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Chapter 1

Chapter 1. Personal Finance Basics and the Time Value of Money. Chapter 1 Learning Objectives. LO1-1 Analyze the process for making personal financial decisions. LO1-2 Assess personal and economic factors that influence personal financial planning.

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Chapter 1

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  1. Chapter 1 Personal Finance Basics and the Time Value of Money

  2. Chapter 1 Learning Objectives LO1-1 Analyze the process for making personal financial decisions. LO1-2 Assess personal and economic factors that influence personal financial planning. LO1-3 Develop personal financial goals. LO1-4 Calculate time value of money to analyze personal financial decisions. LO1-5 Identify strategies for achieving personal financial goals for different life situations. 1-2

  3. Personal Financial Planning LO1-1: Analyze the process for making personal financial decisions. What is Personal Financial Planning? …. The process of managing your money to achieve personal economic satisfaction 1-3

  4. Advantages ofPersonal Financial Planning • Increased effectiveness in obtaining, using, and protecting financial resources • Increased control of one’s financial affairs by avoiding excessive debt, bankruptcy, and dependence on others • Improved personal relationships • Sense of freedom from financial worries 1-4

  5. The Financial Planning Process 1-5

  6. Step 1 in theFinancial Planning Process DETERMINE YOUR CURRENT FINANCIAL SITUATION • Evaluate income, savings, living expenses, and debts • Prepare a list of current asset and debt balances and amounts spent for various items • Match financial goals to current income and potential earning power 1-6

  7. Step 2 in theFinancial Planning Process DEVELOP FINANCIAL GOALS • Identify feelings about money and the reasons for those feelings • Determine the source of your feelings about money (facts or influence of others) • Determine the basis of your financial priorities (social pressures, household needs, or desires) • Determine the effects of the economy on your goals and priorities • Decide on specific financial goals to pursue for your situation 1-7

  8. Step 3 in theFinancial Planning Process IDENTIFY ALTERNATIVE COURSES OF ACTION • Possible courses of action can be: • Continue the same course of action • Expand the current situation • Change the current situation • Take a new course of action • Creativity in decision making is vital for effective choices • Electing to “do nothing” can be a dangerous alternative 1-8

  9. Step 4 in theFinancial Planning Process EVALUATE YOUR ALTERNATIVES • CONSEQUENCES OF CHOICES • Opportunity cost What you give up by making a choice • The cost, or trade-offof a decision, may refer to the value of money or time that you give up 1-9

  10. Step 4 in theFinancial Planning Process(continued) EVALUATE YOUR ALTERNATIVES • EVALUATING RISK • Uncertainty is a part of every decision • Consider inflation risk, interest rate risk, income risk, personal risk, and liquidity risk • FINANCIAL PLANNING INFORMATION SOURCES • To minimize risk, gather relevant information from print and media sources, digital sources, financial experts, and financial institutions 1-10

  11. Step 5 in theFinancial Planning Process CREATE AND IMPLEMENT YOUR FINANCIAL ACTION PLAN • Develop an action plan that identifies ways to achieve financial goals • Possible action plans can be increasing savings, reducing spending, increasing income by working extra hours, or making provisions for taxes • To implement action plans you may need assistance from others 1-11

  12. Step 6 in theFinancial Planning Process REVIEW AND REVISE YOUR PLAN • Financial planning decisions need to be assessed regularly • A complete review should be done at least once a year • More frequent reviews may be required for changing personal, social, and economic factors • Regular reviews of decision-making process can help in making priority adjustments to achieve financial goals 1-12

  13. Influences on PersonalFinancial Planning LO1-2: Assess personal and economic factors that influence personal financial planning. • LIFE SITUATION AND PERSONAL VALUES • Adult life cycle are the stages in the family and financial needs of an adult • Marital status, household size, and employment • Major events • Graduation, engagement, career change, children, retirement, etc. • Values influence spending and saving decisions 1-13

  14. Influence:The Financial System • Describes the flow of money • Providers of funds (savers and investors) • Financial Intermediaries (banks, insurance companies, etc.) • Financial Markets (stock markets, bond markets, etc.) • Users of funds (borrowers and spenders) 1-14

  15. Influence:Economic Factors • Economics is the study of how wealth is created and distributed • Forces of Supply and Demand on setting prices • The economic environment includes various institutions • Federal Reserve Bank and its role in the economy to maintain an adequate money supply 1-15

  16. Influence:Global Influences • Global economy influences personal finance • American companies compete against foreign companies for US dollars • Balance of exports and imports • Foreign investments and their role in the US money supply • The level of money supply affects interest rates 1-16

