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Unit 2: Money Management

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1 Unit 2: Money Management
1. Explain how limited personal financial resources affect the choices people make. 2. Interpret the opportunity costs of financial decisions. 3. Evaluate the consequences of personal financial decisions. 4. Apply a decision-making process to personal financial choices. 5. Summarize how inflation affects spending and saving decisions. 6. Evaluate how insurance (e.g., auto, home, life, medical and long-term health) and other risk-management strategies protect against financial loss. 7. Design a financial plan (budget) for earning, spending, saving, and investing. 8. Demonstrate how to use the services available from financial institutions. 9. Analyze the role of the Federal Reserve in controlling the money supply.

2 Personal Financial Planning

3 Financial Decisions & Goals
Personal Financial Planning: arranging to spend, save, and invest money to live comfortably, have financial security, and achieve goals

4 Benefits to Financial Planning
More money and financial security Knowing how to use money to achieve goals Less chance of going into debt you cannot handle

5 Steps in Financial Planning
Step 1: Determine your current financial situation Savings Monthly income Monthly expenses Debts

6 Steps in Financial Planning
Step 2: Develop your financial goals What is your attitude toward money? What are your personal values? Values: the beliefs and principles you consider important, correct, and desirable Needs vs. Wants Need: something you must have to survive, such as food, shelter, and clothing Want: something you desire or would like to have or do

7 Steps in Financial Planning
Step 3: Identify your options Expand the current situation Change the current situation Start something new Continue the same course of action

8 Steps in Financial Planning
Step 4: Evaluate your alternatives Find different sources of financial information Figure out the consequences of your choices Opportunity Cost: trade-off, what you give up when making one choice instead of another Understand your risks

9 Financial Risks Inflation Risk-uncertainty over the real future value of your money Interest Rate Risk- risk an investments value will change due to a change in interest rate Income Risk- risk of change in income (cash inflow) Personal Risk- loss of income, increase in expenses, or elimination of assets due primarily to death, poor health, old age or unemployment Liquidity Risk Liquidity: the ability to easily convert financial assets into cash without loss in value

10 Steps in Financial Planning
Step 5: Create and use your financial plan of action Utilize the options you have for reaching your financial goals

11 Steps in Financial Planning
Step 6: Review and revise your plan Your needs and finances will change as time goes on, so your financial plan will need to change as well

12 Types of Financial Goals
Time Frame of Goals Short-term goals: take one year or less to achieve Intermediate goals: takes one to five years to achieve Long-term goals: take more than five years to achieve

13 Types of Financial Goals
Goals for Different Needs Good: physical item that is produced and can be weighed or measured Consumable good- used up or depleted, replaced often Durable good- long lasting, replaced infrequently Intangible items- can’t be touched, but can be measured Service: task that a person or machine performs for you

14 Guidelines for Setting Goals
Goals should be SMART Specific Measurable Attainable Results-based Time-bound

15 Setting SMART Financial Goals
What is missing? Goal: Save money this summer to pay for all college fees. Goal: Get a job to afford to buy a motorcycle. Goal: Use money received as birthday gifts to pay own monthly phone fees. Goal: Go on white water rafting trip.

16 Influences on Financial Planning
Life situations Going to college, getting married, starting a new career, having children, moving to a new city

17 Influences on Financial Planning
Economic Factors: Play a role in the day-to-day financial planning and decision making for most people Economics: the study of the decisions that go into making, distributing, and using goods and services Economy: consists of the ways in which people make, distribute, and use their goods and services

18 Influences on Financial Planning
Economic Factors: Market Forces Supply: the amount of goods and services available for sale Demand: the amount of goods and services people are willing to buy High demand or low supply will cause the price of products to rise Low demand or high supply will cause the price of products to drop

19 Influences on Financial Planning
Economic Factors: Financial Institutions Provide services that increase financial activity in the economy Banks Credit unions Insurance companies Investment companies Federal Reserve System: Fed, central banking organization of the US that regulates the money supply

20 Influences on Financial Planning
Economic Factors: Global Influences We are part of a global market Economy of every nation is affected by competition with other nations

