Personal Finance & Financial Planning
Personal finance – is a specialized area of study that focuses on individual and household financial decisions.
Personal financial planning – is the process of developing and implementing an integrated comprehensive plan to meet your financial goals.
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Importance of Financial Planning
• Developing a financial plan helps you achieve financial goals.
• Planning is a five step process which must be reevaluated and revised continually.
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Step 1: Analyze Your Current Financial
Position
Analyzing your current financial position requires you to do the following:
• Collect & Organize all of your financial information.
• Create personal financial statements. • Evaluate your current position.
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Step 2: Develop Short & Long Term Financial Goals
• The second step requires that you identify and prioritize specific goals & objectives.
• It involves an assessment of why you have certain goals.
• You must keep in mind that short-term and long-term goals change over time.
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Step 3: Identify & Evaluate Alternative Strategies
for Achieving Your Goals You must develop
alternative strategies to meet your goals.
• For example, Jack Naughton and his family lived on his salary of $50,000. Jack lost his job and the family had just purchased a larger home.
• What alternative strategies should Jack develop?
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Factors that Influence Financial Planning
• Changing needs over the course of your life cycle
• Values and attitudes • General economic conditions • Life Situations
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Economic Factors
• Consumer Price Index (CPI) – Reported monthly, the CPI tracks prices of a representative basket of goods and services.
• For example, healthcare costs, have risen at a much faster rate than other elements of the CPI.
• Inflation – changes in prices over time.
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Additional Factors• Federal Reserve
Bank – the central bank of the United States, which controls the money supply and short term interest rates.
• Interest rate – is the cost to borrow money.
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How the Fed Moves Interest Rates
• Between 2000 and 2003, the Federal Reserve took action to lower the Fed Funds Rate.
• The Fed Funds Rate is the rate banks charge each other to borrow money.
• The rate was reduced from 6.5% to 1.0%, over time.
• These actions helped to pull our economy out of a recession.
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Economic Cycles
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Economic cycles are the historical pattern of ups and downs
common to the U.S. economy.
Recession: A low point characterized by reduced business investment and high unemployment.
Expansion: a period characterized by growth in business and employment.
Elements of a Financial Plan
1. Establish a firm
foundation 2. Secure basic
needs 3. Build wealth 4. Protect wealth
and dependents
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Apply marginal reasoning
Making Effective Decisions
A sound financial plan involves important & effective decision
making:
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Base your decisions on reasonable
assumptions
Consider opportunity costs & use sensitivity analysis
Decision Making • Reasonable Assumptions
Use information currently available to you to make reasonable assumptions.
• Marginal Reasoning Take into changes in the outcome or possible
additional benefits. • Opportunity Costs Take measure of what you have to give up in order
to take a particular action. • Sensitivity Analysis Be sure to ask the question, “What effect would it
have on my personal finances if my assumptions were wrong?”
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All rights reserved. Reproduction or translation of this work beyond that permitted in section 117 of the 1976 United States Copyright Act without express permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages caused by the use of these programs or from the use of the information herein.
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