Twelve Key Elements of Practical Personal Finance

1. Twelve Key Elements of Practical Personal Finance Common Sense Economics JamesGwartney, Richard L. Stroup, and Dwight R. Lee CommonSenseEconomics.com CommonSenseEconomics.com

2. Why Is There Financial Insecurity in America? • Do You Think It Is Because Incomes Are Low? • See next slide. CommonSenseEconomics.com

3. U.S. Income Is Rising and Has Never Been Higher CommonSenseEconomics.com

4. Consumption Per Person Is Also Growing CommonSenseEconomics.com

5. Financial Insecurity: • Let’s take a look at how households divide their income between consumption and savings. • Remember, saving helps households prepare for surprise expenditures. CommonSenseEconomics.com

6. U.S. Saving Rates Are Falling While Consumption Rates Are Rising … CommonSenseEconomics.com

7. And Interest on Household Debt as a Percentage of Income CommonSenseEconomics.com

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11. Summarizing Trends in Household Finance • While real income per person is rising, • The savings rate is falling, and • Debt is increasing. • A failure to save regularly, use credit cards prudently, consume wisely and invest strategically are largely responsible for financial insecurity in America. • These trends highlight why it is important to get control of your finances before they get control of you. CommonSenseEconomics.com

12. Planning to Achieve Financial Security • Set financial goals for the short and long run. • Put plans in place to achieve these goals. • Work hard and work smart. CommonSenseEconomics.com

13. Why Do We Need or Want Financial Security? Financial security will help us live less stressful lives and pursue other goals Less Conflict in Marriage Better Health Family Religious Goals Education Retirement Charitable Contributions CommonSenseEconomics.com

14. “If you don't know where you are going, you might wind up someplace else.”~ Yogi Berra CommonSenseEconomics.com

15. Practical Element of Personal Finance #1 Discover your comparative advantage. CommonSenseEconomics.com

16. Comparative Advantage • Discover what you can produce at a lower cost than others. Think opportunity costs! • Find out what others value and know how much they are willing to pay you to produce your low cost good or service. • Trade your valuable services and goods for income. • Use that income to buy those goods that would be expensive for you to produce and save to achieve other financial goals. • Exchange is mutually advantageous! Consider the scenario presented in the next slide. CommonSenseEconomics.com

17. Farmer John vs. Nurse Kelly: Can They Gain From Specialization and Trade? CommonSenseEconomics.com

18. What’s Your Comparative Advantage? • Think about what you are good at doing and enjoy. Is this something others’ value highly? How do you know? • Is your educational training helping you develop a comparative advantage? CommonSenseEconomics.com

19. Practical Element of Personal Finance #2 Be entrepreneurial. In a market economy, people maximize their income by providing services and goods others value. They get ahead by discovering better ways of doing things in and outside their workplaces. CommonSenseEconomics.com

20. The Entrepreneur Next Door • Entrepreneurs actively pursue discovering better ways of doing things. • They act quickly and strategically on new opportunities. • Entrepreneurs fuel economic growth and development! CommonSenseEconomics.com

21. Entrepreneurs’ Success: • Entrepreneurial talent: the ability to discover • new products that are highly valued relative to costs, • cost-reducing production methods, and • profitable opportunities that others overlook. • Tolerance for risk: Entrepreneurial activity and self-employment are riskier than being employed by a proprietor, partnership or corporation. But greater risk can translate into higher income and more wealth. CommonSenseEconomics.com

22. Entrepreneurs’ Success (cont.) • High Savings Rates: Entrepreneurs have high savings rates. Often they invest in their businesses, adding to their wealth. • Work Hard and Smart: Entrepreneurs, business owners and independent contractors tend to work longer hours and more strategically. CommonSenseEconomics.com

23. Practical Element of Personal Finance #3 Spend Less Than You Earn CommonSenseEconomics.com

24. Why Should You Save? • Increase your wealth. • Live a less stressful, more financially free life. • Achieve high consumption levels in the future. CommonSenseEconomics.com

25. How Do You Start? • Just do it. • Make savings a part of your monthly plans, e.g. channel a designated amount into an electronic savings account. • Develop a budget and figure out how to reduce discretionary spending. • Buy used or sale items and place the “savings” into an account. CommonSenseEconomics.com

26. Just Do It!!! • Exert the willpower to save now. • It is unlikely that you will do so later. • If you wait to save until your income goes up, it will be extremely costly in terms of the funds available at retirement. CommonSenseEconomics.com

27. Coffee Anyone? • Many people buy one premium cup of coffee each day. Assume each cup costs $4. If they could earn a 7% return, how much could this “coffee” money earn over a 50 year period if saved or invested? • Nothing. The coffee is consumed! • $1,460 • $73,000 • $ 443,918 CommonSenseEconomics.com

28. Strategic Savings • Tax deferred savings. • Automatically deduct savings from your gross income, thereby reducing your taxable net income. • There are many types of tax-deferred savings plans: traditional IRAs, 401(k) plans, 403(b) plans, etc. • Think of creative ways to spend less. • Use coupons and allocate savings into an account. • Strategically purchase used items. • Shop when there are bargain sales and promotions. • Budget, budget and budget. Spend less and save more. CommonSenseEconomics.com

29. Practical Element of Personal Finance #4 Don’t finance anything for longer than its useful life. CommonSenseEconomics.com

