Basics of Personal Financial Planning [date] [venue] [contact information]

Introduction About the PFP Section & PFS Credential The AICPA PFP Section provides information, resources, advocacy and guidance for CPAs who specialize in providing estate, tax, retirement, risk management and investment planning advice to individuals and their closely held entities The CPA/Personal Financial Specialist (PFS) credential distinguishes CPAs as subject-matter experts who have demonstrated their financial planning knowledge through experience, education and testing

Today’s Objectives You gain an enhanced understanding of the basics of financial planning and how a company’s compensation and benefits programs add to your financial well-being You gain an enhanced understanding of basic investing concepts and how to develop your investment plan You gain an enhanced understanding of how a Company’s compensation and benefits programs can contribute to the success of your investing You identify and commit to taking the actions you can to significantly enhance your financial well-being

Life Events: Will You Be Ready? • Premature Death Retirement Serious Illness Death of Spouse Aged Parents Children Getting Married Second Home Remarriage Starting a Business Paying for College Divorce Job Loss Relocation Home Purchase Birth of Children Marriage Temporary Disability

Life’s Financial Trade-Offs CURRENT NECESSITIES FUTURE NECESSITIES CURRENT EXTRAS FUTURE EXTRAS Basic shelter, food clothing, transportation and medical care clothing, cash for emergencies and nursing home care L arger home, private college, retirement travel, bequests/charity New kitchen, new car, vacation, family gifts Trade - offs

The Value of a Financial Plan A financial plan will help you to clarify: Your financial goals Strategies to achieve the goals Specific steps to implement the strategies

Areas to Explore Saving Managing debt Insurance Investing Education funding Retirement funding Pre-retirement planning Incapacitation planning Estate planning Company stock ownership

The Financial Planning Process What do you want? What will you have? Will you have a shortfall? What strategy will you employ? What actions will you take?

What Do You Want? These are your financial planning goals Each goal will have its own horizon For the period of accumulation For the period over which it will be spent Make a list and refine as you go along Start with broad ideas and work toward increasingly specific and measurable goals

What Will You Have? What you have now What you will save from future income Future investment earnings on the above if invested Expected future benefits

Managing Debt

What Managing Debt Means Conquering excessive debt Using debt wisely: Credit cards 401(k) plan loans Home mortgages Home equity loans Automobile debt Maintaining a good credit history

Debt Ratios Housing expense ratio Debt to income ratio Housing expenses (mortgage, taxes and insurance) should not exceed 28% of gross pay Gross pay is before taxes and deductions Debt to income ratio Total consumer debt (not including mortgage) should be less than 20% of take-home-pay Take-home pay is after taxes and deductions

Warning Signs of Too Much Debt Unable to save 10% or more of gross income Habitually pay only the minimum monthly payments on your credit cards Borrowed from one lender to pay another Asked a friend or relative to co-sign a loan because credit record is weak Unable to figure out how much you owe Would be in immediate financial trouble if you lost your job tomorrow

Conquering Debt Stop borrowing Start using a debit card Prioritize your debt repayment Seek lower rates Determine the maximum you can pay Repay highest cost debt first Continue paying the maximum

Decrease Debt or Invest? Pay down debt when you can’t invest at a higher rate 401(k) Match* Credit Card Investment Mortgage Interest Paid / Received 100.0% 18.0% 8.0% 6.5% Tax effect @ 25% -- 0.0% -2.0% -1.6% Net Paid / Received 6.0% 4.9% * 100% of first 3% of your pre-tax regular contributions for ABC Company.

