Chapter 1 Personal Financial Planning: An Introduction

1. Chapter 1Personal Financial Planning: An Introduction 1-1

2. 1-2 Learning Objectives – Chapter 1 • Analyze the process for making personal financial decisions • Develop personal financial goals • Assess personal & economic factors that influence personal financial planning • Determine personal and financial opportunity costs associated with personal financial decisions • Identify strategies for achieving personal financial goals for different life situations

3. 1-3 Learning Objective # 1Analyze the process for making personal financial decisions

4. 1-4 Financial Planning and Its Benefits • Personal financial planning is the process of managing your money to achieve personal economic satisfaction • Most people want to handle their finances so that they get full satisfaction from each available dollar • Financial goals include such things as a new car, a larger home, advanced career training, contributions to charity, extended travel, and self-sufficiency during working and retirement years

5. Advantages of personal financial planning; • Increased effectiveness in obtaining, using, and protecting your financial resources • Increased control of your financial affairs • Improved personal relationships • A sense of freedom from financial worries

6. The Financial Planning Process

7. 1-5 The Financial Planning Process • Determine your current financial situation • Develop financial goals • Identify alternative courses of action • Evaluate alternatives • Create and implement a financial action plan • Reevaluate and revise your plan

8. STEP 1DETERMINE YOUR CURRENT FINANCIAL SITUATION • Determine your current financial situation, regarding income, savings, living expenses, and debts • Preparing a list of current asset and debt balances and amounts spent for various items gives you a foundation for financial planning activities • The personal financial statements discussed will provide the information needed to match your goals with your current income and potential earning power

9. Step 1 Example • Within the next 2 months, Kent Mullins will complete his undergraduate studies with a major in international studies • He has worked part-time in various sales jobs • He has a small savings fund ($1,700) and over $8,500 in student loans • What additional information should Kent have available when planning his personal finances?

10. STEP 2DEVELOP YOUR FINANCIAL GOALS • Periodically analyze your financial values and goals • Identifying how you feel about money and why you feel that way • Are your feelings about money based on factual knowledge or on the influence of others? • Are your financial priorities based on social pressures, household needs, or desires for luxury items? • How will economic conditions affect your goals and priorities? • The purpose of this analysis is to differentiate your needs from your wants

11. Specific financial goals are vital to financial planning • Others can suggest financial goals for you. However, you must decide which goals to pursue • Your financial goals can range from spending all of your current income to developing an extensive savings and investment program for your future financial security

12. Step 2 Example • Kent Mullins has several goals • Paying off his student loans • Obtaining an advanced degree in global business management • Working in Latin America for a multinational company • What other goals might be appropriate for John?

13. STEP 3IDENTIFY ALTERNATIVE COURSES OF ACTION • Developing alternatives (best another way) is crucial when making decisions • Many factors will influence the available alternatives, possible courses of action usually fall into 4 categories: • Continue the same course of action • Expand the current situation • Change the current situation • Take a new course of action • When you decide not to take action (do nothing) which can be a dangerous alternative

14. Continue the same course of action • You may determine that the amount you have saved each month is still appropriate • Expand the current situation • You may choose to save a larger amount each month • Change the current situation • You may decide to use a money market account instead of a regular savings account • Take a new course of action • You may decide to use your monthly savings budget to pay off credit card debts

15. Step 3 Example • Kent Mullins has several options available for the near future • Work full time and save for graduate school • Go to graduate school full time by taking out an additional loan • Go to school part time and work part time. • What additional alternatives might he consider?

16. STEP 4EVALUATE YOUR ALTERNATIVES • Evaluate possible courses of action, taking into consideration your life situation, personal values, and current economic conditions • How will the ages of dependents affect your saving goals? • How do you like to spend leisure time? • How will changes in interest rates affect your financial situation?

