I. Financial Planning SPEND MONEY WISELY - Personal Financial Planning- the best way to achieve financial objectives to define our financial goals and develop appropriate strategies to reach them. Creating flexible plans and regularly revising them is the key to building a sound financial future. Successful financial planning also brings rewards that include greater flexibility, an improved standard of living, wise spending habits, and increased wealth. Effective, consistent plan can help your resources wisely. Careful planning increases the chance that your financial goals will be achieved and that you will have sufficient flexibility to handle such as contingencies such as illness, job loss, and even financial crises. IMPROVING YOUR STANDARD OF LIVING Personal financial planning- learn to acquire, use and control our financial resources more efficiently. - Allows to gain more enjoyment from our income and thus to improve our standard of living- the necessities, comforts and luxuries we desire. Quality of life is closely tied to our standard of living. Geographic location, public facilities, local cost of living, pollution, traffic and population density- also affect quality of life, wealth is commonly viewed as a key determinant. Material items such as a house, car and clother and money available for health care, education, art, music, travel and entertainment all contribute to quality of life. Many so-called wealthy people live “plain” lives choosing to save, invest or support philanthropic organizations with their money rather than indulge themselves with luxuries. Two-Income family (1970s) - - - One trend with a profound effect on our standard of living. It was relatively rare in the early 1970s but has become commonplace today and the incomes of millions of families have risen sharply as a result. About 75% of married adults state that they and their mate share all their money, while some partners admit to having a secret stash of cash. Two incomes buy more, but also requires greater responsibility to manage the money wisely. - - Spending money wisely is a major benefit of financial planning. Determining your current and future spending patterns is an important part of personal money management. The goal is to spend money to get the most satisfaction from each currency Current Needs - Your current spending level is based on the necessities of life and your average propensity to consume. Average propensity to consume- percentage of each dollar of income, on average, that is spent for current needs rather than savings. - A minimum level of spending would allow to obtain only the necessities of life: food, clothing and shelter. - People with high average propensities to consume earn low income and spend a large portion of it for basic necessities - Many “ultra-consumers” choose to splurge on a few items and scrimp elsewhere; these people also exhibit high average propensities to consume. - Individuals earning large amounts quite often have low average propensities to consume, in part because the cost of necessities represents only a small portion of their income. - Two people with significantly different incomes could have the same average propensity to consume because of differences in their standard of living. - The person making more money may believe it is essential to buy better-quality items or more items and will thus, on average, spend the same percentage of each dollar of income as the person making far less. Future Needs - - You should set aside a portion of current income for deferred, or future spending. Placing these funds in various savings and investment vehicles allows you to generate a return on your funds until you need them. Deferred spending include saving for a child’s education, primary residence of vacation home, a major acquisition (such as a car or home entertainment center), or even a vacation. - - - The portion of current income we commit to future needs depends on how much we earn and our average propensity to consume. The more we are and the less we devote to current spending, the more we can commit to meeting future needs. Some portion of current income should be set aside regularly for future use. 1 ACCUMULATING WEALTH - - - - Our assets largely determine how wealthy we are. - Personal financial planning plays a critical role in the accumulation of wealth by directing our financial resources to the most productive areas. One’s wealth depends on the value of all the items that the individual owns. Wealth consists of financial and tangible assets Financial assets- are intangible, paper assets such as savings accounts and securities. (earning assets that are held for the returns they promise) Tangible assets- physical assets, such as real estate and automobiles. It can be held for either consumption (house, car, artwork or jewelry) or investment purposes (duplex purchased for rental income). The goal of most people is to accumulate as much wealth as possible while maintaining current consumption at a level that provides a desired standard of living. - Must be stated in monetary terms because money and the satisfaction it can buy, is an integral part of financial planning. The Role of Money Money- medium of exchange used to measure value in financial transactions - It would be difficult to set specific personal financial goals and to measure progress toward achieving them without the standard unit of exchange provided by the dollar. - Most of the people want utility, the amount of satisfaction received from buying certain types or quantities of goods and services. - The added utility may result from the actual usefulness of the special feature or from the status it’s expected to provide or both. THE