30. Financing Consumption • Purchase on credit only when you are buying revenue generating assets in order to earn positive net returns. • Financing makes it possible for you to spend now and pay later. Don’t build up debt unless it is strategic! CommonSenseEconomics.com

31. Good Debt. When can you finance? When goods and services financed now promise to yield a return greater than cost (principal and interest). • Residential home • Education Under certain circumstances, these assets generate income and wealth over time. They can help increase your net worth (assets less liabilities). CommonSenseEconomics.com

32. What Should Not Be Financed? • Nondurables – Goods that are consumed or items that lose their value quickly. • Once consumed, food, clothing and concerts are gone. Payments will linger if not paid for when purchased. CommonSenseEconomics.com

33. Practical Element of Personal Finance #5 Get More Out of Your Money 1. Avoid credit card debt. 2. Consider purchasing used items. CommonSenseEconomics.com

34. Paint a Bright Future!!! • Save today and spend in the future! • Use credit cards wisely and pay them off immediately. • Build a strong credit history in order to get the best interest rates when financing a house, car and other big ticket items. “…ordinary people can have lots of nice things and still accumulate a lot of money.” CommonSenseEconomics.com

35. Credit Card Convenience • Paying with a credit card is NOT spending your own money, but borrowing someone else’s IF you do not pay right away. • Interest rates on credit cards are high because they are unsecured. Interest charges will outstrip what you can earn on savings and investments. • Think of your credit card as an extension of your checking account…Always pay your credit card bill in full. CommonSenseEconomics.com

36. You paid how much? • You buy new clothes, go to a once-in-a-life-time concert with friends and buy more and more until you gradually hit your credit limit of $2000 at 13.4%.You can only manage to pay the minimum of $50 each month. • How many months will it take you to pay the credit card off? • 40, 80, 120, or 166 months? • 166 months! • How much does the $2000 end up costing you in interest? • $0, $130.40, about $260, over $1300? • $1300 in interest! And the items costing $2000 are gone! CommonSenseEconomics.com

37. Buy UsedWhen Strategic • Is buying new worth it? • Depreciation costs make new cars expensive. They depreciate substantially when driven off the lot and they depreciate rapidly in the first three years. • Used cars may have slightly higher maintenance costs but their depreciation costs are much lower. • Buy used! Visit Edmunds.com and compare. CommonSenseEconomics.com

38. Do Credit Card Companies Prey on the Financially Illiterate and Undisciplined? • Advertisement of a credit card company: “You want it all, and you want it now! Our credit card will make it possible.” • Is this a lie? • Are goods scarce? Can we have everything? • How will going deeper into debt affect your wealth and future consumption? CommonSenseEconomics.com

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40. Practical Element of Personal Finance #6 Pay into a “real-world” savings account every month. CommonSenseEconomics.com

41. Rainy Days & the Real World • Life is full of “surprises”, and they’re usually expensive! • Cars break down. • Heaters and air conditioners go. • People get sick or injured. CommonSenseEconomics.com

42. Plan For Your Rainy Days! • The only “surprise” is the timing. So put a plan in place! • Purchase “peace of mind” by building a savings cushion. • Make contributions regularly and a mandatory part of your monthly budget! CommonSenseEconomics.com

43. Practical Element of Personal Finance #7 Put the power of compound interest to work for you. CommonSenseEconomics.com

44. It’s a Miracle!!! • Save and invest regularly. There is a huge payoff! • Compound interest allows you to earn more and more interest on interest and your investment! CommonSenseEconomics.com

45. The Rule of 70 • Determine how long it takes to double your investment. • Place funds in an investment and let it grow over time. • Divide 70 by the expected rate of return (R) and see how long it takes to double in size. 70 = Number of years R to double • When R = 7%, your investment will double in? • 10 years (=70/7) CommonSenseEconomics.com

46. Take A Closer Look • Save $2000 at the age of 16 and place it in an investment that promises a 10 percent return. • How long will it take you to generate $4000 in funds? • 7 years (70/10) • So at the age of 23 you will have $4000. • How much will you have at the age of 30 if you continue to invest the funds? • $8,000 ($4000 + $4000) • Age 37? • $16,000 • Age 51? • $64,000 ($16,000 + $16,000 + $32,000) CommonSenseEconomics.com

47. Practical Element of Personal Finance #8 Diversify - don’t put all of your eggs in one basket. CommonSenseEconomics.com

48. Accumulate Wealth and Gain Financial Security • Investments involve risk, especially in the short-run. • Manage this risk by building a broad portfolio based on diversification. • Historically, long term returns on stocks have been attractive. But diversification is essential. • Hold a large number of unrelated stocks for a lengthy period of time. Put the law of large numbers to work for you! CommonSenseEconomics.com

49. The Law of Large Numbers The law of large numbers states that while some of the investments in a diversified portfolio will do poorly, others will do well. • The performance of the latter will offset that of the former, and • The rate of return will converge toward the historic average. CommonSenseEconomics.com

50. Avoid Double Jeopardy • Does your employer offer a company stock-based retirement program or agree to match any income used to purchase company stock if held for a period of time? • IF your company is well established and has solid growth potential, consider this investment opportunity. • However, sell your company shares and diversify as soon as permitted. • Failure to do so puts you in double jeopardy …You are now beholden to your company both for current employment and retirement income. If your company fails, you lose both. Diversify! CommonSenseEconomics.com