Chapter 1 Personal Financial Planning in Action Copyright

Chapter 1 Personal Financial Planning in Action Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Personal Financial Planning Chapter Learning Objectives LO 1. 1 Identify social and economic influences on personal financial goals and decisions LO 1. 2 Develop personal financial goals LO 1. 3 Calculate time value of money situations associated with personal financial decisions LO 1. 4 Implement a plan for making personal financial and career decisions. 1 -2 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Financial Planning �Process of managing your money to achieve personal economic satisfaction �Financial Plan: ◦ Formalized report ◦ Summarizes current financial situation ◦ Analyzes financial needs ◦ Recommends future financial activities 1 -3 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Advantages of Financial Planning �Increased effectiveness in obtaining, using, and protecting financial resources �Increased control of your financial affairs �Improved personal relationships �Sense of freedom from financial worries 1 -4 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Learning Objective LO 1. 1 Identify Social and Economic Influences on Personal Financial Goals and Decisions �Life situation and personal values �Financial planning in our economy ◦ Domestic economic influences ◦ Global Influences ◦ Inflation ◦ Interest rates 1 -5 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Life Situation and Personal Values �Adult life cycle �Life Situation Factors: ◦ Marital status, household size, employment �Exhibit 1 -1 �Major events: ◦ Graduation, marriage, divorce ◦ Birth or adoption of child ◦ Career or health changes �Values: ◦ The ideas and principles you consider correct, desirable, and important 1 -6 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Financial Planning in Our Economy Domestic Influences �Economy’s influence on financial planning ◦ Business, labor & government �The Federal Reserve ◦ “. . Sets the nation’s monetary policy to promote the objectives of maximum employment, stable prices and moderate long-term interest rates. ” �http: //www. federalreserve. gov/ 1 -7 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Financial Planning in Our Economy Domestic Influences 1 -8 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Financial Planning in Our Economy Global Influences �U. S economy affected by foreign investors and competition from foreign companies �Level of imports/exports affects available supply of dollars �Level of foreign investment affects domestic money supply �Money supply affects consumer interest rates 1 -9 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Financial Planning in Our Economy Inflation = in the general level of prices �Reduces buying power of the dollar �Most harmful to those on fixed incomes �Inflation rates vary �“Hidden inflation” �CPI = a measure of inflation �Deflation = decline in prices 1 -10 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Financial Planning in Our Economy Interest Rates Interest Rate = the cost of money � Affected by supply and demand � Risk premium: ◦ Length of time funds in use ◦ Expected inflation ◦ Uncertainty � Major impact on financial planning 1 -11 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

8 Basic Financial Planning Activities �Obtaining Chapter 1 �Planning Chapters 2, 3 �Saving Chapter 4 �Borrowing Chapter 5 �Spending Chapters 6, 7 �Managing Risk Chapters 8 -10 �Investing Chapters 11 -13 �Retirement/Estate Planning Chapter 14 1 -12 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Learning Objective LO 1. 2 Develop Personal Financial Goals �Time Frames for Achieving Financial Goals: ◦ Short-term goals. . . within 1 year ◦ Intermediate goals. . 1 -5 years ◦ Long-term goals. . . > 5 years �Financial Needs Goals: ◦ Consumable-product goals. . . ◦ Durable-product goals. . . ◦ Intangible-purchase goals. . . Food, clothing Car, appliances Education, health 1 -13 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Goal-Setting Guidelines The “SMART” Approach Effective Goals should be: • S = Specific • M = Measurable • A = Action-oriented • R = Realistic • T = Time-based 1 -14 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Learning Objective LO 1. 3 Using Time Value of Money to Evaluate Personal Financial Decisions Opportunity cost = what you give up making a choice The trade-off of a decision � Not always measurable in dollars; may be time � Consider lost opportunities resulting from your decisions � 1 -15 Copyright © 2016 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 �Increase in an amount of money as a result of interest earned ◦ Saving today = more money tomorrow ◦ Spending today = lost interest �Saving and spending decisions involve considering the trade-offs ◦ Current needs can make spending worthwhile 1 -16 Copyright © 2016 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 �Calculating interest earned: ◦ Principal = amount of savings ◦ Annual interest rate ◦ Length of time money on deposit (in years) �Simple Amt in Svgs X interest: Annual Interest Rate X Time Period = Interest 1 -17 Copyright © 2016 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 Calculation Example $500 on deposit at 6% annual interest for 6 months: Principal = $500 Interest rate = 6% Time period = ½ (6/12 months) $500 X 6% X 1/2 = $15 1 -18 Copyright © 2016 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 Types of TVM Calculations �Future Value = Amount that will be available at a later date �Present Value = Current value of an amount desired in the future 1 -19 Copyright © 2016 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 Calculation Methods 1. 