21 Influences on Financial Planning
Economic Factors: Economic Conditions Consumer prices Inflation: the rise in the level of prices for goods and services, mainly caused by an increase in demand without an increase in supply Consumer spending Consumer: person who purchases and uses goods or services Interest rates Interest: the price that is paid for the use of another’s money

22 Opportunity Costs & Strategies
Personal opportunity costs Must make choices about how to manage your personal resources Health, knowledge, skills, and time Financial opportunity costs Must make choices about how you spend money Time value of money: the increase of an amount of money due to earned interest or dividends

23 Time Value of Money: Terminology
Future value: the amount your original deposit will be worth in the future based on earning a specific interest rate over a specific period of time Annuity: series of equal regular deposits; like depositing $50 each month into your savings

24 Time Value of Money: Terminology
Present Value: amount of money you would need to deposit NOW in order to have a desired amount of money in the future Annual Interest Rate: Interest rate you are earning on your deposited funds

25 Calculating Simple Interest
Need to know: Principal: original amount of money on deposit Annual Interest Rate Length of Time Principal x Rate x Time = Interest Earned

26 Strategies for Achieving Your Financial Goals
Obtain financial resources Plan Spend wisely Save Borrow wisely Invest Manage risk Plan for retirement

27 Money Management Strategy

28 Organizing Financial Records
Opportunity Costs and Money Management Money Management: planning how to get the most from your money In order to manage your money well, you may have to consider financial trade-offs (or opportunity costs) Consider the factors that influence your decisions before you chose an option

29 Organizing Financial Records
Personal Financial Documents: a variety of materials, such as bank statements and paycheck stubs May also include receipts, ownership titles, birth certificates, and tax forms Tell you how much money you have and/or spend

30 Organizing Financial Documents
First step in effective money management is organizing your information Bank statements, paycheck stubs, receipts, car title, tax forms Benefits of organizing financial documents: Quickly find needed documents Plan and measure financial progress Handle routine money matters (ex. paying bills on time)

31 Storing Financial Documents
Home File Simple, takes limited space Bank account statements, receipts, employment information, tax records, insurance records, investment records Safe-Deposit Boxes Small, secure storage box rented at a bank Car title, birth certificates, stock certificates, valuable documents not easily replaced Home Computer Budgets, check summary, personal financial statements

32 Personal Financial Statements
Personal Financial Statements: document that provides information about an individual’s current financial position and presents a summary of income and spending Helps determine what you own and owe Measures your progress towards goals Track financial activities Organize financial information

33 Personal Financial Statements
Personal Balance Sheet: (net worth statement) a financial statement that lists items of value owned, debts owed, and a person’s net worth Net Worth: the difference between the amount you own and the debts you owe; measure of your current financial position

34 Personal Financial Statements
To create a BALANCE SHEET: Step 1: Determine Your Assets Assets: any items of value that an individual or company owns, including cash, property, personal possessions, and investments Wealth: the abundance of valuable material possessions or resources Asset Categories: liquid assets, real estate, personal possessions, and investments

35 Personal Financial Statements
Asset Categories: Liquid Assets: cash and items that can be quickly converted to cash Real Estate: land and any structures that are on it, such as a house or any other building that a person or family owns Valued at the Market Value: the price at which it would sell Personal Possessions: cars and any other valuable belongings that are not real estate Should be listed at current market value Investment Assets: include retirement accounts and securities such as stocks and bonds

36 Personal Financial Statements
To create a BALANCE SHEET: Step 2: Determine Your Liabilities Liabilities: debts that you owe Current Liabilities: short-term debts that have to be paid within one year (medical bills, cash loans, taxes) Long-Term Liabilities: debts that do not have to be fully repaid for at least one year (car loans, student loans, and mortgage loans)

37 Personal Financial Statements
To create a BALANCE SHEET: Step 3: Calculate Your Net Worth Subtract your Liabilities from your Assets NET WORTH = ASSETS – LIABILITIES Insolvency: a financial state that occurs if liabilities are greater than assets; unable to pay all of your debts

38 Personal Financial Statements
To create a BALANCE SHEET: Step 4: Evaluate Your Financial Statements Is your net worth increasing? Is it decreasing? Are you holding steady? Maybe you need to re-evaluate and update your budget!

