33 Kapoor Dlabay Hughes 7e © The McGraw-Hill Companies, Inc., All Rights Reserved. P ERSONAL F INANCE Irwin/McGraw-Hill

© The McGraw-Hill Companies, Inc., All Rights Reserved. Irwin/McGraw-Hill 1-1 C HAPTER 1 Personal Finance Personal Financial Planning: An Introduction Kapoor Dlabay Hughes 7e Irwin/McGraw-Hill

© The McGraw-Hill Companies, Inc., All Rights Reserved. Irwin/McGraw-Hill Financial Planning and Its Benefits Personal financial planning is the process of managing your money to achieve personal economic satisfaction. There are several advantages of personal financial planning.  Increased effectiveness in obtaining, using, and protecting your financial resources.  Increased control of your financial affairs.  Improved personal relationships.  A sense of freedom from financial worries obtained by looking to the future. 1-2

© The McGraw-Hill Companies, Inc., All Rights Reserved. Irwin/McGraw-Hill The Financial Planning Process  Determine your current financial situation.  Develop your financial goals.  Identify alternative courses of action.  Evaluate your alternatives.  Create and implement your financial action plan.  Review and revise your plan. 1-3

© The McGraw-Hill Companies, Inc., All Rights Reserved. Irwin/McGraw-Hill Consequences of Choices: Opportunity Cost Opportunity cost is what you give up by making a choice.  The cost, referred to as the trade-off of a decision, cannot always be measured in dollars. Sometimes the cost is your time.  Consider lost opportunities that will result from your decisions. 1-4

© The McGraw-Hill Companies, Inc., All Rights Reserved. Irwin/McGraw-Hill Every Financial Decision Involves Evaluating Types of Risk Inflation risk.  Rising prices cause lost buying power. Interest-rate risk.  Effect costs of borrowing and rate of return. Income risk.  The loss of a job. Personal risk.  Health, safety, or costs. Liquidity risk.  Higher return may mean less liquidity. 1-5

© The McGraw-Hill Companies, Inc., All Rights Reserved. Irwin/McGraw-Hill Financial Planning Information Sources Printed materials. Financial institutions. School courses and educational seminars. Computer software, World Wide Web, and on-line information sources. Financial specialists.  Financial planners, bankers, accountants, insurance agents, lawyers and tax preparers. 1-6

© The McGraw-Hill Companies, Inc., All Rights Reserved. Irwin/McGraw-Hill Developing Personal Financial Goals Types of financial goals include those...  Influenced by the time frame in which you want to achieve your goals.  Influenced by the financial need that drives your goals. Timing of goals.  Short-term, intermediate and long-term goals. Goals for different financial needs. Goal setting guidelines suggests goals should...  Be realistic, be stated in specific, measurable terms, have a time frame, and indicate the type of action to be taken. 1-7

© The McGraw-Hill Companies, Inc., All Rights Reserved. Irwin/McGraw-Hill Influences on Personal Financial Planning Adult life cycle stage. Marital status, household size, and employment. Major events.  Graduation, marriage, divorce.  Birth or adoption of child.  Career or health changes. Values.  What are the ideas and principles you consider correct, desirable and important? Life situation and personal values 1-8

© The McGraw-Hill Companies, Inc., All Rights Reserved. Irwin/McGraw-Hill Influences on Personal Financial Planning Global influences.  The global marketplace influences financial activities.  Foreign investors.  Competition from foreign companies. Economic conditions.... Economic factors: 1-9 (continued)

© The McGraw-Hill Companies, Inc., All Rights Reserved. Irwin/McGraw-Hill Changing Economic Conditions Consumer The value of the dollar prices changes in inflation. Consumer The demand for goods and services spending by individuals and households. Interest rate The cost of money; cost of credit when you borrow; return on yourmoney when you save or invest. 1-10