  17. Influence:Economic Conditions • Changing economic conditions and financial decisions • Consumer prices • Consumer spending • Interest rates • Money supply • Unemployment • Housing starts • Gross domestic product (GDP) • Trade balance • Stock market indexes 1-17

  18. Influence:Economic Conditions(continued) • Inflation is a rise in the general level of prices • Rule of 72 • Divide 72 by the annual inflation (or interest) rate • Example: An annual inflation rate of 4% means prices (or your savings) will double in 18 years (72/4 = 18) 1-18

  19. Select a Path to Financial Security • Save for emergencies and the future • Maintain a low level of debt • Have a risk management plan • Research to avoid investment scams • Communicate with others 1-19

  20. Developing Personal Financial Goals LO1-3: Develop personal financial goals. • FINANCIAL GOALS • Can be influenced by the time frame in which you want to achieve your goals • Can be influenced by the type of financial need that drives your goals 1-20

  21. Types of Financial Goals • TIMING OF GOALS • Short-term (within the next year) • Intermediate (one to five years) • Long-term goals (more than five years) Long-term goals should be planned in coordination with short-term and intermediate goals • GOALS FOR DIFFERENT FINANCIAL NEEDS • Consumable-product goals • Durable-product goals • Intangible-purchase goals 1-21

  22. Goal-Setting Guidelines Goals should be S-M-A-R-T: Specific: know exactly what your goals are to create a plan Measurable: with a specific amount Action-oriented: identify the personal financial activities you will undertake Realistic: utilizing your income and life situation Time-based: identify the time frame to achieve the goal 1-22

  23. Opportunity Costs and the Time Value of Money LO1-4: Calculate time value of money situations to analyze personal financial decisions. 1-23

  24. Personal Opportunity Costs • Every financial decision involves giving up something to obtain something else • Time, energy, health, abilities, knowledge • Personal resources like financial resources require careful management 1-24

  25. Financial Opportunity Costs • Financial choices depend on current needs, future uncertainty, and current interest rates • Time Value of Money • Increases in an amount of money as a result of interest earned • Saving (or investing) today means more money tomorrow. Spending means lost interest • Saving and spending decisions involve considering the trade-offs. Current needs can make spending worthwhile 1-25

  26. Time Value of Money • INTEREST CALCULATIONS Three amounts are required to calculate the time value of money • Principal (the amount of savings) • Interest rate (annual) • Time period 1-26

  27. Time Value of Money(continued) COMPUTING SIMPLE INTEREST =Amount in savings × annual interest rate × time period =interest amount For Example: =$500 × 6% × 6 months/12 months=$500 × .06 × ½ year =$15.00In six months, a $500 deposit (principal) will earn $15.00 interest. Therefore, you will have a total of $515 at the end of six months. 1-27

  28. Time Value of Money: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 called compounding — earning interest on previously earned interest • Future value can be computed for a single amount or for a series of deposits (or payments) called an annuity • FUTURE VALUE OF A SINGLE AMOUNT • FUTURE VALUE OF A SERIES OF DEPOSITS 1-28

  29. Time Value of Money:Present Value • Present value is the current value of 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 • Present value can be computed for a single amount or for a series of deposits • PRESENT VALUE OF A SINGLE AMOUNT • PRESENT VALUE OF A SERIES OF DEPOSITS 1-29

  30. Methods for CalculatingTime Value of Money • Formula calculation • Time value of money tables • Financial calculator • Spreadsheet software • Websites and Apps 1-30

  31. Achieving Financial Goals LO1-5: Identify strategies for achieving personal financial goals for different life situations. • COMPONENTS OF PERSONAL FINANCIAL PLANNING • Obtaining (Chapter 2) • Planning (Chapters 3, 4) • Saving (Chapter 5) • Borrowing (Chapters 6, 7) • Spending (Chapters 8, 9) • Managing risk (Chapters 10, 11, and 12) • Investing (Chapters 13, 14, 15, 16, and 17) • Retirement and estate planning (Chapters 18, 19) 1-31

  32. 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, with assistance from a financial planner, or made using a money management software package 1-32

  33. Implementing Your Financial Plan • Develop good financial habits • Use a well-conceived spending plan that helps 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 taxes and investments to expand your financial resources 1-33

  34. Studying Personal Finance • Resources • Personal Financial Planner sheets • This book’s library resource site in Connect • Practice Quizzes and end-of-chapter activities • Online sources and apps for current personal finance information • Talk to others, experts, and friends • Search the Internet • Achieving your financial objectives requires a willingness to learn and appropriate information sources 1-34

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