Chapter 10 Personal Financial Planning

Financial Resources

• Financial Resources is money or assets that can be converted into cash…• For Example:

• Forms of Income-Salary, investment returns, etc.

• Savings- Savings Accounts, Retirement Plans, College Savings, etc.

• Investments- Stocks, Bonds, IRA’s, etc • Property- businesses, homes, buildings, etc.

Financial Plan

• Financial Plan-is like a road map toward your financial goals and future • Your personal financial plan will take into

consideration:• Where you are now…• Where you want to be in the future… • HOW YOU ARE GOING TO GET THERE!!!

Financial Plan Continued…

• Short Term Goals- goals that are a year or less • Examples

• Get a job

• Get a car • Good Grades

Financial Plan Continued…

• Long Term Goals- goals that are a year or more• For Example

• Buy a house/ apartment• Retirement• Get Married • Kids

Net Worth

• Net Worth- The total amount of money you are worth…

• Take your Assets (Anything of value that you own)(Cash on hand/ in the bank, Stocks/Bonds, ETC)

• SUBTRACT

• Liabilities (Anything of value on which you owe) (Unpaid bills, unpaid loans, mortgage on a home, etc)

• EQUALS NET WORTH

Cash Flow…

• You may have heard of Cash Flow like this…

• But… Cash Flow represents actual income AND expenditures.

• If you want to keep track of money coming in and how it is being spent, you can easily see how “liquid”, or how much money you have to spend, you are

Cash Flow…

• With knowledge of your cash flow, you are ready to prepare a preliminary budget

• A budget consists of 3 sections:1. Current Monthly Income2. Current Monthly Expenses3. A Financial Summary

1. Current Monthly Income• This is easily stated as money you get through a

salary.

• Your salary is, initially, your gross pay, (Total paycheck before deductions such as taxes, retirement plans, pension, health care, etc

• Gross pay seems great, but we receive Take Home Pay which is the money you actually receive from your paycheck after all deductions. (Taxes, Social Security, see above)

2. Current Monthly Expenses • This is easily stated as money you pay for bills,

rent, mortgage payments, etc.

• Expenses can be Fixed or Variable Expenses

• Fixed Expenses are expenses that do not vary from month to month• (Rent, payments on a loan, car insurance, etc.)

• Variable Expenses that vary from month to month• (Entertainment, going out for food, gifts, etc.)

3. Financial Summary • Just as in Net Worth, you

• Take your “Current Monthly Income… then…• Subtract you Monthly Expenses • Then you have your budget of cash flow

• Obviously after you do this, you have 3 results..• Surplus Budget- You have more income then

expenses• Balanced Budget-They are the same• Deficit Budget-More expenses than income

Spend or Save…

or

But First… Who wants to spend?

or

They DO!!!

To Spend or To Save… • In order to learn about spending or saving money, we should

define these terms and how they are huge factors in determining if we save or spend money

• Income represents money that a family or individual receives (such as salary, sale of house, and dividends of a stock)

• One thing to note about income is how much we spend or save depends on our income. For example people with more income spend more money (DUHHHHHHHH!)

• Sources of income, as mentioned about, are varied.• Some people earn salaries• Some gain money from investments • Some are retired and are paid by pensions or retirement plans• Some are business owners who make profits • Some people are on social assistance programs like welfare.

To Spend or To Save… • Sources of income, as mentioned about, are

varied.• Some people earn salaries• Some gain money from investments • Some are retired and are paid by pensions or

retirement plans• Some are business owners who make profits • Some people are on social assistance programs

like welfare. • Disposable Family Income is how much a family

has left of their income, after paying taxes. • This is the BIGGEST factor of whether a family

spends or saves

Ernst Engel and Disposable Family Income

• Ernst Engel, a German statistician, concluded that as a family’s income increases, the percentage that they spend on food decreases.

• However, spending on everything else increases such as luxuries, transportation, entertainment, medical care, personal care, etc. This is also where people begin to also SAVE more as well (DUH, again!)

• This is known as “Engel’s Law”

Wealth• Wealth is NOT the same as income. Wealth is anything that has

value (such as stocks, bonds, real estate, and savings).

• “Remembering ‘Ceretus Paribus’ wealth does not make people save more, but rather the OPPOSITE

• The percentage of family income saved decreases as its wealth increases

• For example: “The Blues and the Greens” example in the textbook.

• Because some families have money to fall back on, or wealth in the bank, they CAN spend more on anything they’d like.

Interest Rates • Interest Rates are used when…

• Someone pays interest for the use of someone else’s money

• Consumers who borrow money to finance a purchase

• Banks pay their customers for the use of their money they deposit (Often forgotten about with IR’s)

Interest Rates • When interest rates are rising…

• Its more costly to borrow

• The higher rates discourage consumer spending

• Encourage consumer saving, however

• Interest Rates rise when a government wants to have people save money in an economy

Interest Rates • When interest rates are falling…

• The propensity to save goes down

• The lower rates discourage consumer saving

• Encourage consumer spending, however

• Interest Rates fall when a government wants to have people spend money in an economy

Future Expectations….

