of deposits (See Exhibit 1-8D)
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Achieving Financial Goals
Objective 5: Identify strategies for achieving
personal financial goals 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)
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Achieving Financial Goals (continued)
DEVELOPING A FLEXIBLE FINANCIAL PLAN
 A financial plan is a formalized report that...
 Summarizes your current financial situation
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Analyzes your financial needs
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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 (continued)
IMPLEMENTING YOUR FINANCIAL PLAN
 Develop good financial habits
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Use a well conceived spending plan to help you stay
within your income, while allowing you to save and
invest for the future
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Have appropriate insurance protection to prevent
financial disasters
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Become informed about tax and investment
alternatives
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