Transcript BobD`sCUBIC `14 Personal Finance Section 2x

CUBIC 2014
Section 2: Topics 5-8
Personal Finance
Bob Donchez
MAYMESTER 2014
The Financial Planning Process
Personal Finance Topics
1)
2)
3)
4)
5)
6)
7)
8)
Financial planning process
Assessing financial position
Managing personal debt
Setting and achieving goals
Retirement topics
Investment topics
Insurance
Putting it all together
MAYMESTER 2014
Do you currently have:
A.
B.
C.
D.
E.
An IRA
A 401k or 403b
Some kind of retirement account
More than 1 above
None of the above
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Planning for Retirement
5-1 Approach to Retirement
Retirement should be a priority financial goal.
• Everyone will retire someday
• It requires the largest commitment of funds over the
longest period of time
MAYMESTER 2014
Planning for Retirement
5-1 Approach to Retirement
What is retirement to you?
• Not having to work full time
• Doing work other than your original career
• Being at least partially financially independent
• Taking time for life interests other than original career
(such as family, travel, starting a business, etc)
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Planning for Retirement
5-1 Approach to Retirement
Life cycle approach to retirement
Stage 1: Growing up, preparing to generate cash flow
Stage 2: Establishing career, increasingly generating cash flow
– Accumulation phase, dollar cost average saving
Stage 3: Retirement
– Distribution phase, dollar cost average distribution
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Planning for Retirement
5-2 Retirement Tax Shelters
The evolution of retirement plans
• Defined Benefit (DB) plans: traditional pension
• Defined Contribution (DC) plans: IRA, 401k, 403b
• DB plans disappearing, replaced by DC plans
– DC plans more flexible, but shifts risk from
employer to employee
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Planning for Retirement
5-2 Retirement Tax Shelters
The evolution of retirement plans
MAYMESTER 2014
Planning for Retirement
5-2 Retirement Tax Shelters
Description of Defined Contribution (DC) plans
• Approach
– Tax benefit for saving for retirement, but access to
funds constrained until older (59 1/2)
• IRAs,
– Traditional
– Roth
• 401k, 403b
– Traditional
– Roth
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Planning for Retirement
5-2 Retirement Tax Shelters
Effect of Tax Deferral
(saving $2,500 per year)
$600,000
Tax Deferred (9.0% return)
$500,000
Investment Value
Taxable at 30% (6.3% return)
$400,000
$300,000
$200,000
$100,000
$0
1
6
11
16
21
Year
MAYMESTER 2014
26
31
Planning for Retirement
5-2 Retirement Tax Shelters
Account Type
Maximum
Tax Features
Annual
Contribution
Penalty for
early
withdrawal
Traditional IRA
$5,000
$6,000 if over
50 years old
Contributions
tax deductible;
distributions
taxed as income
Normal tax
plus 10%
penalty
591/2
Traditional
401k/403b
$17,500
$23,000 if over
50 years old
Contributions
tax deductible;
distributions
taxed as income
Normal tax
plus 10%
penalty
591/2
Roth versions of
IRA and
401k/403b
Same as
above
Contributions
not tax
deductible;
distributions tax
free
No regular
tax, but 10%
penalty
591/2
MAYMESTER 2014
Normal age
to begin
withdrawal
Planning for Retirement
5-2 Retirement Tax Shelters
Investor “problem” behavior versus recommendations
Investment Item
Recommendation
Investor Behavior
Contributions
10% of salary by age 35
Doesn’t happen until age 55
Loans
Don’t take out loans
20% of workers borrow on
401k
Early Withdrawals
Don’t make withdrawals 15% of workers near
before retirement
retirement start withdrawing
early
Retirement
distributions
Withdraw 4-5% of asset
each year
Source: JPMorgan Chase, 2010
MAYMESTER 2014
Many withdraw more than
20% per year
Planning for Retirement
5-2 Retirement Tax Shelters
Other commonly used retirement tax shelters
• Keogh—equivalent to IRA for self employed
• Annuities—an income stream in return for an initial
payment(s)
• Life insurance (see section 7)
MAYMESTER 2014
What do you predict regarding social
security when it’s your turn to retire?
