Chapter 1 Personal Finance Basics and the Time

Chapter 1 Personal Finance Basics and the Time Value of Money Copyright © 2018 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Chapter 1 Learning Objectives LO 1 -1 Analyze the process for making personal financial decisions. LO 1 -2 Assess personal and economic factors that influence personal financial planning. LO 1 -3 Develop personal financial goals. LO 1 -4 Calculate time value of money to analyze personal financial decisions. LO 1 -5 Identify strategies for achieving personal financial goals for different life situations. 1 -2 Copyright © 2018 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Personal Financial Planning LO 1 -1: Analyze the process for making personal financial decisions. What is Personal Financial Planning? …. The process of managing your money to achieve personal economic satisfaction 1 -3 Copyright © 2018 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Advantages of Personal Financial Planning • Increased effectiveness in obtaining, using, and protecting financial resources • Increased control of one’s financial affairs by avoiding excessive debt, bankruptcy, and dependence on others • Improved personal relationships • Sense of freedom from financial worries 1 -4 Copyright © 2018 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

The Financial Planning Process 1 -5 Copyright © 2018 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Step 1 in the Financial Planning Process DETERMINE YOUR CURRENT FINANCIAL SITUATION • Evaluate income, savings, living expenses, and debts • Prepare a list of current asset and debt balances and amounts spent for various items • Match financial goals to current income and potential earning power 1 -6 Copyright © 2018 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Step 2 in the Financial Planning Process DEVELOP FINANCIAL GOALS • Identify feelings about money and the reasons for those feelings • Determine the source of your feelings about money (facts or influence of others) • Determine the basis of your financial priorities (social pressures, household needs, or desires) • Determine the effects of the economy on your goals and priorities • Decide on specific financial goals to pursue for your situation 1 -7 Copyright © 2018 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Step 3 in the Financial Planning Process IDENTIFY ALTERNATIVE COURSES OF ACTION • 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 • Creativity in decision making is vital for effective choices • Electing to “do nothing” can be a dangerous alternative 1 -8 Copyright © 2018 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Step 4 in the Financial Planning Process EVALUATE YOUR ALTERNATIVES • CONSEQUENCES OF CHOICES – Opportunity cost What you give up by making a choice – The cost, or trade-off of a decision, may refer to the value of money or time that you give up 1 -9 Copyright © 2018 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Step 4 in the Financial Planning Process (continued) EVALUATE YOUR ALTERNATIVES • EVALUATING RISK – Uncertainty is a part of every decision – Consider inflation risk, interest rate risk, income risk, personal risk, and liquidity risk • FINANCIAL PLANNING INFORMATION SOURCES – To minimize risk, gather relevant information from print and media sources, digital sources, financial experts, and financial institutions 1 -10 Copyright © 2018 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Step 5 in the Financial Planning Process CREATE AND IMPLEMENT YOUR FINANCIAL ACTION PLAN – Develop an action plan that identifies ways to achieve financial goals – Possible action plans can be increasing savings, reducing spending, increasing income by working extra hours, or making provisions for taxes – To implement action plans you may need assistance from others 1 -11 Copyright © 2018 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Step 6 in the Financial Planning Process REVIEW AND REVISE YOUR PLAN – Financial planning decisions need to be assessed regularly – A 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 -12 Copyright © 2018 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Influences on Personal Financial Planning LO 1 -2: Assess personal and economic factors that influence personal financial planning. • LIFE SITUATION AND PERSONAL VALUES – Adult life cycle are the stages in the family and financial needs of an adult – Marital status, household size, and employment – Major events – Graduation, engagement, career change, children, retirement, etc. – Values influence spending and saving decisions 1 -13 Copyright © 2018 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Influence: The Financial System • Describes the flow of money – Providers of funds (savers and investors) – Financial Intermediaries (banks, insurance companies, etc. ) – Financial Markets (stock markets, bond markets, etc. ) – Users of funds (borrowers and spenders) 1 -14 Copyright © 2018 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Influence: Economic Factors • Economics is the study of how wealth is created and distributed – Forces of Supply and Demand on setting prices – The economic environment includes various institutions – Federal Reserve Bank and its role in the economy to maintain an adequate money supply 1 -15 Copyright © 2018 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Influence: Global Influences – Global economy influences personal finance – 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 -16 Copyright © 2018 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Influence: Economic Conditions • Changing economic conditions and financial decisions – Consumer prices – Consumer spending – Interest rates – Money supply – Unemployment – Housing starts – Gross domestic product (GDP) – Trade balance – Stock market indexes 1 -17 Copyright © 2018 