2. 3. 4. 5. Formula calculation Time value of money tables Financial calculator Spreadsheet software Websites and apps 1 -20 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Future Value �The increased value of money from interest earned �Amount to which current savings will increase �Total amount available in the future �“Compounding” your interest. is earning interest on 1 -21 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Future Value Formula Method Future Value = Original Amount in Savings + Interest Earned $100 deposited for 1 year at 6% per year Future Value = $100 + ($100 X. 06 X 1) Future Value = $100 + $6 = $106 1 -22 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Future Value Formula method �This could be repeated for several time periods, but there’s an easier way: FV = PV(1+i)n �In the previous example: FV = 100(1. 06)1=$106 1 -23 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Future Value Formula method �If you left the money in for two years: FV = 100(1. 06)2=$112. 36 �Notice that $6 interest for two years would give you $12. The extra $0. 36 is the result of compounding. �Another example: ◦ $650 invested at 8% for 10 years FV = $650(1. 08)10=$1, 403. 30 1 -24 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Future Value Table Method �Appendix Amount Exhibit 1 -A = FV of a Single ◦ Multiply Table Factor by amount deposited ◦ All Future Value factors > 1. 0 �Example: ◦ $650 invested at 8% for 10 years ◦ Factor = 2. 159 ◦ FV = $650 × 2. 159 = $1, 403. 35 ◦ Because of rounding, the answer is slightly off. 1 -25 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Future Value Financial Calculator Method �Every financial calculator has five buttons of interest for time value of money: N �Means the number of time periods I/YR �Means the interest rate period PV PMT FV �Means present value �Means payment amount period �Means future value 1 -26 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Future Value Financial Calculator Method �In the example above, $650 at 8% for 10 years: N I/YR PV PMT FV � 10 � 8 (not 0. 08!) �-650 � 1, 403. 30 Enter all the values you know first (these are in red here), then press the key matching the value you want to know. In the TI BAII Plus, you must press “CPT” before solving. Notice you must enter -650. Otherwise, the answer will be negative. 1 -27 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Future Value Spreadsheet Method �In a spreadsheet such as Microsoft Excel, there are financial functions. �For FV, the function is: =FV(rate, periods, payment, pv, type) �In the above example, it would be: =FV(0. 08, 10, 0, -650, 0) �When you press enter, the answer will be in the cell. ($1, 403. 30) �We will introduce “type” later. 1 -28 Copyright © 2016 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 TVM Websites �www. moneychimp. com/calculator �www. dinkytown. net 1 -29 Copyright © 2016 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 Calculation Methods 1 -30 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Future Value Series of Deposits �“Annuity” = series of equal deposits at equal intervals earning a constant rate �Examples are retirement savings, or any other savings goal in which you deposit an equal amount at equal intervals. 1 -31 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Future Value of a Series of Deposits Formula method � 1 -32 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Future Value of a Series of Deposits Table Method �Appendix Annuity Exhibit 1 - B = Future Value of an ◦ Multiply Table Factor by Annuity amount ◦ All future value of an annuity factors > 0. �Example: ◦ Deposit $50 per year at 7% for 6 years ◦ Factor = 7. 153 ◦ FV = $50 × 7. 153 = $357. 65 ◦ Because of rounding, the answer is slightly off. 1 -33 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Future Value of a Series of Deposits Financial Calculator Method �In the example above, $50 at 7% for 6 years: N I/YR PV PMT FV � 6 � 7 (not 0. 07!) � 0 �-$50 � 357. 66 Enter all the values you know first (these are in red here), then press the key matching the value you want to know. In the TI BAII Plus, you must press “CPT” before solving. Notice you must enter -50. Otherwise, the answer will be negative. 1 -34 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Future Value of a Series of Deposits Spreadsheet Method �For FV, the spreadsheet function is: =FV(rate, periods, payment, pv, type) �In the above example, it would be: =FV(0. 07, 6, -50, 0, 0) �When you press enter, the answer will be in the cell. ($357. 