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Personal Finance: a Gospel Perspective

Personal Finance: a Gospel Perspective. Cash or Liquid Asset Management. Day 6 Objectives. A. Understand the importance of good cash management and how it can help you achieve your goals B. Understand the different cash management alternatives?

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Personal Finance: a Gospel Perspective

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  1. Personal Finance: a Gospel Perspective Cash or Liquid Asset Management

  2. Day 6 Objectives A. Understand the importance of good cash management and how it can help you achieve your goals B. Understand the different cash management alternatives? C. Understand that while technology can help, unless you plan and spend at least 1-2 hours a week following your finances, you will not be able to keep up with your financial goals D. Understand the different types of financial institutions, and how they can help you meet your financial goals (and pay you the most on your liquid savings)

  3. Your Personal Financial Plan • Section VI: Cash Management • What is your current Cash Management Framework? • What are you earning on your Savings? • What costs/fees are you paying? • What are you earning on your Checking? • What costs/fees are you paying? • Which Cash Management vehicles should you be using and why?

  4. Application • You are with a friend who heard you have taken Personal Finance at the Marriott School. She just got married two months ago, and she and her husband were given $3,000 as a wedding present. She will be graduating in two years, and she and her husband want either to save the money for law school when she graduates or to use it to go on a vacation before law school. Her husband wants to invest the money in the stock market—he has two stocks he really likes, but she is unsure of what to do. She asks for your advice. What should you tell her?

  5. Understand the Importance of Good Cash Management • What is cash management? • The management of cash and liquid assets to help you meet your personal goals • What needs does cash supply? • The need for liquidity--protection • Liquidity enables you to have immediate access to your funds • It keeps you from selling less liquid long-term investments at substantial discounts

  6. Cash Management: the Tradeoffs • Key Cash Management tradeoffs: • 1. The Risk-Return tradeoff • Higher liquidity means lower returns • 2. The Spending-Investment Risk tradeoff • Cash on hand is easier to spend than investments • 3. The Time Expended-Return tradeoff • Returns are smaller, so time expended should be smaller. • However, you still can impact your portfolio in a big way by using liquidity wisely—get into the habit!

  7. The Key: Relate your Personal Goals to Cash Management • What do you want to accomplish? • Let Cash Management help you • Want to save more money? • Automate Savings: Pay Yourself First and Just Do It! • Do it through payroll deductions or automatic deposit • Want to shorten your time working on finances? • Use cash management/budgeting software

  8. Cash Management: Your Emergency Fund • What is an Emergency Fund? • It is a resource that can be used to meet unexpected needs for cash • How much should include? • The traditional rule of thumb is for sufficient liquid assets to cover 3-6 months of expenses. I changed expenses to income so you won’t ever need to tap into long-term money to meet current needs • Is it still wise to have this emergency fund in this world of credit cards and home equity lines of credit? • Yes—perhaps even more so

  9. Understand Cash Management Alternatives • There are lots of alternatives, each of which has their benefits and costs • Checking accounts • Savings accounts • Money market deposit accounts • Certificates of deposit • Money market mutual funds • Asset management accounts • U.S. Treasury bills, U.S. Series EE bonds, U.S. Series I Bonds

  10. Cash Management (continued) • Traditional Cash Management Instruments • Checking accounts • Liquidity: Very liquid, daily • Required minimum balances: low • Interest rates: Fixed, but minimal, currently 0% to 1.2% • Safety: Very -- FDIC insured • Penalties for early withdrawal: No • Source of information: banks and credit unions • How to invest: contact a bank or other financial institution to set up an account

  11. Checking Account Rates over Time Source: Bankrate.com 5/3/05

  12. Cash Management (continued) • Savings accounts • Liquidity: Very liquid, daily • Required minimum balances: Low • Interest rates: Fixed, but minimal, currently .25% to 3.30% (at UFB direct WSJ C2) • Safety: Very --FDIC insured • Penalties for early withdrawal: No • Source of information: traditional and internet banks • How to invest: contact a bank or other financial institution to set up an account

  13. Savings Rates over Time Source: Bankrate.com 5/3/05

  14. Cash Management (continued) • Less Traditional Alternatives: • Money Market (Deposit) Accounts (MMA or MMDA) • An alternative to a commercial bank’s savings account • Liquidity: Very liquid, daily • Required minimum balances: Higher than savings • Interest rates: Variable, but higher than savings, currently .50%-2.51% • Safety: Very – FDIC insured • Other features: Limited check writing • Penalties for early withdrawal: No • Source of information: Bankrate.com) • How to invest: contact a financial institution to set up

  15. Money Market Accounts over Time Source: Bankrate.com 5/3/05

  16. Cash Management (continued) • Certificates of Deposits (CDs) • Pays a fixed rate of interest for a fixed period of time • Liquidity: Less liquid, generally monthly, depending on maturity • Required minimum balances: Higher • Interest rates: Higher rates, currently 1m 3.05%, 3m 3.16%, 6m 3.39%, 5 yr 4.21% (C2) • Safety: Very – FDIC insured • Other features: None • Penalties for early withdrawal: Yes • Source of information: WSJ page C15 Money Rates • How to invest: contact a financial institution to purchase a CD