17. CONSEQUENCES OF CHOICES • Every decision closes off alternatives • For ex: • A decision to invest in stock may mean you cannot take a vacation • A decision to go to school full time may mean you cannot work full time

18. 1-6 Every Decision Has An Opportunity Cost (Trade-off) • Opportunity cost is what you give up by making a choice • The cost, referred to as the trade-off of a decision, cannot always be measured in dollars. Sometimes the cost is your time • Consider lost opportunities that will result from your decisions. • Evaluate the risks faced • Refer to the money you forgo by attending school rather than working. Then the resources you give up (money or time) have a value that is lost

19. Decision making will be an ongoing part of your personal and financial situation • Therefore, you will need to consider the lost opportunities that will result from your decisions • Since decisions vary based on each person’s situation and values, opportunity costs will differ for each person

20. EVALUATING RISK • Uncertainty is a part of every decision • Selecting a college major and choosing a career field involve risk • What if you don’t like working in this field or cannot obtain employment in it? • Other decisions involve a very low degree of risk, such as putting money in an insured savings account or purchasing items that cost only a few dollars • Your chances of losing something of great value are low in these situations

21. In many financial decisions, identifying and evaluating risk is difficult • The best way to consider risk is to gather information based on your experience and the experiences of others and to use financial planning information sources • Information is required at each stage of the decision-making process • Changing personal, social, and economic conditions will require that you continually supplement and update your knowledge

22. 1-9 Financial Planning Information Sources • Printed materials • Financial institutions • School courses and educational seminars • Computer software, World Wide Web, and on-line information sources • Financial specialists

23. Financial Planning Information Sources

24. Step 4 Example • As Kent Mullins evaluates his alternative courses of action, he must consider his income needs for both the short term and the long term • He should also assess career opportunities with his current skills and his potential with advanced training • What risks and trade-offs should Kent consider?

25. STEP 5CREATE & IMPLEMENT FINANCIAL ACTION PLAN • Involves developing an action plan that identifies ways to achieve your goals • For ex, you can increase your savings by reducing your spending or by increasing your income through extra time on the job • As you achieve your short-term/ immediate goals, the next priority goals will come to focus • To implement your financial action plan, you may need assistance from others • For example, you may use the services of an insurance agent to purchase property insurance or the services of an investment broker to purchase stocks, bonds, or mutual funds

26. Step 5 Example • Kent Mullins has decided to work full time for a few years while he • (1) pays off his student loans • (2) saves money for graduate school • (3) takes a couple of courses in the evening and on weekends • What are the benefits and drawbacks of this choice?

27. STEP 6REVIEW AND REVISE YOUR PLAN • Financial planning is a dynamic process that does not end when you take a particular action • You need to regularly assess your financial decisions • You should do a complete review of your finances at least once a year • Changing personal, social, and economic factors may require more frequent assessments

28. When life events affect your financial needs, this financial planning process will provide a vehicle for adapting to those changes • Regularly reviewing this decision-making process will help you make priority adjustments that will bring your financial goals and activities in line with your current life situation

29. Step 6 Example • Over the next 6 to 12 months • Kent Mullins should reassess his financial, career, and personal situations • What employment opportunities or family circumstances might affect his need or desire to take a different course of action?

30. 1-7 Economic or Product Risk • Interest Rate Risk • Changing interest rates affect your costs when you borrow and your benefits when you invest • Inflation Risk • Rising prices cause lost buying power • Liquidity risk • Some investments may be more difficult to convert to cash or sell without significant loss in value • Product Risk • Products or services flawed or not meet your expectations • Retailers may not honour their obligations

31. 1-8 Personal Risk • Risk of Death • Premature death causes financial hardship to family members left behind • Risk of Income Loss • Income stops because of job loss, illness or accident • Health Risk • Poor health increases medical costs • May reduce working capacity or life expectancy • Asset and Liability Risk • Assets stolen or damaged • Sued for negligence or damages caused by your actions

32. 1-10 Learning Objective # 2Develop personal financial goals

33. 1-11 Developing Personal Financial Goals • Financial goals are influenced by • Personal values and attitudes towards money (+ or -) • Time frame in which you want to achieve your goals (How long) • Type of financial need that drives your goals • Your life situation