PSYCHOLOGY OF MONEY - Your personal value system- the important ideals and beliefs that guide your life-will also shade your attitude toward money and wealth accumulation. - Financial goals and decisions are consistent with your financial values. - Money is a primary motivator of personal behavior because it has a strong effect on self-image. MONEY AND RELATIONSHIPS THE PERSONAL FINANCIAL PLANNING PROCESS Personal Financial Planning- a systematic process that considers the important elements of an individual’s financial affairs and is aimed at fulfilling his or her financial goals. - Knowing what you need to accomplish financially and how you intend to do it, gives you an edge over someone who merely reacts to financial events as they unfold. Steps in the Financial Planning Process 1. Define financial goals 2. Develop financial plans and strategies to achieve goals. 3. Implement financial plans and strategies 4. Periodically develop and implement budgets to monitor and control progress toward goals 5. Use financial statements to evaluate the results of plans and budgets, taking corrective action 6. Redefine goals and revise plans and strategies as personal circumstances change. - Parents play an important role in financial planning. TYPES OF FINANCIAL GOALS - Financial goals cover a wide range of financial aspirations: controlling living expenses, meeting retirement needs, setting up a savings and investment program and minimizing your taxes. - Goals should be realistic and attainable. - It is important to involve your immediate family in the goal-setting process. - When family members “buy into” the goals, it eliminates the potential for future conflicts and improves the family’s chances for financial success. - After defining and approving your goals, you can prepare appropriate cash budgets - You should assign priorities and a time frame to financial goals - Normally, long-term financial goals are set first, followed by a series of corresponding short-term and immediate goals Define Financial Goals Financial goals- results that an individual wants to attain 2 PUTTING TARGET DATES ON FINANCIAL GOALS - Financial goals are most effective when they are set with goal dates. - Goal dates – target points in the future when you expect to have achieved or completed certain financial objectives Long-Term Goals - Should indicate wants and desires for a period covering about 6 years out to the next 30 or 40 years - It’s important to recognize that long-term goals are bound to change over time and you’ll need to revise them accordingly - If conservative, adjust them to a level that encourages you to make financially responsible decisions rather than squander slush funds Short-term goals and Intermediate Goals Short term goals - Are set each year and cover a 12-month period - Includes making substantial, regular contributions to savings or investments in order to accumulated desired net worth - Key input for the cash budget, a tool used to plan for short-term income and expenses. - To define short-term goals, consider your immediate goals, expected income for the year and long-term goals. - Includes establishing an emergency fund with 3 to 6 months’ worth of income (serves as safety reserve for financial emergencies) Intermediate goals - Bridge the gap between short and long-term goals, and both intermediate and short-term goals should be consistent with long-term goals THE LIFE CYCLE OF FINANCIAL PLANS - Financial planning is a fynamic process. - Personal financial planning life cycle – presents the organizing framework of the entire financial planning process. 3 Personal Finance- process of planning your spending, financing and investing to optimize your financial situation. Personal financial plan- specifies your financial goals and describes the spending, financing and investing plans that are intended to achieve those goals - Poor financial finance decisions can cause you to borrow excessively, to the point at which you might not be capable of repaying your debt COMPONENTS OF FINANCIAL PLAN 1. 2. 3. 4. 5. 6. Budgeting and tax planning Managing your liquidity Financing your large purchases Protecting your assets and income (insurance) Investing your money Planning your retirement and estate 1. A PLAN FOR YOUR BUDGETING AND TAX PLANNING Budget planning (budgeting) – is the process of forecasting future expenses and savings. - Requires to determine how you spend money, the amount of money to spend and how much to save. - Spending decisions are critical as they determine how much of your income can be used for other purposes. - Help to estimate how much of your income will be required to cover monthly expense to set goal for saving each month - Enables to build net worth by setting aside part of income to either invest in additional assets, or reduce liabilities Big spenders- focus their budget decisions on how to spend most or all of their income, and therefore have little or no money left for saving Big savers- set a savings goal and consider spending their income received only after allocating a portion of it toward saving. STEPS IN BUDGETING 1.1. Evaluate your current financial position by assessing your income, expenses, assets and liabilities. - Net worth – value of what you own minus the value of what you owe - As you save money, you increase your assets and net worth. - Budget is influenced by income, which in turn is influenced by education and career decisions. - A key part of budgeting is estimating the typical expense that typically occur each month. - Underestimating expense will need more cash inflows that what you expected to cover your cash outflow. - Many financial decisions are affected by tax laws. 2. A PLAN TO MANAGE YOUR