66) �For annuities, you can change the type from 0 to 1 if the payments occur at the beginning of the year instead of the end. 1 -35 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Present Value �The current value of a future amount based on a certain interest rate and time period �The current value of an amount desired in the future �How much to deposit now to obtain a desired total in the future �“Discounting” 1 -36 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Present Value Formula method � 1 -37 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Present Value Table Method �Appendix amount Exhibit 1 -C = PV of a single ◦ Multiply Table Factor by amount deposited ◦ All present value of factors < 0. �Example: ◦ You want $1, 000 five years from now ◦ You can earn 5% on your money ◦ Present Value = $1, 000 × 0. 784 = $784 ◦ Because of rounding, the answer is slightly off. 1 -38 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Present Value Financial Calculator Method �In the example above, $1, 000 at 5% in 5 years: N I/YR PV PMT FV � 5 (not 0. 05!) � 783. 53 � 0 �-1000 Enter all the values you know first (these are in red here), then press the key matching the value you want to know. In the TI BAII Plus, you must press “CPT” before solving. Notice you must enter -1000. Otherwise, the answer will be negative. 1 -39 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Present Value Spreadsheet Method �For PV, the function is: =PV(rate, periods, payment, fv, type) �In the above example, it would be: =PV(0. 05, 5, 0, -1000, 0) �When you press enter, the answer will be in the cell. ($783. 53) 1 -40 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Present Value of a Series of Deposits Formula method � 1 -41 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Present Value of a Series of Deposits Table Method �Appendix Exhibit 1 -D PV of an annuity ◦ Multiply Table Factor by amount deposited ◦ All present value of factors < 0. �Example: ◦ You want to withdraw $400/year for 9 years ◦ Your money is earning 8% per year ◦ Deposit = $400 × 6. 247 = $2, 498. 80 ◦ Because of rounding, the answer is slightly off. 1 -42 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Present Value of a Series of Deposits Financial Calculator Method �In the example above, $400 at 8% for 9 years: N I/YR PV PMT FV � 9 � 8 (not 0. 08!) �$2, 498. 76 �-400 � 0 Enter all the values you know first (these are in red here), then press the key matching the value you want to know. In the TI BAII Plus, you must press “CPT” before solving. Notice you must enter -400. Otherwise, the answer will be negative. 1 -43 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Present Value of a Series of Deposits Spreadsheet Method �For PV, the function is: =PV(rate, periods, payment, fv, type) �In the above example, it would be: =PV(0. 08, 9, -400, 0, 0) �When you press enter, the answer will be in the cell. ($2, 498. 76) 1 -44 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

The 6 -Step Financial Planning Process 1 -45 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Learning Objective LO 1. 4 Implement a Plan for Making Personal Financial and Career Decisions Determine current financial situation 2. Develop financial goals 3. Identify alternative courses of action 1. • • Continue same course of action Expand current situation Change current situation Take a new course of action 1 -46 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Learning Objective LO 1. 4 Implement a Plan for Making Personal Financial and Career Decisions 4. Evaluate alternatives • Consequences of choices • Evaluate risks • Financial Planning information sources Create and implement financial action plan 6. Review and revise plan 5. 1 -47 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Financial Planning in Action 1 -48 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Career Choice and Financial Planning 1. 2. 3. 4. The life work one selects = key to financial well being and personal satisfaction Career choices have risks and opportunity costs Career choices require periodic reevaluation of trade-offs related to personal, social and economic factors Changing personal and social factors require continuous assessment of your 1 -49 work situation Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Chapter Summary Learning Objective LO 1. 1 �Financial decisions are affected by: ◦ Life situation ◦ Personal values ◦ Economic factors �Major elements of Financial Planning: 1. Obtaining 5. Spending 2. Planning 6. Managing Risk 3. Saving 7. Investing 4. Borrowing 8. Retirement & Estate planning 1 -50 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Chapter Summary Learning Objective LO 1. 2 Financial Goals should be: • S = Specific • M = Measurable • A = Action-oriented • R = Realistic • T = Time-based 1 -51 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Chapter Summary Learning Objective LO 1. 3 �Every decision involves a trade-off �Personal opportunity costs: ◦ Time ◦ Effort ◦ Health �Financial opportunity costs ◦ Based on the time value of money 1 -52 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Chapter Summary Learning Objective LO 1. 4 Personal financial planning involves: 1. Determine financial situation 2. Develop financial goals 3. Identify alternative courses of action 4. Evaluate alternatives 5. Create and implement a financial action plan 6. Review and revise the financial plan 1 -53 Copyright © 2016 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.