Chapter 1

1. The Financial Planning Process Chapter 1

2. Learning Objectives • Explain why personal financial planning is so important • Describe the five basic steps of personal financial planning • Set your financial goals

3. Learning Objectives 4. Explain the personal finance lessons learned in the recent economic downturn 5. Explain how career management and education can determine your income level 6. List ten principles of personal finance 7. Understand that achieving financial security is more difficult for women

4. Introduction • It’s easy to spend money without thinking about it, but saving takes a PLAN • Personal financial planning is an ongoing process—it changes as your financial situation and position in life change • Manage and control your finances with a personal financial plan • It helps you achieve financial and lifestyle goals

5. Importance of Personal Financial Planning • Manage the unplanned • Accumulate wealth for special expenses • Save for retirement • “Cover your assets” • Invest intelligently • Minimize payments to Uncle Sam

6. Five basic steps to personal financial planning • Evaluate your financial health • Define your financial goals • Develop a plan of action • Implement your plan • Review your progress, reevaluate, and revise your plan

7. Step 1: Evaluate Your Financial Health • Examine your current financial situation. • How much money do you make? • How much are you spending and on what? • Use careful record keeping to track finances and spending • Keeping a record of your spending is the first step toward taking control of your finances

8. Step 2: Define Your Financial Goals • Write or formalize your goals – you can’t get what you want if you don’t know what you want • Attach a financial cost to each one • When will you need the money to achieve the goal? • Analyze and revise your goals as necessary

9. Step 3: Develop a Plan of Action • Flexibility: • Plan for life changes and the unexpected • Liquidity • How easily an asset can be turned into cash • You need to be able to get money when you need it • Protection • Prepare for the unexpected with insurance • Minimize Taxes • Keep more of what you earn

10. Step 4: Implement Your Plan • Stick to it! • Use your financial plan as a road map to achieve goals • Keep goals in mind and work towards them

11. Step 5: Review, Reevaluate, and Revise • Review your progress • Changes will happen in your life, so you might need to re-evaluate and revise or even create a new plan to meet your needs

12. Figure 1.1 The Budgeting and Planning Process

13. Establishing Your Financial Goals • Financial goals have three time horizons: • Short-term — can be accomplished within 1 year • Intermediate-term — will take 1 to 10 years to accomplish • Long-term — will take more than 10 years to accomplish

14. Examples of Short–Term Goals • Accumulate emergency funds equaling 3 months’ living expenses • Pay off bills and credit cards • Purchase insurance • Purchase a major item • Finance a vacation

15. Examples of Intermediate-Term Goals • Save for older child’s college • Save for a down payment on a car or home • Pay off major debt • Finance large items (weddings) • Purchase a vacation home

16. Examples of Long-Term Goals • Save for younger child’s college • Purchase retirement home • Create a retirement fund to maintain current standard of living • Take care of elderly family members • Start a business

17. Figure 1.2Personal Financial Goals Worksheet

18. Figure 1.3A Typical Individual’s Financial Life Cycle

19. Stage 1 The Early Years—A Time of Wealth Accumulation • Ages up to age 54 • Develop a regular savings pattern: • How much can be saved? • Is that enough? • Where should the savings be invested? • Cost of raising children

20. Table 1.1 The Cost of Raising a Child

21. Stage 2 Approaching Retirement—The Golden Years • Transition years between ages 55-64 • Focus on preservation of wealth already accumulated • Think about estate planning (planning for your eventual death and passage of your wealth to others) • Reassess financial goals and decisions—retirement, insurance protection and inflation

22. Stage 3 The Retirement Years • After age 65, you will live off savings – you will start to spend more than you earn • Retirement age will depend on how much savings you have accumulated • Focus on a less risky investment strategy • Consider extended nursing home protection • Estate planning decisions and documents are critical

23. Thinking About Your Career • Identify a job that you feel is important, enjoyable, and satisfying • You will be working for 40-50 years, and having a career you enjoy will be important • Does it provide for your desired standard of living? • You may change jobs several times during your lifetime

