Transcript future value

Personal Finance
Chapter 1:
Understanding
Personal Finance
Learning Objectives
1.
Use the building blocs to achieving financial success.
2.
Understand how the economy affects your personal financial
success.
3.
Apply economic principles when making financial decisions.
4.
Perform time value of money calculations.
5.
Make smart decisions about your employee benefits.
6.
Identify the professional qualifications of providers of
financial advice.
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Financial Literacy
•Financial literacy is knowledge of:
– Facts
– Concepts
– Principles
– Technological tools
…that are fundamental
to being smart
about money.
The Building Blocks
of Your Financial Success
Class Discussion Question #1
•How do you make yourself feel financially happy?
Possible Answers
• Invest money in a retirement fund
• Put money away in a savings account
• Pay off debt early (house, credit card,
car note, etc.)
• Avoid relying too much on credit to make
purchases
• Avoid impulse buying
• Don’t collect things that you don’t need
The Economy and Business Cycles
• The economy grows and contracts over time:
– Expansion
– Peak
– Contraction
– Trough
Economy: System of managing the resources of a country, state, or community.
Economic Growth: Increasing production and consumption in the economy.
Business Cycle Phases
The Future Direction of the Economy?
• Track the Gross Domestic Product
• Track the Employment Report
• Track the Index of Leading Economic
Indicators
• Track the Consumer Confidence Index
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Inflation
• Inflation: Steady rise in the general
level of prices.
• How does inflation affect income and
consumption?
• How inflation is measured:
– Consumer Price Index (or CPI)
– Personal Inflation Rate
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Think Like an Economist
• Opportunity Cost:
Cost of decision
measured by the
value of the next
best alternative.
Think Like an Economist
• Marginal Utility/Cost: Usefulness or
cost of the next increment of something.
• Marginal Tax Rate: Tax rate at which
your last dollar earned is taxed.
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FAQ in Personal Finance
• What will an investment (or a series of
investments) be worth after a period of
time?
• How much savings will I have for
retirement?
• This question asks for a future value.
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Calculating Future Values
• Future Value (FV): Valuation of an
asset projected to the end of a particular
time period in the future.
• Savings/Compounding: Interest
earned on interest from multiple periods
– Ex: “How much will I have in 10 years if I invest
$1,000 at 8% interest?”
$1,000
Principle Amount
x(1.08)10
Interest Rate (annual)
$2,158.93
Investment Value
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Future Value of $1 After a Given Number
of Periods
Periods
1
2
3
4
5
10
4%
1.0400
1.0816
1.1249
1.1699
1.2167
1.4802
7%
1.0700
1.1449
1.2250
1.3108
1.4026
1.9672
Appendix A-1
8%
1.0800
1.1664
1.2597
1.3605
1.4693
2.1589
10%
1.1000
1.2100
1.3310
1.4641
1.6105
2.5937
Calculating Future Values
• Future value of a lump sum
Future Value (FV) = P(1 + r)t
Ex: “How much will I have in 10 years if I invest $100 at 10% interest?”
$100(1.10)10 = $259.37
• Future value of an annuity
Future Value (FV) = P(1 + r)t + P(1 + r)t + P(1 + r)t
...
Ex: “How much will I have if I invest $100 at the end of each year for 3
yrs at 10% interest?” = $100(1.10)0 + $100(1.10)1 + $100(1.10)2 =
$100 + $110 + $121 = $331 FV in 3 years !
– Rule of 72: An approximate interest rate earned based upon the
time it will take for an investment to double is determined by:
72
r
r = interest rate earned, so:
Ex: If doubling period is 8 years, the interest rate is
72/8 = 9 %
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Rule of 72 Illustrated
Rule of 72: Reveals number of years it takes for the
principle amount invested to double in value.
Future Value
of $10,000
FAQ in Personal Finance
• How much has to be put away today (or
as a series of investments) to provide
some dollar amount in the future?
• This question asks for a present value.
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Calculating Present Values
• Present value of a lump sum – “How much do I need
to save today to have $259.37 in 10 years if I can earn a 10% return?”
Present Value (PV) = FV
(1+r)t
Ex: $259.37 future value discounted at 10% for 10 years = $259.37 =
$100 needed today
(1.10)10
r = discount rate measures the present or future value of $1
received at time period (t)
t = time period of investment
• Present value of an annuity –
“How much do I need to
save today to be able to withdraw $4,000 each year for the next 3 years
if I can earn a 10% return?”
– A fixed stream of cash flows at the end of each period over time.
• PV =
Pmt
(1+r)t
=PV of $4,000 received each year for
3 years at 10% interest:
$4,000 + $4,000
(1.10)1
(1.10)2
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+ $4,000 =
(1.10)3
$9,947.41
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Smart Money Decisions at Work
• Flexible benefit plans offer tax-free money
• Flexible Benefit (Cafeteria) Plan
• Making decisions about employer-sponsored health
care plans
• High-Deductible Health Care Plan
• Health Savings Accounts (or HSAs)
• Making decisions about employer’s Flexible
Spending Accounts
• Pretax Dollars: Money income that has not been
taxed by the government.
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Smart Money Decisions at Work
• Making decisions about…
– Participating in employer life, disability, and
long-term care insurance plans
– Participating in your employer’s retirement
(or tax-sheltered retirement) plan
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Tax-Sheltered Returns
• Assumes $2,000 Annual Contribution and 8% Return
Employer Retirement Plans
• First advantage: tax-deductible contributions
• Second advantage: employer’s matching
contributions
• Third advantage: tax-deferred growth
• Fourth advantage: starting early really pays
off
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Starting to Save Early Versus
Starting Late at 9%
Earlier
Age $ Value
23 $ 3,000
31
6,000
39 12,000
47 24,000
55 48,000
63 $96,000
Later
Age $ Value
23 $
0
31
3,000
39
6,000
47 12,000
55 24,000
63 $48,000
Professional Financial Planning
Advice
• A true financial planner should be able to
analyze a family’s total needs in such areas as:
– investments
– taxes
– insurance
– education goals
– retirement
Professional Financial Planning Advice
• Appropriate professional designations
and credentials for planners:
– Certified Financial Planner (CFP)
– Chartered Financial Consultant (CFC)
– Certified Public Accountant (CPA)
– Accredited Financial Counselor (AFC)
– Mutual Fund Chartered Counselor (MFCC)
– Registered Investment Advisor (RIA)
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Professional Financial Planning Advice
• How financial planners are compensated:
– Commission-only financial planners/brokers
– Fee-based financial planner/brokers
– Fee-offset financial planners/brokers
– Fee-only financial planners
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Top 3 Financial Challenges in Personal Finance
People are challenged to build and
maintain financial well being when they:
1. Think only about money matters when
faced with a financial problem.
2. Spend more than they earns.
3. Get financial advice from amateurs.
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Good Money Habits in
Personal Finance
•
Spend significantly less than you make and save
using pay-yourself-first.
•
Stay up-to-date with current economic conditions
and the knowledge to manage your personal
finances.
•
When making financial decisions, use marginal and
opportunity costs and time value of money
calculations.
•
Establish financial goals and take actions to
achieve them.
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Good Money Habits in
Personal Finance
•
Take advantage of tax sheltering through your
employer’s benefits program.
•
Believe in compounding by allowing your money to
earn interest on top of the principal and other
accrued interest.
•
Keep debt under control.
•
Take responsibility for managing your own financial
success.
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Questions ?