Future Expectations

• Consumers often base their decisions concerning how much to spend on what they feel about the future

• When the general public is feeling good about the future, consumer spending tends to increase

• When pessimism prevails, consumers tend to postpone some of their more costly purchases.

Government Policies

• Taxes and the power to spend tax revenue are the biggest government policies that effect whether people spend or save

• Raising taxes raises _____________________

• Lowering taxes raises _____________________

Government Policies• Other government programs such as Social

Security, welfare, unemployment insurance, and veterans' benefits can either add or take away from consumers purchasing power

• For example: the money spend by the state government to increase benefits for unemployed workers adds to the workers purchasing power and to consumer spending

• Conversely, holding back welfare, food stamps, or unemployment benefits will lessen spending.

Why Should We Save???

First… YOU TELL ME!!!

WE SHOULD SAVE MONEY FOR…

Why should we save?

• To Prepare for The Unexpected

• When an emergency (such as an accident, long-term illness, or the loss of a job) occurs, savings and investments can help soften the financial burden

• Aka saving for a “Rainy Day”

Why should we save?

• To Finance Costly Purchases

• Some purchases (Such as cars, vacations, and computers) cost more than one’s current income week to week.

• Savings provide a way to afford these purchases

Why should we save?

• For Additional Income

• Money set aside in savings accounts and investments earns a return of interest or dividends

Why should we save?

• For Retirement

• Most people want to retire when they reach a certain age

• When some will leave their job/careers may get a pension and Social Security (NOT US THOUGH!)

• However, these may not be enough to support this person’s lifestyle and that person will want to have retirement investments such as 401k’s, 403b’s, IRA’s, etc.

Why should we save?

• As a Hedge Against Inflation

• The real value of assets or income shrinks with time as the purchasing power of the dollar decreases

• For example $100 in 1940 versus $100 today… Which $100 had more value in its society

• With inflation being a constant in the economy, many people look to save/ invest to prevent their money for being stagnate and not growing with inflation.

With inflation, 2 other terms… • Two ways to hedge against inflation are understanding

Market Risk or investing in Real Estate.

• Market Risk is that the risk or fear that value of the investment, such as a stock or bond, will be low when one wants to sell it.

• Real Estate is land and buildings one can invest their money in for profit and financial gain.

• Most investors expect land and building values will constantly rise and be better then the rate of inflation.

Way$ People $ave and INVE$T• Before we discuss why people save and invest, these

terms should be defined…

• The FDIC is the Federal Depository Insurance Corporation which insures that American bank customers, whose banks are apart of the Federal Reserve, are covered up to $250,000 on each account if the bank failed and shut its doors.

Way$ People $ave and INVE$T• The FDIC was formed in a era, The Great Depression,

when banks just suddenly closed and people could not get the money back that they invested into that closed bank

• Now, even if a FDIC insured bank fails, its depositors will not lose their money and they can feel safe investing in American banks.

Way$ People $ave and INVE$T• With the security of investments being somewhat of an

after thought, investments must be discussed their yield and their liquidity

• Yield is the percentage rate of return on an investment or how much this investment will earn.

• Yield all depends on the following factors:• What kind of investment is opened• When the account was opened• Which bank the money goes to• ETC

Way$ People $ave and INVE$T• Corporate stocks and bonds offer the best potential

yield of savings instruments rather than CD’s, Savings Accounts, Money Market Accounts, etc

• Yield counts as • Dividends• Capital gains of a stock• The stock splitting and now having 2 or more shares

• However yield with stocks and bonds is now attached to the success of those companies

Way$ People $ave and INVE$T• Liquidity is the ease with which a savings vehicle can be

converted into cash

• Liquidity can be easy such In checking and savings accounts with ATM (Automated Teller Machines) withdrawals with a debit or bank card

• It gets harder with savings accounts that can only be withdrawn during bank hours and by walking in there

• Some savings may be harder because they require time to pull funds out of them, such as with a term of a certificate of deposit or a “CD”

Way$ People $ave and INVE$T• Liquidity is the ease with which a savings vehicle can be

converted into cash

• Liquidity can be easy such In checking and savings accounts with ATM (Automated Teller Machines) withdrawals with a debit or bank card

• It gets harder with savings accounts that can only be withdrawn during bank hours and by walking in there

• Some savings may be harder because they require time to pull funds out of them, such as with a term of a certificate of deposit or a “CD”

Way$ People $ave and INVE$TNOW FOR THE WAYS PEOPLE SAVE AND INVEST…

• A savings account is a bank account that offers a low rate of yield but a high rate of liquity.

• A savings account is the entry level of saving money and therefore should have a MAX of 2 months income in it and should NOT be a primary savings vehicle

• It is harder to pull money out of a savings account then a checking account, which usually has no yield

Sooooooo for a Savings Account

YIELD IS LOW LIQUIDITY IS HIGH

Way$ People $ave and INVE$T• A certificate of deposit (CD) is a option to save which

offers a better yield then a savings account but has a lower sense of liquidity

• A CD is a “time deposit” that requires a depositor (you) agrees to keep this cash in the bank for a specified amount of time.