Using Home Mortgages Wisely Determining whether buying is appropriate Choosing the right type of mortgage Deciding if you should refinance Knowing whether to pay points Deciding whether to prepay mortgage principal

Is Buying a Home Right for You? Renting Change location frequently No Yes Maintenance responsibilities Ability to customize Perhaps Payment increases Likely Investment element Tax benefits Initial costs

Tax Benefits of Home Ownership

Types of Mortgages

Consider a Fixed Rate Mortgage When: You intend to live in your home for a significant period of time, or You anticipate rising interest rates in the future

Consider an ARM When: Fixed rate is at least 2% points greater than adjustable rate You expect your income will increase enough to cover any potential payment increases You expect to move before the rate increases (beware of prepayment penalties)

Prepaying Mortgage Principal $170,257 Standard Payment $89,279 Additional $150 Per Month 360 210 Number of Payments Total Interest Paid Assumes a 30 year fixed-rate mortgage of $100,000 at 8.25%

Consider Prepaying Principal When: You use the standard deduction You invest conservatively

Maintaining a Good Credit History Establish a good credit history Obtain your credit report Understand your credit report Correct mistakes in your credit report

Saving & Investing

Importance of Saving and Investing If you don’t have the following Sufficient assets fully devoted to your goal(s) Expected future benefits from third parties Expected future borrowing Then you will need the following to reach your goal(s) Future savings devoted to your goals Future earnings from investing the above if you invest those assets

Key Saving and Investing Concepts Saving versus investing Combining saving and investing Saving and investing early Tax-deferred saving and investing Tax-deductible saving and investing Saving and investing using employer contributions

Saving Versus Investing Means Not spending money Doing something with money to earn a return Needs to be done In a regular, disciplined manner Carefully and with due consideration

Combining Saving and Investing Stan Vickie Saves $2,000 per year Starts at age 25 Saves in a non-interest bearing account Saves $2,000 per year Starts at age 25 Invests and earns an 8.9% pretax and 6.68% after-tax return

Combining Saving and Investing Stan Vickie

Saving and Investing Early Stan Vickie Saves $2,000 per year Starts at age 35 Continues for 30 years Invests and earns an 8.9% pre-tax and 6.68% after-tax return Saves $2,000 per year Starts at age 25 Stops after 10 years Invests and earns an 8.9% pre-tax and 6.68% after-tax return

Saving and Investing Early Vickie Stan

Tax-Deferred Earnings Stan Vickie Saves $2,000 per year Starts at age 25 Continues for 40 years Invests in a taxable account and earns an 8.9% pre-tax and 6.68% after-tax return Saves $2,000 per year Starts at age 25 Continues for 40 years Invests in a Tax-Deferred account and earns an 8.9% pre-tax return

Tax-Deferred Earnings Vickie Stan

The Saving Process What do you want? What will you have? Will you have a shortfall? What strategy will you employ? What actions will you take?

What Do You Want? Identify your specific savings goals Identify your time horizon Quantify your saving goals Prioritize your saving goals

Identify Your Specific Saving Goals Pay down existing debt Create an emergency fund Save for retirement Accumulate a down payment for a house Build a college fund for your children’s education Set aside money for a specific goal (vacation, fun and games, etc.)

Create an Emergency Fund Set aside 2 to 4 months of living expenses Use it for a crisis (i.e., roof leaks) Use it and replace it Don’t use it for discretionary spending (i.e., vacation)

Save for Retirement Do everything possible NOW Start early—you’ll end up with more

Identify Your Time Horizon Identify number of months or years until goal Allow as much time as possible: You can accept a lower investment risk Your monthly saving and investing commitment will be less

Examine Your Spending Habits Keep a list of all spending for one month Compare total spending to take-home pay Examine closely if you have a substantial unexplained gap Become highly knowledgeable about your expenses

Identify Ways to Save More Save your next raise Save your next bonus Reinvest dividends and interest Save all cash gifts Rent instead of buying (books, videos, etc.) Delay buying a new car upon paying off present car loan Save the “donut money”—and lose weight! Buy generic products Trim your spending by 5% Be creative

What About Investing? Combined with savings, a key resource for achieving your financial goals Investing skills are needed to prudently utilize Company 401(k) investments IRAs investments Savings invested outside these plans All investments involve risks Approach investing carefully

What Investing Carefully Means Phase I: Learn investing basics Phase II: Develop your investment plan Phase III: Implement your investment plan

