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Canton Center for Economic Education

Canton Center for Economic Education. Presents What Personal Finance Is About May 13 th , 2011. Agenda What Personal Finance Is About. Limited Resources, Scarcity, and Opportunity Cost The Circular Flow Model of a Market Economy

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Canton Center for Economic Education

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  1. Canton Center for Economic Education Presents What Personal Finance Is About May 13th, 2011

  2. AgendaWhat Personal Finance Is About • Limited Resources, Scarcity, and Opportunity Cost • The Circular Flow Model of a Market Economy • Essentials of Personal Finance: Income, Career Decision, Taxes, Spend or Save, and Insurance • Savings, Investments, and the Financial Market • The Pyramid of Risk and Reward • Types of Insurance

  3. OBJECTIVES • Describe the Economics of Financial Decision Making • Explain this decision making inside a market economy • Justify the essentials of Personal Finance: Income, Career Decision, Taxes, Spend or Save, and Insurance • Clarify Savings, Investments, and the Financial Capital Market • Interpret Financial Risk and Insurance

  4. Scarcity and Opportunity Cost • Sheila graduate from high school with multiple career interest and abilities • Choices High school biology teacher (salary range = $30,000 - $45,000) or Doctor (salary range = $150,000 – $250,000)

  5. Economic Principles • Scarcity forces choice (e.g. teacher or doctor) • Choices have opportunity cost (e.g. college cost, current income, future doctor salary) • Response to incentives is predictable (such as income potential, time, money, and social status)

  6. Economic Principles • Market forces and economic systems influence choices (current salaries, college cost) • Choices have intended and unintended consequences (e.g. marriage, family) • Gain from voluntary trade

  7. Opportunity Cost • Best alternative forgone (doctor) • Producer Choice: Becoming a teacher or doctor • Consumer Choice: Buying a car or home Non-Money Cost: family time, vacation

  8. Circular Flow Model:Simple Market Economy Players

  9. A Market Economy • 3 Major Markets: • Product Market of finished goods and services supplied by Businesses (prices determined by supply and demand) • Productive Resource Market of labor (wage/salary depend on supply and demand)

  10. 3. Financial Capital Market • Saved income from household (and businesses) • Burrowed by businesses (consumers and government) to finance production • Banks, Credit Unions, Insurance Company, Brokerage Houses and other institutions channel funds determined by interest rate

  11. Fundamentals of Personal Finance • Earning an Income • Taxes • Investment and • Insurance

  12. Earning and Income Key Factors that Influence Career Decisions: • Personal Preferences • Skills/Human Capital • Demand for Certain Jobs (flexible marketable skills) • Earning Potential based on contribution to productive activity (support desired standard of living)

  13. Earned Income

  14. Acquiring Skills/Human Capital • Formal Education • Internships • Apprenticeships • On-the-job Training • Certificate Programs etc.

  15. Uncertainty and Risk • Intended and Unintended Consequences • Risk is always associated with decision to improve human capital through education and training • Mitigate Risk with skill inventory test, “job shadow,” and an analysis of job market

  16. Major Taxes • Income • Sales • Property The taxes are paid to 3 levels of federal, state, and/or local governments

  17. Income Tax • % of Income earned • Increases or decreases with income • Paid to the federal, (and some state and local governments) • Payroll tax (FICA or Federal Insurance Contribution Act) for Social Security and Medicare

  18. Sale and Property Taxes • Paid on goods and services purchased • Excise taxes are special taxes such as those on gasoline, tobacco, alcohol, and telephone services. • Property taxes paid, on real estate owned, to local government

  19. Spend or Save • Realities of scarcity and opportunity cost • Save implies more in the future from investments or interest gains • Spend means benefiting now from present consumption

  20. Eric the Construction Worker • Gross Income = $3,000 a month • Disposable Income (after taxes) = $2,300 • Save = $300 • Spend (by giving, education and training, and typical consumer expenditure) = $2,000

  21. Giving and Investing • In 2008, Giving USA Reported that Households give out 75% of the whole estimated giving • Give immediately after pay and carefully in financial trouble • Investing in education, training, and skill development leads to better and more fulfilling job prospect

  22. Consumer Spending • Right consumer choices • Compare Needs with Want e.g. car? car guzzlers? • Check Opportunity Cost of consumer decision

  23. Major Steps in Decision Making • Identify wants • Determine how much you can spend • Find products/services available at price • Choose features that you most want • Use a decision grid to analyze alternatives • Watch for hidden cost • Make choice

  24. Budgets • Planning tool that requires discipline and careful record keeping • Types of Budget Expenses: Fixed expenses, variable expenses, and occasional expenses • Planned and unplanned expenses (use special “emergency” savings)

  25. Cash or Credit • Cash from cutting back or extra work • Debit Cards: cash out of checking account • Credit Card: cash burrowed to be repaid later with interest • Cautious with financing current consumption with credit/debt ►less future consumption and impending uncertainty

  26. Benefits of Borrowing • Mortgage on home purchase with adequate down payment and affordable monthly payments • Auto, emergency, and education loans • 28% gross monthly income ≈ mortgage + taxes + insurance + interest • 35% debt (mortgage, credit cards, child support, and students loan) to income ratio

