Copyright ©2004 Pearson Education, Inc. All rights reserved. Chapter 1 Overview of a Financial Plan

Copyright ©2004 Pearson Education, Inc. All rights reserved.1-2 Chapter Objectives Introduce the subject of personal finance Identify the key components of a financial plan Outline the steps involved in developing your financial plan

Copyright ©2004 Pearson Education, Inc. All rights reserved.1-3 Definitions Personal finance: the process of planning your spending, financing, and investing so as to optimize your financial situation Personal financial plan: a plan that specifies your financial goals and describes the spending, financing, and investing plans that are intended to achieve those goals

Copyright ©2004 Pearson Education, Inc. All rights reserved.1-4 Definitions Opportunity cost: what you give up as a result of a decision

Copyright ©2004 Pearson Education, Inc. All rights reserved.1-5 How You Benefit From An Understanding of Personal Finance Make your own financial decisions –Every spending decision has an opportunity cost Judge the advice of financial advisors –Make informed decisions Become a financial advisor –Many career opportunities available

Copyright ©2004 Pearson Education, Inc. All rights reserved.1-6 Components of a Financial Plan Budgeting and tax planning Managing your liquidity Financing your large purchases Protecting your assets and income (insurance) Investing your money Planning your retirement and estate

Copyright ©2004 Pearson Education, Inc. All rights reserved.1-7 A Plan for Your Budgeting and Tax Planning Budget planning: The process of forecasting future expenses and savings Evaluate your current financial position –Assets: what you own –Liabilities: what you owe –Net worth: the value of what you own minus the value of what you owe

Copyright ©2004 Pearson Education, Inc. All rights reserved.1-8 Budgeting and Tax Planning Exhibit 1.1: How a Budget Affects Savings

Copyright ©2004 Pearson Education, Inc. All rights reserved.1-9 A Plan to Manage Your Liquidity Liquidity: access to funds to cover any short-term cash deficiencies Money management: decisions regarding how much money to retain in a liquid form and how to allocate the funds among short-term investment instruments

Copyright ©2004 Pearson Education, Inc. All rights reserved.1-10 A Plan to Manage Your Liquidity Credit management: decisions regarding how much credit to obtain to support your spending and which sources of credit to use

Copyright ©2004 Pearson Education, Inc. All rights reserved.1-11 Managing Your Liquidity Exhibit 1.2: Managing Your Liquidity

Copyright ©2004 Pearson Education, Inc. All rights reserved.1-12 A Plan for Your Financing Loans often needed for large expenditures –College tuition, car, house Managing loans –How much can you afford to borrow? –Determining maturity of the loan –Selecting a loan with a competitive interest rate

Copyright ©2004 Pearson Education, Inc. All rights reserved.1-13 Financing Your Large Purchases Exhibit 1.3: Financing Process

Copyright ©2004 Pearson Education, Inc. All rights reserved.1-14 A Plan for Your Investing Funds not needed for liquidity can be invested –Stocks, bonds, mutual funds, real estate All investments have some level of risk Risk: uncertainty surrounding the potential return on an investment

Copyright ©2004 Pearson Education, Inc. All rights reserved.1-15 A Plan for Your Retirement and Estate This includes insurance planning, retirement planning, and estate planning –Retirement planning: determining how much money should be set aside each year for retirement and how those funds should be invested –Estate planning: determining how your wealth will be distributed before or upon your death

Copyright ©2004 Pearson Education, Inc. All rights reserved.1-16 Exhibit 1.4: Components of Your Financial Plan Components of Your Financial Plan

Copyright ©2004 Pearson Education, Inc. All rights reserved.1-17 How the Text Organization Relates to the Financial Plan’s Components Each of the six parts of the text covers one specific component of the financial plan An effective financial plan enhances net worth and builds wealth Follow the steps to a complete financial plan at the end of the school term