Investing Basics and Planning

Why Learn Basic Investing Concepts? ALL investments involve risks Even so-called risk-free investments like a cash As such, approach investing carefully Learning basic investing concepts is part of investing carefully

What Are The Major Asset Classes? Characteristics Goals Historical Average Returns* Cash Matures in less than one year Capital preservation Liquidity 3-4% Bonds Fixed income Varied maturities Income 5-7% Stocks Company ownership Possible dividend income Capital appreciation 10-13% Hard assets Asset ownership Inflation hedge Varies * Pretax return over 75 years through 2008

What Risks are Involved in Investing? Primary long-term risk Inflation risk Loss of purchasing power Primary short-term risk Volatility risk Instability of investment Other risks Business risk Market risk Liquidity risk Interest rate risk Currency risk Inherent risks of a particular business Likelihood that the market as a whole will fall Risk of not being able to access money when needed Loss of principal on fixed-rate investments due to rising interest rates Investment’s value will be affected by changes in exchange rates

How are These Risks Managed? Primary long-term risk Inflation risk Invest in stocks Primary short-term risk Volatility risk Hold investments for the long-term Other risks Business risk Market risk Liquidity risk Interest rate risk Currency risk Diversify within an asset class Diversify among asset classes Have an emergency fund “Ladder” portfolios Diversify among countries or hedge

However, Stocks Have More Volatility Risk Lower Deviation Higher Deviation Degree of Volatility Return Lower Annual 5% 10% 15% 20% Cash Intermediate-Term Government Bonds Large Company Stocks Small Company Stocks

Manage Volatility Risk by Investing Over Time 150% 125% One-Year Holding Periods Volatility Risk Over Time Five-Year Holding Periods 100% Twenty-Year Holding Periods Average Return 75% 50% Ranges of Return 25% 12.7% 10.4% 5.4% 3.7% 0% Assessing risk For many people, risk is the overriding factor in developing an investment strategy. In selecting investments, risk must be reviewed in several ways, such as measuring the likelihood of achieving a desired outcome. As you seek to build your wealth through investing, consider these additional areas of risk. Overall, risk can be divided into two main categories - systematic (non-diversifiable) and unsystematic (diversifiable) risk. This distinction is fundamental to investment planning and portfolio management. Market risk Systematic risk, which is due to such factors as the market in general, interest rates, purchasing power and currency fluctuation, is unavoidable. You must live with this type of risk, coping as best as possible. Bear in mind that, although it is invisible, it can decimate your wealth. Inflation, in particular, can be devastating. Some of the safest and most conservative investments (such as Treasury bills) may not protect your principal from inflation. They promise to return the same number of dollars you invest, with interest of course, but the purchasing power of these dollars may be reduced, perhaps sharply, by the time you get your money back. For these reasons, a structured investment program, in which stock, mutual funds or other investments are purchased steadily over a period of time, can help reduce risk. This technique, generally known as dollar-cost averaging, can take advantage of price declines because you will purchase more shares when the price is low and fewer shares when the price is high. This strategy tends to produce a portfolio with a lower average cost than one assembled through a limited number of large block purchases. This risk management technique keeps you focused on being invested versus trying to time the market peaks and valleys before deciding on investment purchases and sales. Timing the market is difficult, if not impossible, and introduces more risk to the investment process. -25% -50% -75% Small Company Stocks Large Company Stocks Long-Term Government Bonds Cash Range of compound annual returns over the period 1926-2002. Source: Ibbotson Associates, 2004.

