Chapter 01 Personal Finance Basics and the Time Value of Money McGraw-Hill/Irwin Copyright 2012 by The McGraw-Hill Companies, Inc. All rights reserved. 1-1 Chapter 1 Learning Objectives 1. Analyze the process for making 2. Develop personal financial 3. Assess personal and factors that influence personal financial planning 4. Calculate situations associated with personal financial decisions 5. Identify strategies for achieving personal financial goals for different 1-2 The Financial Process Objective 1: Analyze the process for making personal financial decisions What is Personal Financial?.. The process of to achieve personal. 1-3
The Financial Process Advantages of Personal Financial are: 1. Increased effectiveness in obtaining, using and protecting financial resources. 2. Increased control of one s financial affairs 3. Improved personal relationships 4. Sense of freedom from financial worries 1-4 Six-step Procedure for Financial Continued 1-5 Six-step Procedure for Financial Step 1: DETERMINE YOUR CURRENT Evaluate income, savings, living expenses, and debts Prepare a list of current asset and debt balances and amount spent for various items Match financial goals to current income and potential earning power Continued 1-6
Six-step Procedure for Financial Step 2: DEVELOP YOUR FINANCIAL Identify feelings about money and the reasons for those feelings Determine the source of your feelings about money Determine the effects of the economy on your goals and priorities Make sure that your goals are your own and are specific to your situation Continued 1-7 Six-step Procedure for Financial Step 3: IDENTIFY ALTERNATIVE Possible courses of action can be: Continue the same course of action Expand the current situation Change the current situation Take a new course of action Continued 1-8 Six-step Procedure for Financial Step 3: IDENTIFY ALTERNATIVE COURSES OF ACTION (continued) Creativity in decision making is vital to effective choices can be a dangerous alternative Continued 1-9
Six-step Procedure for Financial Step 4: EVALUATE CONSEQUENCES OF CHOICES - What you give up when you make a choice The cost or of a decision cannot always be measured in dollars. Sometimes the cost is your time Continued 1-10 Six-step Procedure for Financial Step 4: EVALUATE YOUR ALTERNATIVES EVALUATING Uncertainty is a part of every decision. Best way to analyze and minimize risk is to gather information from financial planning sources. Continued 1-11 Six-step Procedure for Financial Step 5: CREATE AND IMPLEMENT YOUR Develop an action plan that identifies ways to achieve financial goals Possible action plans can be increasing savings, reducing spending, or making provisions for taxes To implement action plans you may need assistance from others Continued 1-12
Six-step Procedure for Financial Step 6: AND YOUR PLAN Financial planning decisions need to be assessed regularly Complete review should be done at least once a year More frequent reviews may be required for changing personal, social, and economic factors Regular reviews of decision-making process can help in making priority adjustments to achieve financial goals 1-13 Developing Personal Financial Goals Objective 2: Develop personal TYPES OF FINANCIAL GOALS can be: a) Influenced by the in which you want to achieve your goals b) Influenced by the need that drives your goals 1-14 Developing Personal Financial Goals Objective 2: Develop personal financial goals TIMING OF GOALS Short-term, intermediate and long-term goals Long term goals should be planned in coordination with short-term and intermediate goals GOALS FOR DIFFERENT FINANCIAL NEEDS Consumer product goals Durable-product goals Intangible-purchase goals 1-15
Developing Personal Financial Goals (continued) GOAL-SETTING GUIDELINES Goals should be: S : know what your goals are to create a plan M : with a specific amount A : identify the personal financial activities R : utilizing your income and life situation T : identify the time frame to achieve the goal 1-16 Influences on Personal Financial Objective 3: Assess and factors that influence personal financial planning LIFE SITUATION AND PERSONAL VALUES stage Marital status, household size, and employment Major events Graduation, marriage, career change, children, retirement, etc. Values influence spending and saving decisions 1-17 Influences on Personal Financial (continued) ECONOMIC FACTORS is the study of how wealth is created and distributed Federal Reserve Bank and it s role in the economy 1-18
Influences on Personal Financial (continued) GLOBAL INFLUENCES Global marketplace influences financial activities American companies compete against foreign companies for US dollars Balance of exports and imports Foreign investments and their role in the US Money Supply The level of Money Supply affects interest rates 1-19 Influences on Personal Financial (continued) ECONOMIC CONDITIONS Consumer prices Consumer spending Interest rates Money Supply Unemployment Housing Starts Gross domestic product (GDP) Trade balance Stock market indexes 1-20 Tools in every financial situation Reduce debt usage Reduce spending Review savings investments Evaluate insurance coverage Avoid financial scams Communicate with family 1-21
Influences on Personal Financial (continued) 1-22 Opportunity Costs and the Time Value of Money Every financial decision involves giving up something to obtain something else PERSONAL Time Other personal opportunity costs can be related to health, leisure etc. Personal resources like financial resources require careful management 1-23 Opportunity Costs and the Time Value of Money (continued) FINANCIAL OPPORTUNITY COSTS Increases in an amount of money as a result of interest earned Saving today means more money tomorrow. Spending means lost interest. Saving and spending decisions involve trade-offs. Current needs can make spending worthwhile. 1-24
Future Value Example You deposit $100 today in a bank account that pays 3% interest per year. How much do you have in 1, 2 and 3 years? 1-25 Opportunity Costs and the Time Value of Money (continued) 1) OF A SINGLE AMOUNT Future value is the amount to which current savings will increase based on a certain interest rate and a certain time period Future value is also call compounding - earning interest on previously earned interest 2) FUTURE VALUE OF A SERIES OF DEPOSITS Future value can be computed for a single amount or for a series of deposits called an 1-26 Future Value of an Annuity You deposit $100 in each of the next 3 years (starting next year) in a bank account that pays 3% interest per year. How much do you have 3 years from now? 27
Future Value Formulas 28 Present Value Example You want $500 in three years. How mucg must you deposit today in a bank account that pays 3% interest per year? 1-29 Opportunity Costs and the Time Value of Money (continued) 3) OF A SINGLE AMOUNT is 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 The present value of the amount you want in the future will always be less than the future value. 4) PRESENT VALUE OF A SERIES OF DEPOSITS Present value can be computed for a single amount or for a series of deposits. 1-30
Present Value of an Annuity How much do you need to deposit today in a bank account that pays 3% interest per year if you plan to withdraw $250 per year for three years, starting next year? 31 Present Value Formulas 32 Achieving Financial Goals Objective 5: Identify for achieving personal financial goals for different life situations COMPONENTS OF PERSONAL FINANCIAL PLANNING Obtaining (chapter 2) (chapters 3, 4) Saving (chapter 5) Borrowing (chapters 6, 7) Spending (chapters 8, 9) Managing risk (chapters 10-12) Investing (chapters 13-17) Retirement and estate planning (chapters 18, 19) 1-33
Achieving Financial Goals (continued) DEVELOPING A FINANCIAL PLAN A financial plan is a formalized report that... Summarizes your current financial situation Analyzes your financial needs Recommends future financial activities Your financial plan can be created by you, with assistance from a financial planner, or made using a money management software package 1-34 Achieving Financial Goals (continued) IMPLEMENTING YOUR FINANCIAL PLAN Develop good financial habits Use a well conceived spending plan to help you stay within your income, while allowing you to save and invest for the future Have appropriate insurance protection to prevent financial disasters Become informed about tax and investment alternatives 1-35