24. Figure 1.4 Job Search Worksheet

25. Figure 1.4 Job Search Worksheet (cont.)

26. Figure 1.4 Job Search Worksheet (cont.)

27. Choosing a Major and a Career • Perform an effective self-assessment • Look at your interests, skills, values, personal traits • Desired lifestyle – get a job that will support you and your future family • Research potential earnings • Research career alternatives and match with your skills and interests

28. Table 1.2 What Different College Majors Earn

29. Getting a Job • Getting your first real job is a job in itself - start early • Prepare and practice for interviews • Research the company • Dress appropriately, be confident, and follow-up

30. Table 1.3 Most Common Interview Questions

31. Being Successful in Your Career -Increase Your Value as an Employee • Do your best work • Project the right image – aligned with the company’s values and wants • Understand and work within the power structure • Gain visibility – make people aware of your contributions

32. Being Successful in Your Career • Take new assignments– gain experience and an understanding of the company • Be loyal and supportive • Acquire new skills and keep up with technology • Develop a strong network of contacts in case you need to look for a new job • Be ethical

33. What Determines Your Income? • Skills – the higher the skill level required for a job, the higher it will pay • Education – generally the more education you have, the more you get paid • The wealthy are generally married

34. Figure 1.5 Education and Earnings

35. Lessons from the Great Recession • The economic downturn starting in 2008 affected Americans in two ways: • Dramatic and swift rise in unemployment. Additionally, many people who didn’t lose their jobs had their wages and/or hours cut • Disruption of financial markets, leading to heavy losses in 401(k)s and other retirement savings • The average American family lost $50,000 - $120,000 in wealth

36. It could take up to 15 years for many families to recover

37. Lessons from the Great Recession • Many people have insufficient emergency funds • Most Americans are very concerned about having enough retirement income, but most are not adequately prepared • Americans have too much debt

38. Figure 1.6 How Long Households Go Without Income Before Hardship Sets In

39. Ten Principles ofPersonal Finance The Foundation Of Personal Finance

40. Principle 1: The Best Protection Is Knowledge • Knowledge enables you to protect yourself against bad advice • Helps you understand the importance of planning for the future • Gives you the ability to make intelligent investments and take advantage of changes in the economy

41. Principle 2: Nothing Happens Without a Plan • Easier to think about spending than to think about saving • Saving must be planned • Putting off a financial plan means goals are harder to achieve

42. Principle 3: The TimeValue of Money • Money received today is worth more than money received in the future – probably the most important financial concept you will learn • Helps you understand how savings and investments grow over time • Helps you to understand compound interest, which is interest paid on interest

43. Table 1.4 Importance of Starting Early—Just Do It!—to Accumulate $1 Million by Age 67 Investing Your Money at 12%

44. Principle 4: Taxes Affect Personal Finance Decisions • Don’t make financial decisions without knowing the effect of taxes on the rate of return of investments • Compare investment alternatives on an after-tax basis • Understand tax laws

45. Principle 5: Stuff Happens, or the Importance of Liquidity • Plan for unexpected events • Have money or liquid funds available • In an emergency, if you don’t have liquid assets, you may have to cash in a long-term asset or go into debt • Liquid funds should cover 3 to 6 months of living expenses

46. Principle 6: Waste Not, Want Not - Smart Spending Matters • Differentiate spending on wants from spending on needs • A need is something necessary for survival • A want is anything else • Do homework before the purchase • Make the purchase at the best price • Maintain your purchase to prolong its life

47. Principle 7: Protect Yourself Against Major Catastrophes • Have the right kind of insurance to protect yourself before a tragedy occurs • Know your insurance policy coverage • Focus insurance purchases to protect against major catastrophes which can be financially devastating

48. Principle 8: Risk and Return Go Hand in Hand • Saving and investing increases our money • Investors demand a minimum return above anticipated inflation • Low return = low risk • High return = high risk • Diversification reduces risk by spreading money in several investments. If we lose money on one investment, we should make enough on others to make up for the loss

49. Figure 1.7 The Risk-Return Trade-Off

50. Principle 9: Mind Games, Your Financial Personality, and Your Money • Behavioral biases lead to big financial mistakes • Mental accounting affects financial decisions • For example, we keep money in a savings account earning 3%, when we should use the money to pay off debt charging 14% • “Sunk cost effect” pours good money after bad money because we are attached emotionally