A.
B.
C.
D.
E.
It will be similar to the current program
There will be less benefits
There will be higher costs
It won’t be there for me
None of the above
MAYMESTER 2014
What’s the value of a cash flow stream of
$18,000 received annually for 25 years that
grows the same rate as inflation (discount
rate = 0%)?
A.
B.
C.
D.
$0
$18,000
$100,000
$450,000
MAYMESTER 2014
Planning for Retirement
5-3 Social Security and Medicare
Social Security
• Is a government “transfer” system supported by taxes
– 6.2% SS + 1.45% Medicare (15.3% for self employed)
• Very important element of retirement for most
• Normal retirement about 66 years of age
Medicare
• Again, a very important element of retirement for most
MAYMESTER 2014
Planning for Retirement
5-3 Social Security and Medicare
Social Security Annual Report—Estimated Benefits
MAYMESTER 2014
Planning for Retirement
5-3 Social Security and Medicare
Social Security Annual Report—Earnings Record
Social Security Benefits Estimator:
https://secure.ssa.gov/acu/ACU_KBA/main.jsp?URL=/apps8z/ARPI/main.jsp&LVL=4
MAYMESTER 2014
When do you want to retire? (not HAVE
to work)
A.
B.
C.
D.
E.
Under 55 years old
56 – 60 years old
61 – 65 years old
66 – 70 years old
Over 70 years old
MAYMESTER 2014
How much money do you expect to have
saved by your retirement? (current
dollars)
A.
B.
C.
D.
E.
Less than $500,000
$500,000 - $750,000
$750,000 - $1 million
$1 million - $ 1.5 million
Over $1.5 million
MAYMESTER 2014
What overall, long term return do you
expect to get from your future
investments?
A.
B.
C.
D.
E.
3 – 7%
7 – 10%
10 – 13%
13 – 16%
Over 16%
MAYMESTER 2014
How long will it take to become a millionaire
if you save $5,000 per year, starting next
year, if your investment return is 9%?
A.
B.
C.
D.
E.
21.5 years
28.7 years
31.5 years
34.2 years
44.9 years
MAYMESTER 2014
You plan to retire in 35 years as a
millionaire. You expect to live another 30
years. What level payment can you
withdraw per year (in 35 years), starting at
retirement, if returns are 8%?
A.
B.
C.
D.
E.
$21,567
$48,765
$82,248
$88,827
$98,825
MAYMESTER 2014
When you retire in 35 years, your retirement
account pays a fixed $90,000 per year (starting
at retirement). If inflation is 3.5% between now
and retirement, what is the purchasing power
of the $90,000 payments today?
A.
B.
C.
D.
E.
$26,998
$36,452
$66,789
$78,962
$97,254
MAYMESTER 2014
Planning for Retirement
5-4 Retirement Cash Flow Models
Examples of retirement planning
• A look at a simple spreadsheet model
Retirement cash flow projections
• On-line retirement resources—retirement needs
calculators
http://money.msn.com/retirement/retirement-calculator.aspx
http://www.thecalculatorsite.com/finance/calculators/retirementplanning.php
MAYMESTER 2014
You have quite a bit of money invested in the
stock market. Lately the market has fallen a
lot. What is your “instinct” for taking action?
A.
B.
C.
D.
Sit tight—I’m in it for the long haul
Bail out (sell) now before it gets worse
Sell some now—make adjustments
Buy now—it’s a good opportunity
MAYMESTER 2014
Investments “101”
6-1 General Approach to Investing
No “secret” path to successful investing:
• Regular, consistent savings (dollar cost averaging);
• Over a long period of time;
• Using simple, disciplined investment strategies.