  17. CD Rates over Time Source: Bankrate.com 5/3/05

  18. Cash Management (continued) • Money Market Mutual Funds (MMMFs), • Pool funds from many investors to buy higher priced securities • Liquidity: Very, daily • Required minimum balances: Much higher • Interest rates: Higher, with current rates: 0.5%-1.2% • Safety: Not FDIC insured • Other features: Limited check writing, charge administrative fees, bought by the share • Penalties for early withdrawal: No • Source of information: Brokers, www.bankrate.com • How to invest: contact a mutual fund company to set up an account and purchase a fund

  19. Cash Management (continued) • Asset Management Accounts • Offer comprehensive financial services • Liquidity: Very, daily • Required minimum balances: Higher • Interest rates: Higher, currently 0.75%-2.25% • Safety: Not insured • Other features: Checking accounts, credit cards, loans, brokerage services, overdraft protection, • Penalties for early withdrawal: No, but charge higher annual fees ($50-125) • Source of information: Brokerage firms • How to invest: contact a financial firm to set up an account

  20. Cash Management (continued) • U.S. Treasury Bills • Short-term, less-than 12 months, government debt • Liquidity: Somewhat, monthly • Required minimum balances: Much higher • Interest rates: Higher, currently 3m 2.69%, 6m 3.085%: • Safety: Very, guaranteed • Other features: state and local income tax exempt, and purchased at a discount, but don’t accrue periodic interest payments • Penalties for early withdrawal: Yes • Source of information: WSJ page C15 Money Rates • How to invest: 3 or 6 month bills can be purchased from www.treasurydirect.gov, and other bills from banks/brokers

  21. Treasury Bills over Time

  22. Cash Management (continued) • U.S. Series EE Bonds • U. S. government savings bonds • Liquidity: Somewhat, after 5 years • Required minimum balances: Higher • Interest rates: Higher, 3.5% fixed through Oct05 • Safety: Very • Other features: State and local income tax exempt, issued at half their face value, interest tax-free if spent on eligible college tuition, sold in $25 to $10,000 bonds • Penalties for early withdrawal: 3 month before 5 years • Source of information: http://www.savingsbonds.gov/) • How to invest: can purchase via the above website

  23. Cash Management (continued) • US Series I Bonds • U.S, Government Savings bonds linked to inflation • Liquidity: Very, after 5 years • Required minimum balances: Minimal • Interest rates: Linked to inflation, 4.80 until Oct05 • Safety: Very, guaranteed • Other features: taxed only in year cashed, interest tax-free if spent on eligible college tuition, interest income free from state and local taxation, sold in $25 to $10,000 bonds • Penalties: Yes, 3 month penalty before 5 years • Source of information: www.treasurydirect.gov • How to invest: can purchase via the above website

  24. WSJ 4May05 C15 Bankrate.com

  25. Comparing Cash Management Alternatives • How do you compare different alternatives? • 1. Use comparable Interest rates • Look at the Annual Percentage Yield (APY) • The APY is the yield or return number you should use when comparing different cash management alternatives • Financial institutions are required by law to state the APY which converts the different interest rates into similar compounding periods • 2. Consider safety • Some alternatives are explicitly or implicitly guaranteed by the government

  26. Comparing Alternatives (continued) 3. Use comparable after-tax returns • A. Calculate the after-tax return of taxable assets • After tax return = taxable return (1- tax rate) • Tax rate = (Federal + State + Local taxes) • B. Calculate the equivalent taxable yield (ETY) for tax-advantaged assets • The ETY is the yield that is offered on a comparable taxable bond to give the same after-tax yield as a tax-advantaged security. • 4. Consider inflation • Calculate your return after the impact of taxes and inflation

  27. Application:Calculating After-tax Returns • Calculate the after-tax return for each of the following bonds for Bill and Suzie. Bill is an investor in the 15% federal marginal tax bracket and 7% state tax bracket. Suzie is an investor in the 35% Federal tax bracket and 7% state tax bracket. Which bonds should Bill or Suzie purchase? • A 6.5% corporate bond (all taxable) • A 4.75% municipal bond (federal tax-free) • A 5.0% treasury bond (state tax-free)

  28. Answer • Bill (After-tax return = taxable return (1- tax rate)) • 6.5% Corporate Bond • 6.5% * (1 - (.15 + .07) = 5.07% • MB: 4.75% * (1 - .07) = 4.42% • TB: 5.0 * (1 - .15) = 4.25% • The corporate bond is the best for Bill • Suzie • CB: 6.5% * (1 - (.35 + .07) = 3.77% • MB: 4.75% * (1 - .07) = 4.42% • TB: 5.0 * (1 - .35) = 3.25% • The municipal bond is the best for Suzie

  29. Application: Calculating Equivalent Taxable Yields • Assume you are in the 25% federal and 7% state tax bracket. What is the equivalent taxable yield to you of a U.S. Series I bond that earns 4.8% and where the principle and interest are: • A. Planned to be used to pay for your child’s college tuition expense? • B. Planned to be used to save for family personal goals?