  27. Using Credit Cards • Use low interest cards as a $3,000 balance at 19.8% APR with minimum monthly payment will cost 32 years and $9,000 in interest • Pay of the balance each month to avoid interest payments • Or pay as much as you can each month to lower interest payments

  28. Credit Reports • Experian, Equifax, and TransUnion • Summarizes the risk level of a consumer to lenders • Late credit card payments raise interest payment and lower credit score • Free Annual Credit Report @www.annualcreditreport.com

  29. Savings and Investment Accounts • Savings Account • Certificates of Deposit (CDs) • Mutual Funds • Real Estate • Collectibles and Commodities • Stocks • Bonds

  30. Reaching Financial Goals • Short, medium and long term goals • Time (compound interest) • Investment Size • Rate of Return (r or interest rate) • Rule of 72: Savings double (in years) = 72/r e.g. 8% rate of return on $1000 will have $2000 in 9 years. Use: http://lei.councilforeconed.org/interactives/compound/

  31. Guide for Financial Investment • Liquidity: Ease of conversion to cash • Risk: Chance of lost of cash • Return: Earnings from the investment • Tax Treatment: Extent to which earning are taxed

  32. Financial Investment Options • Regular (Passbook) Savings Account • Certificates of Deposit • Stocks • Bonds • Mutual Funds • Real Estate • Commodities

  33. Regular Savings Account • Depositors insured up to $250,000 by the Federal Deposit Insurance Cooperation (FDIC) • Low risk • Low rate • Money Market Deposit Account (larger deposits and limited withdrawals) interest paid similar to money market mutual fund

  34. Certificates of Deposit (CD) • Also insured up to $250,000 by FDIC • Savings account left for set period of time earns fixed interest rate • Longer the time the higher the interest rate • Depositors lose interest earned if cashed before maturity

  35. Stocks • First issued with Initial Public Offering (IPO) • Represent ownership of company shares • Traded on various stock exchanges—New York Stock Exchange (NYSE) and National Association of Securities Dealers Automated Quotation System (NASDAQ) • Value should increase as the company grows and prospers

  36. Stocks • Dividends: profit payments to shareholders • Growth Stocks: reinvest in the company and seldom pay dividends • Income Stock: larger, more established companies pay dividends • Value Stock: Underpriced relative to stock fundamentals—earnings, dividends, sales • Penny Stock: risky low price stock (< $5)

  37. Bonds • IOU certificates • Coupon Bonds • Zero Coupon Bond • Municipal Bonds • US Treasury Bills • Saving Bonds

  38. Coupon Bonds • Borrowers promise to pay back a fixed rate of interest (coupon rate) on face value (principal) over fixed time period • At maturity date the entire face value of the bond is paid back

  39. 2-year coupon bond of 6% coupon rate and $1000 face (par) value

  40. Zero Coupon Bonds • Bought at a discount • The lower the discounted price the more the interest • Matures (interest + principal) at an even amount--$1000, $5000, or $10000 • Actual interest is inferred from difference between price at maturity and purchase price

  41. 2-year zero coupon bond at $1000 face (par) value

  42. Market Interest Rate • Bonds are safe investments but drop value with increases in market interest rate • Compare $1000 20-year corporate bond with coupon rate of 4% • With a new $1000 20-year corporate bond issued at 8% • Latter pay better interest of $80 • Issuer’s creditworthiness

  43. Municipal Bonds • Tax exempt from federal, state, and local governments • U.S. Treasury bills, notes, and bonds are backed by the full faith, credit, and taxing authority of the government

  44. Savings Bonds • U.S. Treasury securities • Issued at a set non-negotiable price • Not liquid as it trades in organized secondary market after issue • Incurs interest penalty if cashed early • Attractive—issued in small denomination and easy to purchase

  45. Mood’s Investor Service Bond-Rating Codes Aaa Highest quality Aa High quality A Upper-medium quality Baa Medium grade Ba Somewhat speculative B Low grade, speculative Caa Low grade, default possible Ca Low grade, partial recovery possible C Default, recovery unlikely

  46. Mutual Funds • Diversified professionally managed portfolio of securities • Individual investors share gains and loses of the fund • Diversified mutual funds spreads risk

  47. Real Estate • Property consisting of houses (live or rent) and land • House prices dropped significantly in 2008 and still dropping • Costly to maintain and not as liquid as stocks or bonds • Good investment and interest on mortgage can be tax deductable

  48. Commodities, Precious Metals, and Collectables • Rare coins, stamps, and art • Hedge against inflation • Can be risky

  49. Risk Associated with Financial Investments • Financial Risk: a business is unable return someone’s money • Market Price Risk: drop in the price of investment • Liquidity Risk: difficult to sell or transfer • Inflation Risk: inflation rate reduces value • Fraud Risk: or scam investigate investment at a state’s securities regulator

  50. Watch Out for Investment Scams • No such thing as a completely safe investment • Investigate before you invest • Call state’s securities regulator • Don’t be pressured • Be cautious • Beware of fantastic promises of easy profits

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