Understanding the Financial Planning Process #1

Learning Goals Identify the benefits of using personal financial planning techniques to manage your finances Describe the personal financial process and define your goals Explain the life cycle of financial plans, the role they play in achieving your financial goals, how to deal with special planning concerns, and the use of professional financial planners Examine the economic environment’s influence on personal financial planning Evaluate the impact of age, education, and geographic location on personal income Understand the importance of career choices and their relationship to personal financial planning

The Rewards of Sound Financial Planning Improving Your Standard of Living Spending Money Wisely Accumulating Wealth

Standard of Living Closely related to quality of life Wealth if key determinant in both Two Income families and its affect

Spending Money Wisely Major benefit of financial planning Average Propensity to Consume Low income who spend large portion on necessities have High APC Large income spend small portion on necessities have Low APC Different incomes can have same APC because of differences in Standard of Living

Future Needs Set aside a portion of current income for future needs 35% of Americans say retirement planning is their most pressing concern.

Wealth – total value of all assets you own Financial Assets Intangible Paper assets Savings accounts Stocks Bonds “earnings” assets Tangible Assets Physical assets Real estate Cars For consumption or investment

Organizational Planning Model

Average American Family

The Personal Financial Planning Process Systematic process that considers important elements of an individual’s financial affairs in order to fulfill financial goals

Six-Step Financial Planning Process 1. Define financial goals 2. Develop financial plans and strategies 3. Implement financial plans and strategies 4. Develop and implement budgets 5. Use financial statements to evaluate results 6. Redefine goals, revise plans as circumstances change

The Role of Money Medium of exchange used to measure value Utility amount of satisfaction derived from purchases versus cost Link to personal psychological concepts and key role in personal relationships

Putting Target Dates on Financial Goals Long-term 6 years or more Intermediate-term the next 2-5 years Short-term in the next year

From Goals to Plans: A Lifetime of Planning Early childhood High school and college Family formation Career development Pre-retirement Retirement

Personal Financial Planning Life Cycle

How a $1,000 Investment Grows over Time

Plans to Achieve Your Financial Goals Asset acquisition planning Liability and insurance planning Savings and investment planning Employee benefits planning Tax planning Retirement and estate planning

Assets – things we own Liquid assets Investments Used to pay everyday expenses Cash, savings, money market accounts Investments Acquired to earn a return Stocks, bonds, mutual funds

Assets – things we own Personal property Real property Movable property Cars, household items, jewelry, clothing Real property Immovable property Land, anything fixed to it such as a house

Liabilities Something we owe debt

Insurance Way to reduce financial risk and protect income and assets Adequate insurance is essential

Special Planning Concerns Managing two incomes Managing employee benefits Managing finances through tough economic times

Using Professional Financial Planners Commission-based planners earn commission on selling financial products Fee-only planners charge fees based on complexity of prepared plans Hybrid approach involves both charging fees and collecting commissions

The Planning Environment Financial planning environment contains various interrelated groups of players, each fulfilling certain goals.

Financial Planning Environment

Government Federal government plays a major role in regulating the level of economic activity Taxation and regulation constrain personal financial planning

The Economy Monetary Policy Fiscal Policy Controls money supply Used to stimulate or contract economic growth Fiscal Policy Controls levels of taxation Sets levels of government spending

The Economy Economic Cycles Inflation Stages related to employment and production levels Growth measured by changes in GDP Inflation Measured by changes in CPI Affects purchasing power and interest rates Affects financial plans and goals

Exhibit 1.7: The Business Cycle The business cycle consists of four stages: expansion, peak, contraction, and trough

Business Cycle The stronger the economy, the higher the levels of GDP and employment

Inflation and Prices Inflation – general level of price increases over time Most common measure of inflation is the CPI – Consumer Price Index Inflation DIRECTLY affects interest rates

What Determines Your Personal Income? Demographics and income Age, marital status Education Where you live Career

How Age and Education Affect Family Income