Transcript Budgeting Practices Over the Life Cycle

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1. To describe the family life cycle.
2. To formulate a personal budget.
3. To describe the various tools available to
invest extra money.
4. To associate risks involved with various
types of investments.
5. To compare Traditional IRAs with Roth
IRAs.
6. To examine how economic conditions
effect personal finances.
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• Are the focal point of developing your
personal financial plan
• Can be either
– short term (<1 year) such as a vacation or
piece of furniture
– long term such as a house, education or
retirement
• Need to have a set of priorities and a
target date for achievement
• Require constant updating as a result of
the changing family life cycle
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• Explains how a person changes financial
position, earnings, consumption and savings
throughout the life cycle
• Was introduced by marketers, for example
– a single male of 30 will purchase no diapers,
meanwhile a married male of 30 with an
infant will purchase many diapers
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• Was extended to the realm of personal finance
in 2000
• Is categorized into eight stages
Younger single
Younger couple, no
children
Couple, dependent
children
Single, dependent
children
Older couple, children
independent
Older single
Couple, retired
Single, retired
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• Provides a framework to
examine issues that are most
likely important for a variety of
family units
• Allows personal finance
professionals to argue that the
first four stages involve a greater
need for budgeting
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• Differentiates the various financial
planning issues between groups;
– in other words, a single person with
children is going to have different
financial needs (e.g., preparing for
college, putting food on the table)
than a single person who is retired
(e.g., traveling, investing in expensive
hobbies such as hunting)
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• Recommend the life cycle as the initial tool
when evaluating a family unit
• Argue that financial behavior does conform to
the eight stages within the family life cycle
• Recognize faults in the family life cycle model,
for instance
– goal-planning is not strongly emphasized,
focuses more on the “here and now”
– utility, fails to incorporate an empirical way to
measure consumption and satisfaction
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• Begins with budgeting your finances
– Calculate income sources (fixed and variable )
• salary
• savings account
• benefits (Social Security, alimony)
– Calculate expenses (fixed and variable)
• rent
• utilities
• insurance
• food
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• Assist in planning your financial
situation throughout the year
• Identify shortages before they happen
• Act as a control mechanism in regards
to the way you spend money
• Allow you to see the larger picture and
assist in reorganizing finances to
reduce debt or increase savings
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Personal budget
Jan
Feb
March
April
May
June
July
Aug
INCOME
Wages
0.00
0.00
0.00
0.00
0.00
0.00
0.00
Interest/dividends
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
Mortgage/rent
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
Cellular telephone
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
Groceries
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
Dining out
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
Gas/fuel
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
Insurance
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
Cable TV
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
Movies
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
Clothing
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
Salon/barber
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
Long-term savings
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
Credit card payments
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
Income totals
0.00
EXPENSES
Home
Home totals
Daily living
Daily living totals
Transportation
Transportation totals
Entertainment
Entertainment totals
Personal
Personal totals
Financial obligations
Financial obligation totals
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Total expenses
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Cash short/extra
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• My expenses exceed my income?
– cut down
– do you need to eat out so much?
– did you call nine different insurance companies
for the best quote?
– increase your income sources
• invest in certificates of deposit (CD’s)
• donate plasma
– consolidate your debt
• consumer loan
• home equity loan
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• My income exceeds my expenses
– food for you
– research investment and savings
options
• certificates of deposit
• 401k/IRA plans
• mutual funds
• stock market
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• Are similar to a savings account, with the
following exceptions:
– CDs have higher interest rates
– CDs have fixed terms, in other words
you intend to invest an amount of cash
for 6 months, 12 months, 18 months, etc.
