The Financial Planning Process Chapter 1 The Financial Planning Process

Introduction It’s easier to spend than to save. Personal financial planning is an ongoing process—it changes as your financial situation and position in life change. Manage and control your finances with a personal financial plan. It helps you achieve financial and lifestyle goals.

Importance of Personal Financial Planning Accumulate wealth for special expenses Save for retirement “Cover your assets” Invest intelligently Minimize payments to Uncle Sam

Five basic steps to personal financial planning Evaluate your financial health Define your financial goals Develop a plan of action Implement your plan Review your progress, reevaluate, and revise your plan

Step 1: Evaluate Your Financial Health Examine your current financial situation. How much money do you make? How much are you spending and on what? Use careful record keeping to track finances and spending.

Step 2: Define Your Financial Goals Write or formalize your goals. Attach a financial cost to each one. When will you need the money to achieve the goal? Analyze and revise your goals.

Step 3: Develop a Plan of Action Flexibility: Liquidity Protection Minimize Taxes

Step 4: Implement Your Plan Stick to it. Use your financial plan as a road map to achieve goals. Keep goals in mind and work towards them.

Step 5: Review, Reevaluate, and Revise Review progress. Reevaluate and revise for changes in your life. Be prepared to formulate a different plan to meet your goals.

Figure 1.1 The Budgeting and Planning Process

ESTABLISHING YOUR FINANCIAL GOALS Short-term—within 1 year Intermediate-term—1 to 10 years Long-term—more than 10 years

Short–Term Goals – Examples?

Intermediate-Term Goals

Long-Term Goals

Figure 1.2 Personal Financial Goals Worksheet

Figure 1.3 A Typical Individual’s Financial Life Cycle

Stage 1 The Early Years—A Time of Wealth Accumulation Prior to age 54 Develop a regular savings pattern: How much can be saved? Is that enough? Where should the savings be invested? Cost of raising children

Stage 2 Approaching Retirement—The Golden Years Transition years between ages 55-64. Depends on preparation for retirement. Reassess financial goals and decisions— retirement, insurance protection and estate planning.

Stage 3 The Retirement Years After age 65, live off savings Less risky investment strategy Consider extended nursing home protection. Estate planning decisions and documents are critical.

Thinking About Your Career A series of positions to show your skills. Is the job important, enjoyable, and satisfying? Does it provide for your desired lifestyle?

Choosing a Major and a Career Effective self-assessment Interests, skills, values, personal traits Desired lifestyle Research career alternatives and match with your skills and interests Research potential earnings

Table 1.2 What Different College Majors Earn

Getting a Job Start early Prepare and practice for interviews – page 15 Research the company Dress appropriately, be confident, and follow-up – handout on SF

What Determines Your Income? Skills Education

Figure 1.5 Education and Earnings

Ten Principles of Personal Finance The foundation of personal finance.

Principle 1: The Best Protection Is Knowledge Understand the basics of personal finance. Take responsibility for your lifetime financial plan. Seek professional advice wisely.

Principle 2: Nothing Happens Without a Plan Easier to think about spending than about saving. Saving must be planned. Putting off a financial plan means goals are harder to achieve.

Principle 3: The Time Value of Money Money received today is worth more than money received in the future. Understand how savings and investments grow over time Understand compound interest. Understand spending now and paying later

Principle 4: Taxes Affect Personal Finance Decisions Know the effect of taxes on the rate of return of investments. Compare investment alternatives on an after-tax basis. Understand tax laws.

Principle 5: Stuff Happens, or the Importance of Liquidity Plan for unexpected events Have money or liquid funds available Liquid funds should cover 3 to 6 months of living expenses

Figure 1.6 How Long Households Go Without Income Before Hardship Sets In

Principle 6: Waste Not, Want Not - Smart Spending Matters Differentiate want from need Do homework before the purchase Make the purchase at the best price Maintain your purchase

Principle 7: Protect Yourself Against Major Catastrophes Have the right kind of insurance before a tragedy occurs. Know your insurance policy coverage. Focus insurance on major catastrophes which can be financially devastating.

Principle 8: Risk and Return Go Hand in Hand Saving and investing grows money. Investors demand a minimum return above anticipated inflation. Investors demand higher return for added risk. Diversification by spreading money in several investments reduces risk.

Principle 9: Mind Games, Your Financial Personality, and Your Money Behavioral biases lead to big financial mistakes. Mental accounting impacts financial decisions. “Sunk cost effect” pours good money after bad money because of bias.

Principle 10: Just Do It! Taking the first step towards your goals is difficult. The following steps become easier. First step is to pay yourself first—save then spend. Saving early can make a big difference.

Women and Personal Finance Tougher to achieve financial security. Generally earn less. Less likely to have pensions. Qualify for less Social Security. Live longer than men. Planning for financial independent more difficult for them than it is for men.

Women and Personal Finance Need to take charge of their money and financial future. Acquire knowledge. Make things happen—need a plan. See a financial planner about specific concerns.