Most people maintain two basic investment portfolios:
– Taxable portfolio for near term goals
– Tax sheltered portfolios for long term goals
(retirement)
MAYMESTER 2014
Investments “101”
6-2 Investing Terms and Concepts
Relationship between risk and return
• Long term risk and return of various asset classes
Empirical Evidence: (1925-2011)
Growth in $1
Small-company stocks
$15,532
Large-company stocks
3,045
Long-term corp. bonds
167
Long-term govt. bonds
119
Intermediate govt. bonds
92
U.S. treasury bills
21
Inflation
13
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Return
16.5%
11.8
6.4
6.1
5.5
3.6
3.1
Risk(σ)
32.5%
20.3
8.4
9.8
5.7
3.1
4.2
Investments “101”
6-2 Investing Terms and Concepts
Diversification
• Reduces total risk more than any other factor
MAYMESTER 2014
Investments “101”
6-2 Investing Terms and Concepts
Diversification
• The key to diversification is to use securities/asset
classes that behave very differently in the market.
MAYMESTER 2014
Assessing Current Financial Position
6-2 Investing Terms and Concepts
Asset Allocation measures:
– Degree of diversification
– Amount of risk/variation that may occur over time
– Amount of return likely over long period of time
MAYMESTER 2014
Assessing Current Financial Position
6-2 Investing Terms and Concepts
Asset allocation asset classes:
– “Cash”
• Cash, savings, money market, CD
– Fixed income
• Bonds, bond mutual funds and ETFs
– Stock/equities
• Stock, stock mutual funds and ETFs
– “Alternatives”
• Real estate, commodities, collectibles
MAYMESTER 2014
Investments “101”
6-2 Investing Terms and Concepts
Asset Allocation
• One suggestion for long term investing:
“100 to 120 – age in years = equity proportion”
Examples:
30 years old: equity = 70 – 90%
60 years old: equity = 40 - 60%
MAYMESTER 2014
Investments “101”
6-2 Investing Terms and Concepts
Sample Asset Allocations and Characteristics
“Conservative”
“Moderate”
“Aggressive”
MAYMESTER 2014
Assessing Current Financial Position
2-4 Current Investment Asset Allocation
Sample Asset Allocations
MAYMESTER 2014
Assessing Current Financial Position
2-4 Current Investment Asset Allocation
Sample Asset Allocations
MAYMESTER 2014
Investments “101”
6-2 Investing Terms and Concepts
On-line resources: questionnaires to determine asset
allocation:
http://www.smartmoney.com/calculator/investing/managing-assetallocation-1304479164310/
http://cgi.money.cnn.com/tools/assetallocwizard/assetallocwizard.html
MAYMESTER 2014
Investments “101”
6-3 Overview of Securities
Forms of “cash”
• Checking, savings
• Money market mutual funds
• Certificates of deposit
Forms of fixed income securities
• Bonds
• Types of bonds
– Corporate, Federal, “Muni”
– High yield
– Foreign
MAYMESTER 2014
Investments “101”
6-3 Overview of Securities
Forms of equity securities
• Common stock
• Preferred stock
“Alternate” investments
• Real estate
• Gold, Commodities
• Collectibles
MAYMESTER 2014
Investments “101”
6-3 Overview of Securities
Mutual funds and Exchange Traded Funds
• Definition and characteristics
• Differences between mutuals and ETFs
• Active versus Index funds
MAYMESTER 2014
Investments “101”
6-3 Overview of Securities
Mutual funds and Exchange Traded Funds
• Types of funds
– Money market
– Bond funds
• Short term bond funds
• Intermediate bond funds
• Hi yield bond funds
• Total bond market
• Foreign bond funds
MAYMESTER 2014
Investments “101”
6-3 Overview of Securities
Mutual funds and Exchange Traded Funds
• Types of funds
– Equity
• Large firms
• Small firms
• Total stock market
• Value versus growth funds
• Developed foreign markets
• Emerging markets
• Total world market
MAYMESTER 2014
Investments “101”
6-3 Overview of Securities
On-line “screeners” stocks, bonds, mutuals, and ETFs
Bond Screener
http://screen.yahoo.com/bonds.html
Stock Screener
http://screener.finance.yahoo.com/newscreener.html
Mutual Fund Screener
http://screen.yahoo.com/funds.html
ETF Screener
http://finance.yahoo.com/etf/browser/mkt
MAYMESTER 2014
Investments “101”
6-3 Overview of Securities
Mutual funds and Exchange Traded Funds
• Types of funds
– Combination funds
• Balanced
• Asset Allocation
• Life cycle/target retirement
• On-line resources to lifecycle/target retirement funds:
https://personal.vanguard.com/us/funds/vanguard/TargetRetirementList#targ
etAnchor
http://personal.fidelity.com/products/funds/content/WhatYouCanBuy/single_fu
nd_solutions.shtml.cvsr
MAYMESTER 2014
Investments “101”
6-3 Overview of Securities
MAYMESTER 2014
Investments “101”
6-4 Investment Styles
Comparison of Active versus Passive Investment Styles
Active Style
Passive Style
Beat the market by buying low and
selling high
“Make” the market by buying and
holding
Selection and timing of security
trading (fundamental and technical
analysis)
Setting asset allocation and dollar
cost averaging
Narrow focus, less diversification,
very selective
Broad focus, more diversification,
indexing
High turnover of positions, high
trading and tax costs
Low turnover, low expenses and
taxes
MAYMESTER 2014
Investments “101”
6-4 Investment Styles
Comparison of Active versus Passive Investment Styles
Active Style
Passive Style
Time consuming to monitor
portfolio
Buy/hold takes little effort
Requires high level of investing
knowledge
Less specific security knowledge
required
More trading, less diversification
means more risk
Less risk
High risk in selecting managers
who will actually do well
Manager skill not very important
Very hard to consistently beat
benchmarks
Very easy to make benchmarks
MAYMESTER 2014
Investments “101”
6-4 Investment Styles
Active strategies
• Fundamental analysis activities
– Studying financial statements and public information
– Determining “intrinsic” values and comparing to market
values
– Selecting specific securities, timing positions such that:
• undervalued assets are bought and overvalued assets
are sold
MAYMESTER 2014
Investments “101”
6-4 Investment Styles
Active strategies
• Technical analysis activities
– Studying price trends, other measures
– Determining what patterns exist, and opportunities to
profit on future trends
– Selecting specific securities, timing positions such that:
• asset are sold that are likely to fall in value; assets are
bought that are likely to rise in value
MAYMESTER 2014
Investments “101”
6-4 Investment Styles
Technical Analysis—example: Moving averages
MAYMESTER 2014
Investments “101”
6-4 Investment Styles
Technical Analysis—example: Support and resistance
MAYMESTER 2014
Investments “101”
6-4 Investment Styles
Active versus passive strategies—evidence
• Little evidence exists that it is easy to “beat” the market
• Little evidence exists that it is easy to know what strategy
will work in the future
• Much evidence exists that passive strategies tend to out
perform active strategies because of high costs of active
strategies (taxes, commissions, etc)
• This area of research and its results are extremely
“contentious” and controversial
MAYMESTER 2014
Investments “101”
6-4 Investment Styles
MAYMESTER 2014
Investments “101”
6-4 Investment Styles
Quotes related to investment styles:
“Most investors would be better off in an index fund.”
Peter Lynch, Fidelity Investments
“When the dumb investor realizes how dumb he is and buys a low
cost index fund, he becomes smarter than the smartest investors.”
Warren Buffet, Berkshire Hathaway
“The investment business is a giant scam. Most people think they
can find fund managers who can outperform, but most people are
wrong. You should simply hold index funds. No doubt about it.”
Jack Meyer
Manager, Harvard Endowment
MAYMESTER 2014
Investments “101”
6-6 Investing On-line Resources
• Yahoo Finance: http://finance.yahoo.com
• Morningstar Advisory www.morningstar.com
• Vanguard Funds
• Fidelity Funds
www.vanguard.com
www.fidelity.com
MAYMESTER 2014
Indicate your auto and medical insurance
coverage:
A.
B.
C.
D.
E.
I have both
I have auto only
I have medical only
I have neither
I don’t know exactly
MAYMESTER 2014
Do you currently have life insurance?
A.
B.
C.
D.
Yes, and I know amount and type
Yes, but I’m not sure about amount & type
No
I don’t know
MAYMESTER 2014
The Role of Insurance
7-1 Rationale for Insurance
Concept for Insurance: protecting the financial plan
• Protects downside risk; provides cash flows when
planned cash flows interrupted
– Loss of income
– Unexpected expenses
• Comes at an unavoidable cost (premiums)
• Going without insurance very risky; alternatives?
