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Rational Financial Planning: Spending, Saving, and Investing Decisions

Learn the fundamentals of rational financial planning, including spending wisely, saving for short-term and long-term goals, and making informed investment decisions. Understand the importance of balancing current needs with future aspirations to achieve financial stability and growth.

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Rational Financial Planning: Spending, Saving, and Investing Decisions

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  1. Spending, Saving, and Investing

  2. Rational Decisions and Financial Planning • Economist assume that, given enough information, most people are rational and predictable. • People will choose options that maximize their personal happiness and minimize their personal pain.

  3. Rational Decisions and Financial Planning • Another aspect of rational decision making: • Delaying a small benefit now, in exchange for a greater benefit later. • Because the U.S. has a high standard of living, most Americans have more than enough money to provide the things they need in order to survive. • However, people have unlimited wants ordesires.

  4. Rational Decisions and Financial Planning • Market economy – bombards us with ads that try to persuade us to satisfy all our wants NOW. • When we weigh opportunity costs of buying something, we may decide that buying something small now may deprive us of the chance to afford something better later.

  5. Rational Decisions and Financial Planning • We need to decide how much of our income to spend now, and how much to set aside as savings to achieve short-term goals • Also, must decide how much to use for investments to achieve long-term goals.

  6. Rational Decisions and Financial Planning • Savings – money deposits placed securely in a bank or other financial institution, so that the funds will be available for later use. • Savings earn a small amount of interest (interest – the money banks pay for the use of your savings).

  7. Rational Decisions and Financial Planning • Investments – Money you pay into a business with the expectation, but NOT the guarantee, of future rewards (if earn profit). • Investments carry higher risks, but potentially higher returns than savings. • A type of savings plan can help you achieve your goals.

  8. Rational Decisions and Financial Planning • Short term goals – things you would like to have in a few months. • Long-term goals – things you would like to have in a few years (usually more expensive things)‏

  9. Financial Plan • Set goals. • Work out a process for achieving your goals. • Put your plan into action by setting priorities and making decisions.

  10. Financial Institutions for Savings • Deposit money in a bank or Credit Union. • Bank – a corporation that stores deposits and makes loans in order to earn a profit. • Banks use the money their customers deposit to make loans to others. • In exchange for using your money, the bank pays you a small amount of interest per year.

  11. Financial Institutions for Savings • Example: (Simple Interest) • Bank pays you 3% interest in your savings account. • You deposit $100 • You will have $103 at the end of one year.

  12. Financial Institutions for Savings • Certificate of Deposit (CD) – A deposit you promise to leave in the bank for a specific amount of time in exchange for a higher rate of interest.

  13. Financial Institutions for Savings • Those who borrow from a bank must pay the bank interest, a percentage of the loan amount, as they pay back their loans. • The interest a bank charges for loans is always higher than the interest it pays for savings • This is one way a bank earns money.

  14. Financial Institutions for Savings • Savings and Loan Association – Similar to a bank, but it gets most of its deposits from consumers, rather than businesses, and lends most of its money to home buyers. • Reserves – cash on hand in the event you decide to withdraw your savings today.

  15. Financial Institutions for Savings • Federal Deposit Insurance Company (FDIC) – Insurance on your deposits. • Credit union – A not-for-profit financial institution that is owned and controlled by its members, usually people who work in the same company or the same occupation. • Credit union deposits earn interest, and depositors are usually eligible to borrow money at lower interest rates than banks. • Deposits are also protected by the government.

  16. Investments: Higher Returns in Exchange for Higher Risks • When you invest your money, you either lend it to a business or to the government for a specified time, in return for interest. • OR, you actually buy part-ownership of a company and share its profits.

  17. Investments: Higher Returns in Exchange for Higher Risks • General rule of investments: • Bonds • Stocks • Mutual Funds

  18. Investments: Higher Returns in Exchange for Higher Risks • Bonds – When you buy bonds, you are lending money to a corporation, to the federal government, to a state or city, or to an organization involved in a public construction project. • In return, the bond issuer pays you interest periodically and then repays the cost of your bond at its “maturity” date, usually several years later.

  19. Investments: Higher Returns in Exchange for Higher Risks • Issuer of a government bond – Uses your money to pay debts or to pay for a public project such as an airport or school • Corporations use them to raise capital or funds for investments • Bonds are higher interest rates than savings accounts or CDs. • They are considered safe investments because the issuers of the bonds are evaluated in advance to determine their credit worthiness (ability to repay the funds).

  20. Investments: Higher Returns in Exchange for Higher Risks • Investments with the highest potential rewards are also the riskiest – stocks. • When you purchase stocks, you purchase shares in the ownership of a corporation • In return, you earn dividends, your share of the company’s profits. • You may also sell your stock at any time

  21. Investments: Higher Returns in Exchange for Higher Risks • Profits on stock – capital gains • If company fails to earn a profit, you can lose money. • If the company goes bankrupt, you can even lose your entire investment. • That is why many investors choose mutual funds.

  22. Investments: Higher Returns in Exchange for Higher Risks • Mutual funds – A mutual fund pools money from many investors and uses it to buy a variety of stocks and bonds called a portfolio. • Mutual funds offer a compromise – they include low-risk, low-return stocks with some high-risk, high-return stocks. • Investors can never lose all their money and still have the chance to earn some high profits.

  23. Savings Options • Explain the advantages and disadvantage of each of the following types of savings/investments: • Mutual Funds – What is a mutual fund; what are advantages and disadvantages • Certificate of Deposit – Explain how they help you save (list advantages and disadvantages) • Stocks – Identify 2 companies that you think are risky investments and 2 that you think are safe investments • Bonds (corporate and government)

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