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Influence: Economic Conditions (continued) • Inflation is a rise in the general level of prices • Rule of 72 – Divide 72 by the annual inflation (or interest) rate – Example: An annual inflation rate of 4% means prices (or your savings) will double in 18 years (72/4 = 18) 1 -18 Copyright © 2018 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Select a Path to Financial Security • • • Save for emergencies and the future Maintain a low level of debt Have a risk management plan Research to avoid investment scams Communicate with others 1 -19 Copyright © 2018 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Developing Personal Financial Goals LO 1 -3: Develop personal financial goals. • FINANCIAL GOALS – Can be influenced by the time frame in which you want to achieve your goals – Can be influenced by the type of financial need that drives your goals 1 -20 Copyright © 2018 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Types of Financial Goals • TIMING OF GOALS – Short-term (within the next year) – Intermediate (one to five years) – Long-term goals (more than five years) Long-term goals should be planned in coordination with short-term and intermediate goals • GOALS FOR DIFFERENT FINANCIAL NEEDS – Consumable-product goals – Durable-product goals – Intangible-purchase goals 1 -21 Copyright © 2018 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Goal-Setting Guidelines Goals should be S-M-A-R-T: Specific: know exactly what your goals are to create a plan Measurable: with a specific amount Action-oriented: identify the personal financial activities you will undertake Realistic: utilizing your income and life situation Time-based: identify the time frame to achieve the goal 1 -22 Copyright © 2018 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Opportunity Costs and the Time Value of Money LO 1 -4: Calculate time value of money situations to analyze personal financial decisions. 1 -23 Copyright © 2018 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Personal Opportunity Costs – Every financial decision involves giving up something to obtain something else – Time, energy, health, abilities, knowledge – Personal resources like financial resources require careful management 1 -24 Copyright © 2018 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Financial Opportunity Costs • Financial choices depend on current needs, future uncertainty, and current interest rates • Time Value of Money – Increases in an amount of money as a result of interest earned – Saving (or investing) today means more money tomorrow. Spending means lost interest – Saving and spending decisions involve considering the trade-offs. Current needs can make spending worthwhile 1 -25 Copyright © 2018 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Time Value of Money • INTEREST CALCULATIONS Three amounts are required to calculate the time value of money – Principal (the amount of savings) – Interest rate (annual) – Time period 1 -26 Copyright © 2018 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Time Value of Money (continued) COMPUTING SIMPLE INTEREST =Amount in savings × annual interest rate × time period =interest amount For Example: =$500 × 6% × 6 months/12 months =$500 ×. 06 × ½ year =$15. 00 In six months, a $500 deposit (principal) will earn $15. 00 interest. Therefore, you will have a total of $515 at the end of six months. 1 -27 Copyright © 2018 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Time Value of Money: Future Value • 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 called compounding — earning interest on previously earned interest • Future value can be computed for a single amount or for a series of deposits (or payments) called an annuity – FUTURE VALUE OF A SINGLE AMOUNT – FUTURE VALUE OF A SERIES OF DEPOSITS 1 -28 Copyright © 2018 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Time Value of Money: Present Value • Present value 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 • Present value can be computed for a single amount or for a series of deposits – PRESENT VALUE OF A SINGLE AMOUNT – PRESENT VALUE OF A SERIES OF DEPOSITS 1 -29 Copyright © 2018 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Methods for Calculating Time Value of Money • • • Formula calculation Time value of money tables Financial calculator Spreadsheet software Websites and Apps 1 -30 Copyright © 2018 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Achieving Financial Goals LO 1 -5: Identify strategies for achieving personal financial goals for different life situations. • COMPONENTS OF PERSONAL FINANCIAL PLANNING – Obtaining (Chapter 2) – Planning (Chapters 3, 4) – Saving (Chapter 5) – Borrowing (Chapters 6, 7) – Spending (Chapters 8, 9) – Managing risk (Chapters 10, 11, and 12) – Investing (Chapters 13, 14, 15, 16, and 17) – Retirement and estate planning (Chapters 18, 19) 1 -31 Copyright © 2018 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Developing a Flexible 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 -32 Copyright © 2018 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Implementing Your Financial Plan • Develop good financial habits – Use a well-conceived spending plan that helps 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 taxes and investments to expand your financial resources 1 -33 Copyright © 2018 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Studying Personal Finance • Resources – Personal Financial Planner sheets – This book’s library resource site in Connect – Practice Quizzes and end-of-chapter activities – Online sources and apps for current personal finance information – Talk to others, experts, and friends – Search the Internet • Achieving your financial objectives requires a willingness to learn and appropriate information sources 1 -34 Copyright © 2018 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.