Managing Business and Market Risks Portfolio Risk Number of Holdings 3 5 7 9 11 13 15 Portfolio Risk= Market Risk + Business Risk Business Risk Market Risk

Manage Liquidity Risk by Diversifying Current Bonds Real Estate Money market funds Convertible bonds Small - company stocks Certificates of deposit Large Utility stocks Zero coupon bonds Return Deferred Lower Liquidity Risk Higher

Managing Interest Rate Risk Price Price Interest Interest Rates Rates Bonds Managed by “Laddering” Portfolio of Bonds

Risk / Return Trade-Offs: Example 1 Degree of Volatility Lower Deviation Higher Deviation Degree of Volatility Return Lower Annual 5% 10% 15% 20% Cash Intermediate-Term Government Bonds Large Company Stocks Small Company Stocks

Risk / Return Trade-Offs: Example 2 Cash vs. Bonds vs. Stocks Current yield Appreciation Total return Estimated income taxes @ 30% After-tax return Inflation rate After-tax “real” rate of return Relative risk 3.3% 0.0% (1.0)% 2.3% (3.1)% (0.8)% Low 4.8% (1.4)% 3.4% 0.3% Medium 2.2% 6.5% 8.7% (2.6)% 6.1% 3.0% High

Risk / Return Trade-Offs: Example 3 Sub-Categories Within Major Asset Classes Cash Bonds Stocks Hard Assets International Small Company Large Company Stocks Long Term Intermediate Term Short Term High Risk/ High Return Potential Low Risk/ Low Return Potential

Risk / Return Trade-Offs: Example 4 Taxable vs. Tax-Exempt Investments Taxable or tax-exempt investments As a result of income taxes, you require significantly greater investment returns to reach a particular goal. For example, if you are in the 28 percent tax bracket, you would need to purchase a taxable investment earning more than 6.9 percent to outperform a 5 percent tax-exempt investment. Taxable Tax-exempt Investment $1000 $1000 Rate of return 6.9% 5.0% Investment income 69 50 Less taxes - 19 N/A Investment income after taxes $ 50 $ 50 In the 33 percent tax bracket, you would need a 10.4 percent taxable return to be able to keep 7 percent after taxes. The best outcome where taxes are concerned, of course, is not to have to pay them. That's a major reason why many investors favor municipal bonds. Interest on municipal bonds is not generally subject to Federal income taxes, although state or local income taxes may be due if you own municipal bonds issued outside your home state. (Capital gains on municipal bond investments are subject to Federal capital gains tax.) Municipal bonds, however, may not be suitable for your investment strategy. For example, you may need the long-term growth offered by common stocks. Unfortunately, all earnings from common stocks are taxable. This brings us to the next-best outcome where taxes are concerned, and that is to delay or defer them as long as possible. The longer you can keep your money from being taxed, and leave all your earnings free to compound, the easier it will be for you to reach your goals. Tax-equivalent return You can use the following formula to calculate the tax-equivalent return on a municipal bond: Tax equivalent return = tax-exempt return/(1-marginal tax rate) To learn more about tax exempt investments, see the Tax Planning online course in PwC eAdvisor.

Risk / Return Trade-Offs Between Differing Portfolios Portfolio A 6.61% Return 4.25% Risk* Portfolio B 6.61% Return 3.60% Risk* Portfolio C 7.06% Return 4.25% Risk* * Risk = one standard deviation

What One Factor Most Influences Your Return? Your Asset Allocation Source: Brinson, Singer, Beebower

What Most Influences Your Asset Allocation? Your desired rate of return Your risk tolerance Your time horizon Stan and Vickie are different…their asset allocations will be different too. Vickie Stan

Importance of Your Desired Rate of Return The higher the rate of your desired return, the higher the risk you will most likely will have to take Desired Return Likely Risk

Importance of Your Risk Tolerance The higher your risk tolerance the more aggressive you can be Risk Tolerance Be More Aggressive Be More Conservative

Importance of Your Time Horizon Longer time horizons (5 or more years) can absorb the ups and downs of investing more heavily in stocks Shorter time horizons warrant investing more heavily in less volatile investments Time horizon Use more volatile stocks Use less volatile investments

Developing Your Investment Plan

Use This Investment Planning Process What do you want? What will you have? Will you have a shortfall? What strategy will you employ? What actions will you take? Note: this process is applied to each of your investing goals

What Do You Want? Take into account Your goal in today’s dollars Number of years to your goal Expected inflation rate To arrive at What you want Be sure to include important others in deciding what you want.