39 Personal Financial Statements
Cash Flow Statement: Income vs. Expenses; summary of your cash flow during a particular period (usually a month or a year) Cash Flow: money that actually goes into and out of your wallet Cash Inflow: money you receive (INCOME) Cash Outflow: money you spend (EXPENSES)

40 Personal Financial Statements
To create a CASH FLOW STATEMENT: Step 1: Record your income (cash inflow) List all sources of income during the month at the exact amount Gross pay- total amount of money you have earned prior to anything being taken out Take-home pay- (net pay) the amount of income left after taxes and other deductions are taken out of your gross pay Discretionary income- the money left over after paying for the essentials

41 Personal Financial Statements
To create a CASH FLOW STATEMENT: Step 2: Record your expenses (cash outflow) Fixed expenses- more or less the same each month Variable expenses- may change from month to month

42 Personal Financial Statements
To create a CASH FLOW STATEMENT Step 3: Determine your net cash flow Net Cash Flow = Income – Expenses Surplus- extra money that can be spent or saved Deficit- more money is spent than received Every time your cash flow changes, so does your net worth (balance sheet)

43 Personal Financial Statements
Evaluating your financial progress Debt Ratio = Liabilities / Net Worth Compares how much you owe to your total financial position; should be low Liquidity Ratio = Liquid Assets / Monthly Exp. Number of months you would be able to pay your living expenses in case of emergency

44 Personal Financial Statements
Evaluating your financial progress Debt-Payment Ratio = Monthly Credit Payment / Take-home Pay How much you make that goes to pay debts; should be less than 20% each month Savings Ratio = Amount Saved / Gross Income Should be no less than 10% each month Home Payment Ratio = House Payment/Gross Income Should be less than 28%-30%

45 Budgeting for Financial Goals
Budget- a plan for using money to meet wants and needs Using a budget, you learn to live within your income and avoid costly debt

46 Budgeting for Financial Goals
Budgeting Step 1: Set your financial goals What do you want to accomplish with your money?

47 Budgeting for Financial Goals
Budgeting Step 2: Estimate your income Include all income you know you may receive for the next month If you are unsure about a source of income or the amount, do not include it

48 Budgeting for Financial Goals
Budgeting Step 3: Budget for Fixed Expenses List all monthly expenses that do not change from month to month Mortgage, automobile payments, student loan payments, insurance premiums PAY YOURSELF FIRST! (i.e. emergency fund or retirement)

49 Budgeting for Financial Goals
Budgeting Step 4: Budget for Variable Expenses List all monthly expenses that change from month to month Utilities based on usage, food, clothing Make your best guess as to the cost for the month Look at previous month or ask friends and family Consumer Price Index- measure of changes for commonly purchased goods and services If guessing, guess high! 49

50 Budgeting for Financial Goals
Budgeting Step 5: Budget for Unexpected Expenses Put aside a little money each month to pay for unexpected items Set up an “Emergency Fund” 3 to 6 months of living expenses This should be a fixed expense!!! 50

51 Budgeting for Financial Goals
Budgeting Step 6: Record What You Actually Spend Keep track of your actual income and expenses Calculate the budget variance Budget Variance- the difference between the budgeted amounts and what you actually spent Surplus- you spent less money than expected Deficit- you spent more money than expected 51

52 Budgeting for Financial Goals
Budgeting Step 7: Review Spending and Saving Patterns Review financial progress Are you paying your bills on time? Do you have a surplus or a deficit? Revise goals and adjust your budget Do you need to cut your expenses? Should you put more into savings? 52

53 Budgeting for Financial Goals
How to Budget Successfully Carefully plan your budget Create a practical budget Be flexible Write it down and be able to access it easily

54 Budgeting for Financial Goals
How to Increase Your Savings Pay yourself first Use payroll deductions to automatically place money into savings or retirement accounts Spend Less

55 Banking Overview

56 Financial Services and Institutions
How to manage your cash Daily Cash Needs Cash Credit card ATM Sources of quick cash Savings Borrow the money