• The longer the time, the better the rate of yield…

• http://www.bankrate.com/cd.aspx

Sooooooo for a CD

YIELD IS Low to Medium (TERM)

LIQUIDITY IS High to Medium (TERM )

Way$ People $ave and INVE$T• A bond is a long term obligation issued by

corporations or governments

• Most bonds, the issuer of the bonds repays the principal at the end of a specified period of time

• It also makes periodic payments of interest to the bondholders

• State and Local Government bond payments are exempt from taxes on all government levels (NICEEEE)

• Federal bonds are exempt too except on federal taxes

Bonds still… • Unlike bank deposits (CD’s and Saving Accounts),

bonds do not guarantee the return of principal until the date of maturity as promised on the actual bond.

• For example if a corporation or a government agency is selling a bond that has a face value of $1000 with maturity at 2009, it is promising to pay $1000 to the owner of the bond in 2009.

Sooooooo for a Bond…

YIELD IS Medium (TERM)

LIQUIDITY IS Low (TERM )

Way$ People $ave and INVE$T• A US savings bond is a contract showing that money

has been loaned to the Treasury of the United States

• Buying these government guaranteed bonds is absolutely safe and liquid investment

• “Series EE” government bonds, as our US savings bonds are known, are easily available for the small investor because they can be purchased for as low as $25 for a $50 bond.

• Usually these bonds mature in…

18 YEARS!!!Well that’s depressing!!!

Way$ People $ave and INVE$T• However, that 18 years is the ORIGINAL MATURITY

date for these investments, they can be held onto, not cashed in, and kept for addition interest

• The savings bond stops accruing interest after 30 years from issue

• Some extra benefits of the US savings bond are:• Can be cashed in after 6 months (Obviously not for much

interest)• They can be replaced if stolen, mutilated, or destroyed for free• They are completely free from any fees, like other bonds have• They are also completely tax free

Sooooooo for a Savings Bond…

YIELD IS Low (Depends)

LIQUIDITY IS HIGH (Only because it can

be taken out after 6 months )

Common Stocks • Common stocks are purchased through a stock

market, broker, or directly from a corporation itself.

• There is great potential for yield, but that can be limited

• There is also high liquidity, but the higher the liquidity, the lower the price will be when that stock is sold to another owner

• Common stocks require more supervision then perhaps any other investment because of their volitility

Sooooooo for Common Stocks…

YIELD IS A

Spectrum LIQUIDITY IS HIGH

Could be high, could be low… But the more someone wants to sell, the more the price goes down

Mutual Funds • There are thousands of stocks and bonds from which to

choose.

• Investors with much money to invest often look to professional securities consultants to assist them.

• Some huge investors have their wealth traded at the stock exchange as a “hedge fund” where their wealth is used like a brokerage house has their clients’ money being invested onto the stock market.

• This combined by the fact that most consumers, and arguably the brokers themselves, have neither the funds nor the skills necessary to buy or sell securities on their own or to pay people for the services of an investment advisor

Mutual Funds • Mutual Funds are when a corporation uses the

proceeds from the sale of its stock to purchase securities of other corporations

• Mutual fund managers work with pools of funds (from people who give this company money) running into the millions and can spread these funds in-order to make money regardless of losses in some areas of the fund.

Some examples of these funds http://money.cnn.com/magazines/moneymag/bestfunds/

Sooooooo for Mutual Funds…

YIELD IS A

Spectrum LIQUIDITY IS HIGH

Sometimes it can be a guaranteed rate but is usually a small percent Because one can sell their share of these

funds when they’d like

IRA’s and 401k’s • The federal government has authorized several

methods to allow individuals to accumulate funds for retirement.

• An Individual Retirement Account (IRA) can be set up by individuals with earned income in which they take this income, put it into this account (tax free), and it is invested into funds which grow the individuals retirement funds

• IRA’s can be made up of stocks, bonds, CD’s, savings bonds, mutual funds, etc

IRA’s and 401k’s • A 401k (for people in for profit companies, “403b” for

non-profit companies, and “457” for government employees) is a pension plan run by an employer for employees that allows an individual employee to contribute regularly a portion of his or her paycheck into a special “savings” or “investment” account

• The contribution of the employees can be matched by their employers as well.

IRA’s and 401k’s • The special designation for these plans is that they

will not be taxed until they are taken out of the account, most likely when the person retires and needs supplementary income because they are not working

• This means all of the person’s money can be kept and growing. Therefore, it can grow intensely and taxed less because the person will only take some out yearly after they retire.

Sooooooo for IRA’s and 401k’s…

YIELD IS A HIGHLIQUIDITY IS Low

Because they cannot be taken out until retirement age These funds are for when someone

retires and therefore cannot be taken out

SCALE OF YIELD• Highest Yield

• Medium Yield

• Lowest Yield

• IRA’s and 401k’s

• Government and Corporate Bonds

• CD’s • Savings Bonds

• Savings Accounts

Stocks

Mutual Funds