How do You Define Your Goals? Each goal will have its own time horizon For the period of accumulation For the period over which it will be spent Make a list and refine as you go along Start with broad ideas and work toward increasingly specific and measurable goals

What Will You Have? Take into account Current assets set aside for your goal Number of years to your goal Future saving Expected return on your invested assets Expected future benefits To arrive at What you will have

Where Should You Save First? Your Employer 401(k) Plan (at least to the % that gives you the maximum employer match – free money for you) Roth IRA using after-tax contributions or Traditional IRA using pre-tax contributions, depending on your circumstances* Taxable accounts * Only Traditional IRAs can accept pre-tax contributions. Although both Traditional and Roth IRAs can accept after-tax contributions, it is generally preferable to use Roth IRAs. We will be covering IRAs in more detail later. You can use a Financial Calculator to determine which type of IRA is best for your particular situation.

Why These Priorities? Vickie Taxable Account Roth IRA Using After-Tax Contributions Traditional IRA Using Pre-Tax Contributions Employer 401(k) Plan Salary $50,000 Pre-tax $ $2,667 Tax at 25% $667 After-tax $ $2,000 Employee contribution Employer match – assume 3% n/a $1,500 Total contribution $4,167 % of salary contributed 4.00% 5.33% 8.33% Outcome $178,227 What Happens?

Why These Priorities? Vickie

Why These Priorities? Vickie

Consider Tax-Advantaged Accounts First Features Available  Employer 401(k) Plan IRAs 529 Plan Tax-Deferred contributions   (1) No (2) Tax-Deferred earnings Employer contributions No Unlimited contributions  (3) Automatic saving and investing Wide-array of professionally managed funds Varies Self-direction of fund allocation Immediate penalty-free withdrawal No (1) Depends on the type of IRA used. Some states allow you to deduct your contributions. Some states limit contributions.

Then Consider Taxable Accounts Features Available  Employer DESPP (1) Employer DTP (2) Mutual Funds Brokerage Accounts Tax-Deferred contributions No Tax-Deferred earnings Employer contributions Unlimited contributions  Automatic saving and investing Wide-array of professionally managed funds Self-direction of fund allocation Buy Emplyr stock at a discount Buy Emplyr stock without fees Immediate penalty-free withdrawal (1) Discounted Employee Stock Purchase Plan (2) Direct Transaction Program

Now Develop Your Preliminary Plan Question Answers = Plan Your goal? Your risk tolerance? Your expected rate of return? Your time horizon? Current assets set aside for your goal? Future periodic savings/investing? Expected future benefits? Types of account(s) you’ll use? Asset allocation within account(s)?

Then Calculate Your Expected Return* Major Asset Class Asset Allocation Historical Return Estimated Return Cash Bonds Stocks Hard assets __________% X 4% X 6% X 12% X 8% Total 100% * Calculated for each account you are using to invest your savings.

And Then the Future Value of These Items* Contribution Toward Goal Future Value Calculation Current assets set aside for your goal Calculate the future value of this amount invested at your expected rate of return over your time horizon Future periodic savings/investing Calculate the future value of these payments at your expected rate of return over your time horizon Expected future benefits Calculate the future value of this amount invested at your expected rate of return from the date of receipt to the end of your time horizon * Calculated for each account you are using to invest your savings.

The Result is What You Will Have Take into account Current assets set aside for your goal Number of years to your goal Future saving Expected return on your invested assets Expected future benefits To arrive at What you will have

Key Points to Remember Financial planning will help you clarify goals, strategies and action steps Determine whether you have too much debt and develop a plan to conquer it Make wise decisions about using debt Commit to saving and investing Save and invest early Pay yourself first Learn as much as you can about investing to develop a plan and invest according to your “comfort level”

Questions? [insert contact information here] Special thanks to Kevin Roach, CPA/PFS of Texas A&M University for contributing content.