57 Types of Financial Services
Three main categories: Savings Payment services Borrowing

58 Types of Financial Services
Savings Time deposit – money that is to be left for months or years Savings account Certificate of deposit (CD) Payment Services Demand Deposit – the money can be withdrawn at any time or on demand Checking Account Borrowing Options Credit cards Personal cash loans Mortgage Auto loan

59 Electronic Banking Services
Direct deposit – an automatic deposit of net pay to an employee’s designated bank account Employee receives a printed statement listing deductions, etc. Automatic Payments – with an authorization, your bank will withdraw a monthly payment from an account on a specific date Automated Teller Machines (ATMs) – a computer terminal that allows withdrawal of cash from an account or deposits made to that account ATM fees – charge for the convenience of the ATM service Avoid foreign ATMs – they have additional fees

60 Electronic Banking Services
Debit Card – a cash card that allows you to withdraw money or make purchases using the money in that account You can spend ONLY the money in your account Lost Debit Cards – notify bank immediately -within two days usually to avoid financial responsibility Personal Identification Number (PIN) to be used with debit or ATM card Never keep your PIN with your debit card

61 Electronic Banking Services
Plastic Payments Point of sale transactions – a purchase by a debit card for good or service Must use PIN with card Stored Value cards – prepaid cards that you can use at a specific store or for a specific service. They are reloadable or rechargeable.

62 Opportunity Costs of Financial Services
Consider all aspects when choosing financial services including convenience and liquidity Consider the value of your time Reevaluate your choices occasionally

63 Types of Financial Institutions
Commercial Banks – for-profit institution that offers a full range of services: checking, savings, and lending Savings & Loan Associations – traditionally specialized in savings accounts and mortgages; now offers services like commercial banks Credit Union – a nonprofit financial institutions that is owned by its members and organized for their benefit. It offers a full range of services. Members often have a common bond. Fees and loans rates may be lower than commercial banks

64 Types of Financial Institutions
Life Insurance Companies – investment features Investment Companies – purchase stocks, bond and other securities Finance Companies – higher-interest rate loans when you cannot borrow elsewhere FDIC (Federal Deposit Insurance Corporation) – protects deposits in banks that are federally chartered up to $250,000 per account.

65 “Take Charge of Your Finances” Advanced Level
Types of Insurance “Take Charge of Your Finances” Advanced Level

66 What is Insurance? Risk is the uncertainty about a situation’s outcome- may be an unpredictable event which leads to loss or damage Insurance is an arrangement between an individual (consumer) and an insurer (insurance company) to protect the individual against risk

67 Why is It important to have insurance?
Emergency savings - at least six months of expenses set aside to cover costs of unexpected events Risk - chance of loss from an event that cannot be entirely controlled is managed by Insurance – transfers (shifts) risk from an individual to an insurance organization What are examples of unexpected events that may result in a financial loss?

68 What is an Insurance Policy?
A policy is a contract between the individual and the insurer specifying the terms of the insurance arrangements Coverage - The risks covered and amount of money paid for losses under an insurance policy A premium is a fee paid to the insurer to be covered under specified terms outlined in the policy A deductible is the amount paid out of pocket by the policyholder for the initial portion of a loss before the insurance coverage begins- the deductible is stated in the policy A policyholder is a consumer who purchases the policy Experts say that buying insurance is buying financial security. Do you think this is true? Why or why not?

69 An Illustration of How Insurance Works
Suppose there are 100 people in a group With a 1% chance that any one of them could get sick and require $10,000 in medical care But, no one knows who will get sick If each person pays $100 into a “pool” they will collectively have $10,000 to cover the medical costs of the person who gets sick 99 people do not collect anything, but they gain peace of mind and important protection against a large loss So, everyone gives up $100, but nobody loses more than $100 Insurance shifts the risk of big loss from the individual to the insurance company

70 Why is it important to have insurance?
Helps limit financial losses when an accident occurs Helps an individual/family be prepared for the unexpected Plays a large role in most financial management plans

71 The benefits of Insurance
Payments received from an insurance policy can far exceed the premiums paid Provides financial security and peace of mind Types of Insurance Automobile Health Life Disability Homeowners/ Renters Why is the best outcome to have insurance but never collect on it?