LIQUIDITY - Access to funds to cover any short-term cash needs, and enhance through utilizing money management and credit management. Money management- involves decisions regarding how much money to retain in a liquid form and how to allocate the funds among short-term investments. - No access to money to cover cash needs means insufficient liquidity, Credit management- involves decisions about how much credit you need to support your spending and which sources of credit to use. - Credit is used to cover both large and small expenses when you are short in cash, so it enhances your liquidity. - only use when necessary to avoid paying borrowed funds with interest 3. A PLAN FOR LARGE PURCHASES - Loans are typically needed to finance large expenditures. - The amount of financing needed is difference between the amount of the purchase and the amount of money available/ - Managing loans determines how we can afford to borrow depending on maturity and selection of type of loan. 4. A PLAN FOR PROTECTING YOUR ASSETS AND INCOME - Conduct insurance planning, which determines the types and amount of insurance that you need. - Automobile and home-owner’s insurance protect your assets - Heath insurance limits potential medical expense - Disability insurance and life insurance protect your income 5. A PLAN FOR INVESTING YOUR MONEY - Any funds that you have beyond what you need to maintain liquidity should be invested. - These funds normally are not used to satisfy the liquidity needs, they can be invested with the primary objective of earning high return. 4 - Most investments are subject to risk (uncertainty for potential returns) - If cash inflows are less than outflows, you use liquidity management to withdraw savings or obtain funds from another source of income. 6. A PLAN FOR YOUR RETIREMENT AND ESTATE Retirement planning- determining how much money you should set aside each year for retirement and how you should invest those funds. - Begin before retiring. - Money is protected from taxes until it is withdrawn from the retirement account Estate planning- act of planning how your wealth will be distributed before or upon your death - Effective estate planning protects your wealth against unnecessary taxes and ensures that your wealth is distributed in the manner that you desire. BUILDING YOUR OWN FINANCIAL PLAN PART 3: PERSONAL FINANCING - Summarizes financing. - Financing is needed to support large purchase. - Decisions will affect cash outflow. - An effective financial plan enhances your net worth and builds wealth. HOW FINANCIAL PLANNING AFFECTS YOUR CASH FLOW PART 1: TOOLS FOR FINANCIAL PLANING - Budgeting allows you to plan how you will use the cash you receive in a given period. - Salary is the source of cash inflows and budget decisions determine the spending habits and amount of cash outflows each month. PART 4: PROTECTING YOUR WEALTH - Explains how to use insurance to protect your assets and your income. PART 5: PERSONAL INVESTING PART 2: MANAGING YOUR LIQUIDITY - When cash inflows exceed outflows, you use liquidity management to decide how much of this cash should be allocated to savings at your financial institution. - Focuses on investing. - Determine how much money to allocate for investments and how much cash these investments generate over time 5 STEP 3: IDENTIFY AND EVALUATE ALTERNATIVE PLANS THAT COULD ACHIEVE YOUR GOALS - Pursuing additional education- achieve the credentials to obtain the career and income level that you desire to fulfill your long-term financial goals. - Selecting your major - Selecting your college - Establishing a strategy to accumulate wealth PART 6: RETIREMENT AND ESTATE PLANNING - Focuses on retirement and estate planning. - Determines cash outflow that contributes to retirement account while working - It will affect the degree at which the value of your retirement account grows over time and therefore will determine how much cash inflows you will receive during retirement. STEP 4: SELECT AND IMPLEMENT THE BEST PLAN FOR ACHIEVING YOUR GOALS - analyze and select the plan that will be most effective in achieving your goals - Using the internet – provides valuable information for making financial decisions STEP 5: EVALUATE YOUR FINANCIAL PLAN After you develop and implement each component of your financial plan, you must monitor your progress to ensure that the plan is working as you intended. Keep your financial plan easily accessible so that you can evaluate it over time. STEP 6: REVISE YOUR FINANCIAL PLAN DEVELOPING FINANCIAL PLAN STEP 1: ESTABLISH YOUR FINANCIAL GOALS Type of financial goals - General goals in life influence financial goals. Set realistic goals Timing of goals - If you find that you are unable or unwilling to follow the financial plan that you developed, you need to revise the plan to make it more realistic. - As time passes, your financial position will change, especially with specific events such as graduating from college, marriage, a career change, or the birth of a child. As your financial position changes, your financial goals may change as well. You need to revise your financial plan to reflect such changes in your means and priorities. STEP 2: CONSIDER YOUR CURRENT FINANCIAL POSITION Your decisions about how much money to spend next month, how much money to place in your savings account, how often to use your credit card, and how to invest your money depend on your financial position. Economic Impact Economic conditions affect the types of jobs that are available to you and the salary offered by each type of job. They also affect the price you pay for services such as rent, the value of assets (such as a home) that you own, and the return that you can earn on your investments. 6
