Chapter 1

Personal FinancialPlanning in Action

Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

1-1-22

Personal Financial Planning Chapter Learning Objectives

LO1.1 Identify social and economic

influences on personal financial goals and decisions

LO1.2 Develop personal financial goalsLO1.3 Calculate time value of money

situation associated with personal

financial decisionsLO1.4 Implement a plan for these

decisions

1-1-33

Financial Planning

• Process of managing your money to achieve personal economic satisfaction

• Financial Plan: – Formalized report – Summarizes current financial situation– Analyzes financial needs– Recommends future financial activities

1-1-44

Advantages of Financial Planning

• Increased effectiveness in obtaining, using, and protecting financial resources

• Increased control of your financial affairs

• Improved personal relationships

• Sense of freedom from financial worries

1-1-55

• Life situation and personal values (1.6)

• Financial planning in our economy– Domestic economic influences (1.7)– Global Influences (1.8)– Inflation (1.9)– Interest rates (1.10)

Learning Objective LO1.1Identify Social and Economic

Influences on Personal Financial Goals and Decisions

1-1-66

Life Situation and Personal Values

• Adult life cycle• Life Situation Factors:

– Marital status, household size, employment

– Exhibit 1-1 (page 5)

• Major events:– Graduation, marriage, divorce– Birth or adoption of child– Career or health changes

• Values:– The ideas and principles you consider correct,

desirable, and important

1-1-77

Financial Planning in Our Economy

Domestic Influences

• Economy’s influence on financial

planning

– Business, labor & government

• The Federal Reserve – “.. Sets the nation’s monetary policy to promote

the objectives of maximum employment, stable

prices and moderate long-term interest rates.”

– http://www.federalreserve.gov/

1-1-88

Financial Planning in Our Economy

Global Influences• U.S economy affected by foreign

investors and competition from foreign companies

• Level of imports/exports affects available supply of dollars

• Level of foreign investment affects domestic money supply

• Money supply affects consumer interest rates

1-1-99

Financial Planning in Our Economy Inflation

Inflation = in the general level of prices

• Reduces buying power of the dollar• Most harmful to those on fixed incomes• Inflation rates vary• “Hidden inflation”• CPI = a measure of inflation• Deflation = decline in prices

1-1-1010

Financial Planning in Our Economy

Interest RatesInterest Rate = the cost of money

– Affected by supply and demand

– Risk premium:• Length of time funds in use• Expected inflation• Uncertainty

– Major impact on financial planning

1-1-1111

8 Basic Financial Planning Activities

• Obtaining Chapter 1• Planning Chapters 2,3• Saving Chapter 4• Borrowing Chapter 5• Spending Chapters 6,7• Managing Risk Chapters 8-10

• Investing Chapters 11-13

• Retirement/Estate Planning Chapter 14

1-1-1212

• Time Frames for Achieving Financial Goals:

– Short-term goals . . . . . . . . . . . within 1 year– Intermediate goals . . . . . . . . . 1-5 years– Long-term goals . . . . . . . . . . . > 5 years

• Financial Needs Goals:– Consumable-product goals. . . Food, clothing– Durable-product goals . . . . . . Car, appliances– Intangible-purchase goals . . . Education, health

Learning Objective LO1.2Develop Personal Financial

Goals

1-1-1313

Goal-Setting GuidelinesThe “SMART” Approach

A “goal” that is not written down is a dream!

Effective Goals should be:• S = Specific• M = Measurable• A = Action-oriented• R = Realistic• T = Time-based

1-1-1414

Learning Objective LO1.3Assess Personal and Financial Opportunity Costs of Financial

Decisions

• Opportunity cost = what you give up making a choice

– The trade-off of a decision

– Not always measurable in dollars; may be time

– Consider lost opportunities resulting from your decisions

1-1-1515

Opportunity Costs and Financial Trade-Offs

PersonalOpportunity Costs

(time, effort, health)

FinancialOpportunity Costs(Interest, liquidity,

safety )

FinancialAcquisitions(car, home, college education, investments, insurance, retirement fund)

1-1-1616

Time Value of Money

• Increase in an amount of money as a result of interest earned– Saving today = more money

tomorrow

– Spending today = lost interest

• Saving and spending decisions involve considering the trade-offs – Current needs can make spending

worthwhile

– Skip to slide 30

1-1-1717

• Calculating interest earned:– Principal = amount of savings– Annual interest rate– Length of time money on deposit (in years)

• Simple interest:

Time Value of MoneyInterest Calculations

Amt in Amt in SvgsSvgs X

Annual Interest

Rate

Time Period InterestX =

1-1-1818

$500 on deposit at 6% annual interest for 6 months:

Principal = $500

Interest rate = 6%

Time period = ½ (6/12 months)

Time Value of MoneyInterest Calculation Example

$500 X 6% 1/2 $15X =

1-1-1919

• Future Value = Amount that will be available at a

later date

• Present Value = Current value of an amount desired in the future

Time Value of MoneyTypes of TVM Calculations

1-1-2020

1. Formula calculation

2. Time value of money tables

3. Financial calculator

4. Spreadsheet software

5. Websites and apps

Time Value of MoneyCalculation Methods

1-1-2121

Future Value

• The increased value of money from interest earned

• Amount to which current savings will increase

• Total amount available in the future

• “Compounding”

1-1-2222

Future ValueExample

Future Value

Original Amount in Savings

Interest Earned

= +

$100 deposited for 1 year at 6% per year

Future Value = $100 + ($100 X .06 X 1)

Future Value = $100 + $6 = $106

1-1-2323

Future Value Tables

• Appendix Exhibit 1-A = FV of a Single Amount– Multiply Table Factor by amount deposited– All Future Value factors > 1.0

• Example:– $650 invested at 8% for 10 years– Factor = 2.159– FV = $650 X 2.159 = $1,403.35

1-1-2424

Time Value of MoneyCalculation Methods

1-1-2525

Time Value of MoneyTVM Websites

• www.moneychimp.com/calculator

• www.dinkytown.net

1-1-2626

Future ValueSeries of Deposits

• Table factors = Appendix Exhibit 1-B

• “Annuity” = series of equal deposits at equal intervals earning a constant rate

• Example:– Deposit $50 per year at 7% for 6 years– Appendix Exhibit 1-B factor = 7.153

• Period = 6; % = 7%

– Future Value = $50 x 7.153 = $357.65

1-1-2727

Present Value

• The current value of a future amount based on a certain interest rate and time period

• The current value of an amount desired in the future

• How much to deposit now to obtain a desired total in the future

• “Discounting”

1-1-2828

Present Value Tables

• Appendix Exhibit 1-C = PV of a single amount– Multiply Table Factor by amount deposited– All Future Value factors < 1.0

• Example:– You want $1,000 five years from now– You can earn 5% on your money– Present Value = $1,000 X 0.784 = $784

1-1-2929

Present Valueof a Series of Deposits

• Appendix Exhibit 1-D• Determine how much you need to deposit

now in order to withdraw a specific amount for a desired number of years

• Example:– You want to withdraw $400/year for 9 years– Your money is earning 8% per year– Deposit = $400 X 6.247 = $2,498.80

1-1-3030

The 6-Step Financial Planning Process

1-1-3131

1. Determine current financial situation

2. Develop financial goals

3. Identify alternative courses of action

• Continue same course of action

• Expand current situation

• Change current situation (change vehicle)

• Take a new course of action

Learning Objective LO1.4Implement a Plan for Making Personal Financial and Career

Decisions

1-1-3232

4. Evaluate alternatives• Consequences of choices• Evaluate risks• Financial Planning information

sources5. Create and implement financial action

plan6. Review and revise plan

Learning Objective LO1.4Implement a Plan for Making Personal Financial and Career

Decisions

1-1-3333

Financial Planning in Action

1-1-3434

Career Choice and Financial Planning

1. The life work one selects = key to financial well being and personal satisfaction

2. Career choices have risks and opportunity costs

3. Career choices require periodic re-evaluation of trade-offs related to personal, social and economic factors

4. Changing personal and social factors require continuous assessment of your work situation

1-1-3535

Chapter SummaryLearning Objective LO1.1

• Financial decisions are affected by:– Life situation– Personal values– Economic factors

• Major elements of Financial Planning:1. Obtaining 5. Spending2. Planning 6. Managing Risk 3. Saving 7. Investing4. Borrowing 8. Retirement & Estate

planning

1-1-3636

Chapter SummaryLearning Objective LO1.2

Financial Goals should be:• S = Specific• M = Measurable• A = Action-oriented• R = Realistic• T = Time-based

1-1-3737

Chapter SummaryLearning Objective LO1.3

• Every decision involves a trade-off

• Personal opportunity costs:– Time– Effort– Health

• Financial opportunity costs– Based on the time value of money

1-1-3838

Chapter SummaryLearning Objective LO1.4

Personal financial planning involves:1. Determine financial situation2. Develop financial goals3. Identify alternative courses of action4. Evaluate alternatives5. Create and implement a financial action

plan6. Review and revise the financial plan