34. 1-12 Developing Personal Financial Goals • Timing of goals • Short-term, intermediate and long-term goals. • Goals for different financial needs • Consumable products goals • Food, clothing • Durable product goals • Appliances, cars, sporting equipment

35. 1-13 Developing Personal Financial Goals – Your Life Situation • Life Situation takes into consideration personal factors • Age, income, marital status, household size, personal beliefs • Influences your spending and savings patterns • Social Changes • Married at later age • More households with two incomes • Single parents • Living longer

36. 1-14 Developing Personal Financial Goals – Your Life Situation • Other events that influence your life situation include • Graduation • Engagement and marriage • Birth or adoption of a child • Career change or move to a new area • Dependant children leaving home • Changes in health • Divorce • Retirement • Death of spouse or other family member

37. 1-15 Developing Personal Financial Goals • Financial goals should... • Be realistic • Be stated in specific, measurable terms • Have a time frame • Indicate the type of action to be taken

38. 1-16 Learning Objective # 3Assess personal and economic factors that influence personal financial planning

39. 1-17 Influences on Personal Financial Planning • Market Forces • Supply and demand • Production costs and competition • Financial institutions • Influence of the Bank of Canada • Global Influences • Level of exports, foreign investors, competition • Economic conditions.... • Recession, Expansion Economic factors: the study of how wealth is created and distributed

40. 1-18 Changing Economic Conditions • Consumer Prices • Inflation is a rise in the general level of prices • Mainly caused by increase in demand without increase in supply • Harmful to people on fixed incomes • Can adversely affect people who lend money • Rate of inflation varies

41. 1-19 Changing Economic Conditions • Consumer Spending • Demand for goods and services influences employment opportunities • Reduced spending causes unemployment • Interest Rates • Represent the cost of money • Saving and investing increase the supply of money and interest rates decrease • Borrowing increases demand and interest rates rise

42. 1-20 Learning Objective # 4Determine personal and financial opportunity costs associated with personal financial decisions

43. 1-21 Financial Acquisitions (automobile, home, college education, investments, insurance, retirement fund) Opportunity Costs and Financial Results Evaluated When Making Decisions Personal Opportunity Costs (time, effort, health) Financial Opportunity Costs (Interest, liquidity, safety )

44. 1-22 Future Amount Now Value (compounding) Amount Present Value Later Financial Opportunity Costs • Time Value of Money • Increases in an amount of money as a result of interest earned • Every time you spend, save, invest or borrow money you should consider the time value of money as an opportunity cost (discounting)

45. 1-23 How Simple Interest is Computed • Simple Interest: interest compounded on the principal, excluding previously earned interest • $100 x 6% x 1 (1 year) 100 x .06 x 1 = $6.00 In one year you have $106 (P) (r) (T) (I) Amount x Annual x Time = Interest in Savings Interest Rate Period

46. 1-24 How Compound Interest is Computed • Compound Interest: Interest that is earned on previously earned interest • Each time interest is added to the principal, the next interest is computed on the new balance 1st year: $100 x 6% x 1(year) = $106.00 2nd year: ($100 + $6) x 6% x 1(year) = $112.36 3rd year: ($106 + $6.36) x 6% x 1(year) =$119.10

47. 1-25 Future Value of Money • Is the amount to which current savings will increase based on certain interest rate and certain time period • Calculations involve compounding since interest is earned on previously earned interest • Can be computed for a single amount or a series of deposits • Start investing now to take advantage of the future value of money

48. 1-26 Present Value • 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 • Allows you to determine how much to deposit now to obtain desired future amount • Can be computed for a single amount or a series of deposits

49. 1-27 Learning Objective # 5Identify strategies for achieving personal financial goals for different life situations

50. 1-28 Components of Financial Planning • Obtaining (chapter 1) • Planning (chapters 2,3) • Saving (chapter 4) • Borrowing (chapters 5,6) • Spending (chapter 7) • Managing Risk (chapters 8,9) • Investing (chapters 10-13) • Retirement and Estate Planning (chapters 14,15)