72 The Insurance Process Claim - paperwork submitted to insurance organization describing the accident, illness or injury Event occurs resulting in loss Deductible - amount of money paid out of pocket by policyholder before the insurance coverage begins Remaining amount owed is paid by co-insurance (if applicable) Policyholder makes claim to insurance organization Co-insurance - amount of money, after deductible, that is paid jointly by the insured and the insurance company Insurance organization determines if event is covered by policy If so, policyholder pays a deductible

73 Why do insurance policies include deductibles and co-insurance?
When the act of insuring an event increases the likelihood it will occur Deductibles and co-insurance place some of the loss on the policyholder Reduce the problem of moral hazard Not locking a car or parking it in a theft-prone area in hopes it will be stolen and automobile insurance will pay for a new vehicle For example… Dollars paid from an insurance policy are not intended to make a person better off than before the loss happened

74 Not covered by insurance...
Negligence- failure to take ordinary or reasonable care to prevent accidents Sooo... A deductible is the amount of risk the policyholder assumes and Risk Avoidance means it is the consumer’s responsibility to try to avoid unnecessary risk

75 Property & Liability Insurance
Two parts Property insurance - payment to insured person if his/her property is damaged or destroyed by an accident Pays for loss to insured person Liability insurance - payment to others if a member of the insured household accidently causes harm to other people or property Pays for injury or loss to others Provided by individuals

76 Types of Property & liability Insurance
Automobile insurance - payment for liability and property insurance on a vehicle If a person drives an automobile, automobile liability insurance is required by law Homeowners insurance - payment to cover liability losses and damage/loss of home and its contents Renters insurance - payment for damage/loss of property in a rental unit in addition to liability losses

77 Homeowner’s Insurance
Homeowner’s Insurance -combines property and liability insurance into one policy to protect a home from damage costs due to perils Peril -an event which may cause a financial loss like fire, falling trees, lightning and others Property Insurance -protects the insured from financial losses due to destruction or damage to property or possessions Liability Insurance- protects the insured party from being held liable for other’s financial losses

78 Homeowner’s insurance covers
The home or building Additional living expenses Personal property (contents of home-make home inventory) Personal liability Specialized coverage-floods/earthquakes/identity theft Floaters

79 Renter’s Insurance Renter’s Insurance protects the insured from loss of the contents of the dwelling rather than the dwelling itself Necessary because a landlord’s insurance policy on the dwelling does not cover the renter’s personal possessions Covers major perils, provides liability protection and provides for additional living expenses if the dwelling is rendered uninhabitable

80 Insured values Actual Cash Value- replacement cost minus depreciation
Replacement Value- full cost for replacing the items More expensive premiums Required by finance company holding your mortgage

81 Homeowner’s insurance cost factors
Location-fire hydrant, crime rates, geographic location Type of Structure-brick or wood Others-price, coverage amount, deductible Discounts-smoke alarms, security systems, types of locks

82 Automobile Insurance Automobile Insurance - arrangement between an individual (consumer) and insurer (insurance company) to protect the individual against risk from automobile accidents Uninsured or underinsured motorists insurance Medical payment insurance Physical damage insurance Liability insurance Collision Comprehensive

83 Types of Auto Insurance
Liability Insurance covers the insured if injuries or damages are caused to other people or their property Medical Payment Insurance covers injuries sustained by the driver of the insured vehicle or any passenger regardless of fault It is the minimum amount of insurance required BY LAW for automobiles It also covers family members injured as passengers in any car, pedestrians, or bicyclists

84 Bodily injury Expressed by 3 Numbers: 100/300/50
First number-maximum amount paid for injury to one person Second number-maximum amount the company will pay for all injured parties in one accident Third number-the limit for payment for damage to the property of others

85 Types of Auto Insurance
Uninsured or Underinsured Motorists Insurance covers injury or damage to the driver, passengers, or the vehicle caused by a driver with insufficient insurance Physical Damage Insurance covers damages caused to the vehicle (required by finance company if you have a loan) Collision – covers a collision with another object, car, or from a rollover Comprehensive – covers all physical damage losses except collision and other specified losses Why would an individual want automobile insurance coverage beyond liability (the minimum required by law)?