Copyright ©2004 Pearson Education, Inc. All rights reserved.1-18 How the Text Organization Relates to the Financial Plan’s Components How the components relate to your cash flows –Cash inflows are cash that you receive –Cash outflows are cash that you spend –Budgeting balances income and spending –Liquidity deals with cash excesses or shortages

Copyright ©2004 Pearson Education, Inc. All rights reserved.1-19 How the Text Organization Relates to the Financial Plan’s Components –Financing focuses on obtaining cash for large purchases or repaying loans –Protect assets and income by using cash for insurance and retirement –Investing uses cash to build wealth

Copyright ©2004 Pearson Education, Inc. All rights reserved.1-20 How Financial Planning Relates to Cash Flow Exhibit 1.6: How Financial Planning Affects Your Cash Flows

Copyright ©2004 Pearson Education, Inc. All rights reserved.1-21 Developing the Financial Plan Step 1. Establish Your Financial Goals –Types of goals Car, home, college, wealth, charity –Set realistic goals Stronger likelihood of reaching goals –Timing of goals Short term (within one year) Intermediate (between 1–5 years) Long term (beyond five years)

Copyright ©2004 Pearson Education, Inc. All rights reserved.1-22 Developing the Financial Plan Step 2. Consider Your Current Financial Position –How your future financial position is tied to your education Consider your skills, interests, and career paths –How your future financial position is tied to your career choice Choose a career that will be enjoyable and suit your skills

Copyright ©2004 Pearson Education, Inc. All rights reserved.1-23 Developing the Financial Plan

Copyright ©2004 Pearson Education, Inc. All rights reserved.1-24 Developing the Financial Plan

Copyright ©2004 Pearson Education, Inc. All rights reserved.1-25 Developing the Financial Plan Step 3. Identify and Evaluate Alternative Plans That Could Achieve Your Goals –Plans could be conservative or aggressive Step 4. Select and Implement the Best Plan for Achieving Your Goals –The Internet has valuable financial planning information

Copyright ©2004 Pearson Education, Inc. All rights reserved.1-26 Developing the Financial Plan Focus on Ethics: Personal Financial Advice –Your objective is to get the best advice appropriate to your needs –Be wary of unethical behavior Difficult to discern –Be wary of incompetent advice Be alert, ask questions, carefully consider advice

Copyright ©2004 Pearson Education, Inc. All rights reserved.1-27 Developing the Financial Plan Step 5. Evaluate Your Financial Plan –Keep plan in an accessible place and monitor your progress Step 6. Revise Your Financial Plan –Change plan as financial condition and financial goals change

Copyright ©2004 Pearson Education, Inc. All rights reserved.1-28 How the Internet Facilitates Financial Planning The Internet provides information on all aspects of financial planning –Bank deposit rates –Prices of cars and homes –Financing rates –Prices of investments –Insurance premiums

Copyright ©2004 Pearson Education, Inc. All rights reserved.1-29 How the Internet Facilitates Financial Planning Provides updated information on all parts of your financial plan –Current tax rates and regulations –Investment performances –Online calculators

Copyright ©2004 Pearson Education, Inc. All rights reserved.1-30 How the Internet Facilitates Financial Planning 1.1 Financial Planning Online: Should You Pursue a Career in Financial Planning?

Copyright ©2004 Pearson Education, Inc. All rights reserved.1-31 Financial Planning Online: Financial Planning Tools for You Go to This website provides much information and many tools that can be used for all aspects of financial planning. It also provides information for creating retirement plans and wills.

Copyright ©2004 Pearson Education, Inc. All rights reserved.1-32 Integrating Key Concepts

Copyright ©2004 Pearson Education, Inc. All rights reserved.1-33 Looking Ahead Part 1: Financial Planning Tools –Chapter 1 showed an overview of a financial plan –Chapter 2 teaches personal financial statements –Chapter 3 teaches time value of money –Chapter 4 teaches tax planning Part 2: Liquidity Management Part 3: Financing Part 4: Protecting Your Wealth Part 5: Investing Part 6: Retirement and Estate Planning