Chapter 1
Personal Financial
Planning in Action
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Personal Financial Planning
Chapter Learning Objectives
LO1.1 Identify social and economic
influences on personal financial
goals and decisions
LO1.2 Develop personal financial goals
LO1.3 Calculate time value of money
situation associated with personal
financial decisions
LO1.4 Implement a plan for these decisions
1-2
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
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
Learning Objective LO1.1
Identify Social and Economic Influences on
Personal Financial Goals and Decisions
• Life situation and personal values (1.6)
• Financial planning in our economy
– Domestic economic influences (1.7)
– Global Influences (1.8)
– Inflation (1.9)
– Interest rates (1.10)
1-5
Life Situation and Personal Values
• Adult life cycle
• Life Situation Factors:
– Marital status, household
size, employment
– Exhibit 1-1 (page 5)
• 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
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
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
1-8
Financial Planning in Our Economy
Inflation
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
1-9
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
1-10
8 Basic Financial Planning
Activities
• Obtaining
• Planning
• Saving
• Borrowing
• Spending
• Managing Risk
• Investing
• Retirement/Estate Planning
Chapter 1
Chapters 2,3
Chapter 4
Chapter 5
Chapters 6,7
Chapters 8-10
Chapters 11-13
Chapter 14
1-11
Learning Objective LO1.2
Develop Personal Financial Goals
•
Time Frames for Achieving Financial Goals:
– Short-term goals . . . . . . . . . . .
– Intermediate goals . . . . . . . . .
– Long-term goals . . . . . . . . . . .
•
within 1 year
1-5 years
> 5 years
Financial Needs Goals:
– Consumable-product goals. . .
– Durable-product goals . . . . . .
– Intangible-purchase goals . . .
Food, clothing
Car, appliances
Education, health
1-12
Goal-Setting Guidelines
The “SMART” Approach
A “goal” that is not written down
is a dream!
Effective Goals should be:
•
•
•
•
•
S = Specific
M = Measurable
A = Action-oriented
R = Realistic
T = Time-based
1-13
Learning Objective LO1.3
Assess Personal and Financial Opportunity
Costs of 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
1-14
Opportunity Costs and
Financial Trade-Offs
Personal
Opportunity Costs
(time, effort, health)
Financial
Opportunity Costs
(Interest, liquidity,
safety )
Financial
Acquisitions
(car, home,
college
education,
investments,
insurance,
retirement fund)
1-15
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
– Skip to slide 30
1-16
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 interest:
Amt in
Svgs
X
Annual
Interest
Rate
X
Time
Period
=
Interest
1-17
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
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
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
Future Value
• The increased value of money from
interest earned
• Amount to which current savings will
increase
• Total amount available in the future
• “Compounding”
1-21
Future Value
Example
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
Future Value Tables
• Appendix Exhibit 1-A = FV of a Single
Amount
– 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 X 2.159 = $1,403.35
1-23
Time Value of Money
Calculation Methods
1-24
Time Value of Money
TVM Websites
• www.moneychimp.com/calculator
• www.dinkytown.net
1-25
Future Value
Series of Deposits
• Table factors = Appendix Exhibit 1-B
• “Annuity” = series of equal deposits at
equal intervals earning a constant rate
• Example:
– Deposit $50 per year at 7% for 6 years
– Appendix Exhibit 1-B factor = 7.153
• Period = 6; % = 7%
– Future Value = $50 x 7.153 = $357.65
1-26
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”
1-27
Present Value Tables
• Appendix Exhibit 1-C = PV of a single
amount
– Multiply Table Factor by amount deposited
– All Future Value factors < 1.0
• Example:
– You want $1,000 five years from now
– You can earn 5% on your money
– Present Value = $1,000 X 0.784 = $784
1-28
Present Value
of a Series of Deposits
• Appendix Exhibit 1-D
• Determine how much you need to
deposit now in order to withdraw a
specific amount for a desired number of
years
• Example:
– You want to withdraw $400/year for 9 years
– Your money is earning 8% per year
– Deposit = $400 X 6.247 = $2,498.80
1-29
The 6-Step Financial Planning
Process
1-30
Learning Objective LO1.4
Implement a Plan for Making Personal
Financial and Career Decisions
1. Determine current financial situation
2. Develop financial goals
3. Identify alternative courses of action
• Continue same course of action
• Expand current situation
• Change current situation (change vehicle)
• Take a new course of action
1-31
Learning Objective LO1.4
Implement a Plan for Making Personal
Financial and Career Decisions
4. Evaluate alternatives
• Consequences of choices
• Evaluate risks
• Financial Planning information
sources
5. Create and implement financial action
plan
6. Review and revise plan
1-32
Financial Planning in Action
1-33
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 work
situation
1-34
Chapter Summary
Learning Objective LO1.1
• Financial decisions are affected by:
– Life situation
– Personal values
– Economic factors
• Major elements of Financial Planning:
1. Obtaining
2. Planning
3. Saving
4. Borrowing
5. Spending
6. Managing Risk
7. Investing
8. Retirement & Estate
planning
1-35
Chapter Summary
Learning Objective LO1.2
Financial Goals should be:
•
•
•
•
•
S = Specific
M = Measurable
A = Action-oriented
R = Realistic
T = Time-based
1-36
Chapter Summary
Learning Objective LO1.3
• Every decision involves a trade-off
• Personal opportunity costs:
– Time
– Effort
– Health
• Financial opportunity costs
– Based on the time value of money
1-37
Chapter Summary
Learning Objective LO1.4
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
1-38