86 Car insurance cost factors
Vehicle Type- year, make, makes and models of frequently stolen cars Rating Territory- accident rate, population, theft rate Driver Classification- age, gender, marital status, driving record, driving habits

87 Why would it be important to have health insurance?
* 07/16/96 Health Insurance Health insurance provides protection against financial losses resulting from injury, illness, and disability May cover hospital, surgical, dental, vision, long-term care, prescription, or other major expenditures Specific coverage depends upon the individual policy Health care costs are extremely high Large medical expenses could deplete an individual’s savings Why would it be important to have health insurance? Updated statistic and source *

88 Health Insurance May be purchased by the individual or through their employer Individual’s often seek coverage for dependents (spouses and children) Many health insurance policies offer dependent coverage but there is no requirement to do so If dependent coverage is offered, children may stay on their parent’s health care plan until age 26 with no stipulations Federal government website to learn about health insurance and compare policies:

89 Mental health treatment
Health Insurance Provided by And/or Employer Health insurance - provides money to pay for health care Government If dollars are limited, health insurance is extremely important to protect against high medical bills Individual Risks Covered Mental health treatment Hospital bills Preventative care Doctors’ visits Vision care Prescription drugs Medical procedures Dental care

90 Health insurance costs
Co-insurance: percentage of the medical expenses the insured must pay in addition to deductible Co-payment: flat fee that insured pays every time they receive a covered service

91 Which Insurance policy would you choose?
Janet wants to make sure she has the best health insurance policy. She shopped around and received multiple quotes. What are the pros and cons of each policy? Current Policy New Policy Premium amount/month Deductible amount Co-insurance amount $300 $200 $200 $2000 20% owed by policyholder 80% owed by insurance organization 0% owed by policyholder 100% owed by insurance organization

92 What if a Person Cannot Work or live Independently?
Disability insurance Long-term care insurance Payment for extended care when a person cannot live independently (but doesn’t need to be hospitalized) Payment to replace earnings during times when workers cannot work due to illness or injury Why are both disability and long-term care insurance important? Provided by employers, individuals, and/or government Provided by individuals

93 Disability Insurance Disability Insurance replaces a portion of one’s income if they become unable to work due to illness or injury Insurance typically pays between 60-70% of one’s full-time wage Factors such as the length or severity of a disability influence the percentage of income a person will receive

94 Life Insurance Life insurance is a contract between an insurer and policyholder specifying a sum to be paid to a beneficiary upon the insured’s death A beneficiary is the recipient of any policy proceeds if the insured person dies Provides money for family members or dependents when a wage earner dies A dependent is a person who relies on someone else financially

95 When would it be necessary to purchase life insurance?
Provided by employers and/or individuals Life insurance- payment to beneficiaries if an insured person dies May cover paid and unpaid work formerly done by the individual Beneficiary- someone who receives insurance money if the insured person dies Household production- unpaid work, such as child care or meal preparation Dependent - someone who relies on someone else for money income and care When would it be necessary to purchase life insurance?

96 Other types of insurance
Credit Life Insurance: to pay debts when someone dies Identity Theft Insurance: to pay expenses incurred from ID theft

97 Sources of Insurance Employer Individual Government
In most cases, individuals acquire insurance from a combination of sources Long-term care, property and liability insurance Employer Special programs for those who qualify and during catastrophes Health, disability, and occasionally life insurance Individual Government If an employer does not provide insurance, it may be acquired individually

98 Employer Provided Insurance
Employee benefits - products or services that add extra value for employees beyond wages Insurance premiums paid by… In-kind income – the provision of a product or service rather than cash Employer Employee Payroll deduction Policies may be available to the employee’s family members (usually for additional fees) No income taxes are paid on the in-kind income

99 Government Programs Provide basic insurance as a part of the social safety net to protect citizens from economic hardship Social Security, Medicare, Medicaid Many programs require a work history and employer provided participation to be eligible Unemployment insurance, worker’s compensation Can address specific catastrophes Hurricane Katrina

100 In review… Insurance is an important part of a financial plan
Insurance is not intended to make an individual better off than before the event Insurance is an important part of a financial plan Insurance may be acquired from multiple sources Even with insurance, an individual should still have funds to pay the deductible and co-insurance There are several types of insurance for specific purposes

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