© The McGraw-Hill Companies, Inc., All Rights Reserved. Irwin/McGraw-Hill Changing Economic Conditions (continued) Money Supply The dollars available for spending in our economy. UnemploymentThe number of individuals without employment who are willing and able to work. Housing startsNumber of new homes being built. 1-11

© The McGraw-Hill Companies, Inc., All Rights Reserved. Irwin/McGraw-Hill Changing Economic Conditions (continued) GDP: GrossTotal value of goods and services Domestic Product produced in a country. Trade balanceDifference between a country’s exports and imports. Market indexesThe relative value of stocks as represented by the index, such as the Dow Jones Average or the S&P

© The McGraw-Hill Companies, Inc., All Rights Reserved. Irwin/McGraw-Hill Opportunity Costs and Financial Results Evaluated When Making Decisions Personal Opportunity Costs (time, effort, health) Financial Opportunity Costs (Interest, liquidity, safety ) Financial Acquisitions (automobile, home, college education, investments, insurance, retirement fund) 1-13

© The McGraw-Hill Companies, Inc., All Rights Reserved. Irwin/McGraw-Hill Time Value of Money Increases in an amount of money as a result of interest earned.  Saving today means more money tomorrow. Spending means lost interest. Saving and spending decisions involve considering the trade-offs. Current needs can make spending worthwhile. 1-14

© The McGraw-Hill Companies, Inc., All Rights Reserved. Irwin/McGraw-Hill How Simple Interest is Computed Simple Interest. Amount in savings x annual interest rate x time period equals the interest. I = PRT (Interest = Principal x Rate x Time)I $100 x 5% x 1 (1 year) 100 x.05 x 1 = $5.00 In one year you have $100 in principle plus $5.00 in interest for a total of $105 at the end of the year. 1-15

© The McGraw-Hill Companies, Inc., All Rights Reserved. Irwin/McGraw-Hill Future Value Future value is the amount to which current savings will increase based on a certain interest rate and a certain time period. Future value is also call compounding - earning interest on previously earned interest. Future value can be computed for a single amount or for a series of deposits. 1-16

© The McGraw-Hill Companies, Inc., All Rights Reserved. Irwin/McGraw-Hill Present Value The current value for a future amount based on a certain interest rate and a certain time period. Present value calculations are also called discounting. The present value of the amount you want in the future will always be less than the future value. (See Exhibit 1-8C) Present value can be computed for a single amount or for a series of deposits. 1-17

© The McGraw-Hill Companies, Inc., All Rights Reserved. Irwin/McGraw-Hill Components of Financial Planning Obtaining (chapter 2) Planning (chapters 3, 4) Saving (chapter 5) Borrowing (chapters 6, 7) Spending (chapters 8, 9) Managing risk (chapters 10-12) Investing (chapters 13-17) Retirement and estate planning (chapters 18, 19) 1-18

© The McGraw-Hill Companies, Inc., All Rights Reserved. Irwin/McGraw-Hill Developing a Flexible Financial Plan A financial plan is a formalized report that...  Summarizes your current financial situation.  Analyzes your financial needs.  Recommends future financial activities. Your financial plan can be created by you, done with assistance from a financial planner, or made using a money management software package. 1-19

© The McGraw-Hill Companies, Inc., All Rights Reserved. Irwin/McGraw-Hill Implementing Your Financial Plan Develop good financial habits.  Use a well conceived spending plan to help you stay within your income, while allowing you to save and invest for the future.  Have appropriate insurance protection to prevent financial disasters.  Become informed about tax and investment alternatives.  Study personal finance. 1-20

© The McGraw-Hill Companies, Inc., All Rights Reserved. Irwin/McGraw-Hill Implementing Your Financial Plan Achieving your financial objectives requires two things.  A willingness to learn.  Appropriate information sources (see Appendix A). Current periodicals. Financial institutions. Courses and seminars. Personal financial software. The World Wide Web. Financial specialists. (continued) 1-22

© The McGraw-Hill Companies, Inc., All Rights Reserved. Irwin/McGraw-Hill THE END