MAYMESTER 2014
The Role of Insurance
7-2 A Review of Insurance
Emergency cash
• 3 – 6 months of cash savings
– Savings, short term bonds, CD’s
– Covers unexpected expenses such as job loss, medical
problems
– Available for unexpected positive opportunities
– Buys time so you don’t have to sell securities when
markets are down
MAYMESTER 2014
The Role of Insurance
7-2 A Review of Insurance
Auto/Homeowner/Renter Insurance
• Basic description of each
• Selecting good policies
• Methods to reduce premiums
MAYMESTER 2014
The Role of Insurance
7-2 A Review of Insurance
Health Insurance (ACA—Affordable Care Act)
• Coverage options: on parents’ to age 26, work
provided, or exchange
• New: no pre-existing conditions exclusion
• Required or tax penalty
MAYMESTER 2014
The Role of Insurance
7-2 A Review of Insurance
Disability insurance
• The case for disability
• Basic description
• How to select good policies
• Methods to reduce premiums
MAYMESTER 2014
The Role of Insurance
7-2 A Review of Insurance
Life Insurance
• Basic types of insurance
– Term life
– Whole life
– Universal/variable life
• Determining coverage amounts
• Strategies for use of life insurance
MAYMESTER 2014
The Role of Insurance
7-2 A Review of Insurance
Life Insurance
Policy
Type
Coverage Annual
Death
Period
Premium Benefit
Cash Value
Term Life
Specified
period 1-30
years
Least
expensive
Fixed benefit
None
Whole
Life
Permanent
protection
Fixed
premium
Fixed benefit
Fixed, based on
policy
Variable
Life
Permanent
protection
Fixed or
variable
premium
Flexible,
based on
investment
account
performance
Depends on
investment
account
performance
MAYMESTER 2014
Wrap Up
8-1 Putting it all together
Basic Approach from first day:
• Learn basic concepts—knowledge is power
• Spend within income
• Save regularly “off the top”—pay yourself first
• Use debt wisely—not to support lifestyle, but for key uses
• Make retirement planning a top priority early in career
MAYMESTER 2014
Wrap Up
8-1 Putting it all together
Basic Approach (continued):
• Assess financial position annually
• Set goals with a plan to achieve them
• Invest wisely using key concepts
• Use insurance to “protect the plan”
• Use trusted sources for answers
MAYMESTER 2014
Wrap Up
8-1 Putting it all together
Some Key Considerations:
• Nothing happens without a plan
• Remember the relationship between risk and return
• Can’t get “something for nothing”
• Diversification reduces risk
• Make time value of money work for you
• Optimize investment return by asset allocation
• Minimize debt expense
• Begin saving early 10-15% of pay
MAYMESTER 2014
Wrap Up
8-1 Putting it all together
Some Key Considerations (continued):
• Markets are efficient; hard to beat consistently
• Consider low cost, diversified index funds
• Beware the crowd-don’t “chase” returns
• Beware people selling you something
• Money isn’t everything
MAYMESTER 2014
Wrap Up
8-2 A Look at Financial Planning Software*
• Quicken financial planning software
Introductory overview
http://quicken.intuit.com/
• “Mint”: on-line financial planning system
http://www.mint.com/
MAYMESTER 2014
Wrap Up
8-3 Resources
Books
• “Personal Finance—Turning Money Into Wealth” by Arthur
Keown, 5th edition, 2010, Prentice Hall
• “Personal Financial Planning”, 4th ed. By Koh and Fong,
2011, Prentice Hall
Locating a Financial Planner:
www.fpanet.org
MAYMESTER 2014
Wrap Up
8-3 Resources
On-line resources
http://www.investorhelp.com/
http://financialplan.about.com/
American Association of Individual Investors
http://www.aaii.com/
MAYMESTER 2014
Wrap Up
8-3 Resources
On-line resources
BYU Personal Finance Programs
http://personalfinance.byu.edu/?q=node/5
FINRA
http://www.finra.org/Investors/index.htm
Investopedia
http://www.investopedia.com/?viewed=1
MAYMESTER 2014