  30. Answer • A. If you use the principle and interest for tuition, the bond is both federal and state tax exempt. • Return after tax = return before tax * (1 – tax rate) • Since this asset is federal and state tax-free, the equivalent on a taxable bond would be: • 4.8% = x *(1 – (.25+.07)) or x = 4.8% / .68 • x = 7.06% • B. If the bond is used only for personal expenses, it is only state tax free. The equivalent on a taxable bond would be: • 4.8% = x * (1 - .07) or x = 4.8% / .93 • x = 5.16%

  31. Application: Calculating After-tax After-inflation Returns • Calculate the real rate of return to a taxpayer in the 35% federal marginal tax bracket and 7% state on a $50,000 money market account, assuming 4.5% yield and 3.5% inflation. What are the implications of this result for cash management decisions? (Note: the dollar amount is not necessary for this calculation)

  32. Answer • After-tax return = return (1-federal + state tax rate) 4.5% (1-.42) = 2.61% Real Return = (1+ after-tax return) -1 (1 + inflation) (1.0261/1.035) –1 = -.86% It is very difficult to do much more than keep up with taxes and inflation with liquid assets. Only the amount need to meet immediate emergency needs and short-term goals should be here. The result is worse when you factor in charitable giving.

  33. Questions • Do we understand the importance of cash management in helping us reach our goals?

  34. C. Spend the Time Necessary • While technology can help, unless you plan and spend at least 1-2 hours a week following your finances, you will not be able to keep up with your financial goals. • Set aside the time and use it wisely

  35. Spending Time (continued) • From the book, the Millionaire Next Door it states: • People who become wealthy allocate their time. . in ways consistent with enhancing their net worth. [They] allocate nearly twice the number of hours per week to planning their financial investments as [those who do not become wealthy] do. (The Millionaire Next Door, p. 71) • Unless you are spending 1-2 hours a week on your financial oversight, budget, investing process, it will be very difficult to reach your goals.

  36. Spending Time (continued) • Set aside the time, once a week, to: • Review and update your goals and what you want to accomplish in life • Update your budget—how are you doing • Balance your checking/cash management account, and • Ensure all charges/balances are correct from your credit cards/EFTs

  37. Spending Time (continued) • Fixing Errors • Be alert to human and computer errors. • Never deposit cash in an ATM. • Call the institution that made the error. • Write the institution within 60 days of receiving your statement. • Write the Federal Reserve Board’s Division of Consumer and Community Affairs if problems are not resolved

  38. Questions • Do you have any questions on the need to spend 1-2 hours each week on your finances?

  39. Understand the different Types of Financial Institutions • There are two main types of institutions (but the distinction is blurring through deregulation) • “Banks” or deposit-type financial institutions • Non-deposit-type financial institutions • The choice of which one you use depends on which will serve your needs the best

  40. Financial Institutions (continued) • Deposit-type Financial Institutions • Commercial banks • Offer the widest variety of services. Generally do not offer the highest rates, as they compete with a broad range of services • Savings and loan associations • Slight ownership differences, but essentially similar to commercial banks. May offer higher rates.

  41. Financial Institutions (continued) • Credit unions • Similar to above, but since not-for-profit, can offer sometimes higher rates on savings • “Net” banks • Electronic banks that pay more for deposits, but have no local branch network so lower costs and higher rates.

  42. Financial Institutions (continued) • Non-deposit Type Financial Institutions • Mutual funds • You can now write checks on your mutual fund account • Stockbrokerage firms • You can also write checks on your brokerage account

  43. Financial Institutions (continued) • Both Banks and non-Banks can offer on-line financial services which allow access to bank balances and some resources 24 hours a day. • There has been a major blurring of roles between deposit and non-deposit institutions: • Banks can now offer investment services • Non-banks now offer check writing and savings

  44. Financial Institutions (continued) • What to Look for in a Financial Institution? • Kinds of services provided • What are your prioritized needs? • Safety of your money • How important is FDIC insurance? • Cost of achieving your financial goals • Which are most important now? • Type of personal relationship provided • Is this important? • Note: You could use more than one financial institution to take advantage of each one’s strengths.

  45. Financial Institutions (continued) • Choosing a Financial Institution—the three Cs • The Cost Factor • Monthly fees, minimum balance, charge per check, balance-dependent scaled fees • The Convenience Factor • Location (branches, ATMs), safety deposit boxes, overdraft protection, stop-payment ability • The Consideration Factor • Personal attention, financial advice, attention to detail • Note that whatever institution you choose, it is your responsibility to make sure they do what they say they will

  46. Questions • Any questions on the different types of financial institutions and how they can help achieve your financial goals?

  47. Review of Objectives A. Do you understand the importance of good cash management and how it can help you achieve your goals? B. Do you understand the different cash management alternatives? C. Are you convinced that while technology can help, unless you plan and spend at least 1-2 hours a week following your finances, you will not be able to keep up with your financial goals? D. Do you understand the different types of financial institutions, and how they can help you meet your financial goals?

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