– CDs have a fixed interest rate, for
instance the interest rate of savings
accounts fluctuate depending on the
market; meanwhile CD interest rates
cannot change as a result of poor or
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strong market performance
• Provide periodic income, for instance
– at the end of the month, the
interest accrued can be mailed to
you in the form of a check
– at the end of the month, the
interest accrued can be
transferred to your bank account
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Vary according to the
– size of the bank
– length of maturity
• Can secure a new loan with a lower interest rate, for
example,
– securing a car loan may have an interest rate of
9.75 percent; however if you pledge your CD as
collateral and your CD rate is 5.75 percent your
loan rate will also be 5.75 percent
Collateral: property of value that can be
transferred to a creditor in the event a person fails
to repay their debt
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• Are employee sponsored benefit plans
• Provide individuals with the chance to put
a portion of their earnings in a financial
portfolio
• Exempt you from paying income taxes on
the portion of earnings you place in a
financial portfolio
• Can be rolled over into an Individual
Retirement Account or to your future
employers 401k plan, in the event you
leave employment
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• Can contribute a portion of profit into employees
401k plans based on a formula*
• Have the right to enforce a vesting policy, for
example,
– the employee may accrue profit sharing earnings,
however the employee is not entitled to the
earnings until five years of service
• Have to sponsor a 401k plan, in other words an
individual cannot start a 401k plan on their own
*Formulas vary in the variables that are included,
such as: executive, years of service, age,
department, geographic location
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• Allows individuals to open an account and
begin saving cash towards retirement, with
tax benefits
• Come in two different types
– Traditional IRA
– Roth IRA
• Restricts the amount of cash you can
contribute to the account
• Are generally risk-free
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• Reduces your tax-liability, in other words
contributions are tax-deductible
• Requires you to pay taxes on interest
• Gives you the option to withdraw at the
age of 59.5
• Requires you to withdraw at the age of
70.5
• Penalizes you with a 10 percent tax on
any withdrawals made before the age of
59.5
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• Does not provide a tax shelter on contributions,
in other words you cannot reduce your taxliability
• Does not require you to pay taxes on the
interest
• You can withdrawal at any time
• Excludes certain individuals, in order to open a
Roth IRA you must be
– single and making up to $95,000 per year
– married and making a combined $150,000
per year
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• Consists of a portfolio of securities
(e.g., common stock, bonds, moneymarket accounts)
• Are professionally managed
• Carry high-risk
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• Are an investment in publicly traded
companies
• Provide ownership in a company
• Consist of two types:
– common: voting rights in a company, last
to receive dividends
– preferred: no voting rights in a company,
first to receive dividends
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• Are associated with every investment
• Effect the rate of return on your investment
Investment
401k
IRAs
Mutual Funds
Stocks
Savings
Money Market
Accounts
Risk
Varies – Can select high
risk, low risk, moderate
risk portfolio
Low Risk
Return
Volatile – Higher risk, greater
returns or loss in investment
Varies – Can select high
risk, low risk, moderate
risk portfolio
High Risk
Volatile – Higher risk, greater
returns or loss in investment
Low Risk
Low Risk
Lower return on investment
Lower return on investment, but
higher than a savings
Lower return on investment
Volatile – Higher risk, greater
returns or loss in investment
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• Serves a critical purpose in personal finance
• Provides a cushion for your financial condition in the
event of an emergency
• Should be developed through a type of savings, for
instance a
– savings account
– money market account
• Rewards you by earning interest
• Should be easily accessible
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Savings
Lower return rate
Money Market
Higher return rate
Lower minimum
balance required
Higher minimum
balance required
No check writing
authority
Check writing
authority
Limited
withdrawals per
month
Limited
withdrawals per
month
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Cash Available for Savings
• Effects personal finance planning, for example
– when the unemployment rate is low, monetary
supply is increased, which leads to an increase in
savings
• Is only one example of the economic shifts in a
national economy that effect monetary supply, thus
an individuals ability to save
$1,400,000
$1,200,000
$1,000,000
$800,000
$600,000
$400,000
$200,000
$0
1%
2%
3%
4%
5%
Unemployment Rate
6%
7%
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1.
2.
3.
Short term goals cover a time period of 1-2 years. If
false correct the statement.
a. true
b. false
List five financial goals your family has right now.
_________________________ explains how a person
changes financial position, earnings, consumption and
savings throughout the life cycle.
a. financial Evolution
b. life Cycle
c. portfolio growth
d. family life cycle
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4. Which of the following would NOT be considered a
fixed source of income?
a. income from work
b. donating plasma
c. alimony
d. child support
5. __________ banks offer _________ interest rates
when you invest certificates of deposits for a long time.
a. larger, higher
b. smaller, higher
c. larger, lower
d. smaller, lower
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6. Anyone can open a 401k plan. If false
correct the statement.
a. true
b. false
7. An advantage of a Roth IRA is
a. the reduction of tax-liability
b. requires payment of taxes upon
withdrawal
c. does not require payment of taxes
upon withdrawal
d. its high risk factor
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8. Common stock differs from preferred stock in
a. voting rights
b. exchange rates
c. callable features
d. liquidity
9. Would you invest your emergency fund monies
in a savings account or a mutual savings
account? Explain.
10.Explain how the unemployment rate affects
families. Graph this relationship.
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• Brooks, R. (1996). Computing Yields on
Enhanced CDs. Financial Services
Review, 5(1), 31-42.
• Davis, E.P. & Car, R.A. (1992). Budgeting
Practices Over the Life Cycle. Financial
Counseling and Planning, 3, 12-18.
• Robinson Chris (1998). Conceptual
Frameworks for Personal Finance.
Unpublished Manuscript.
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