PERSONAL FINANCE PRIMER
Covering Your Bases!
DEBT: Using Debt Wisely
I. CREDIT CARDS
1. Advantages:
– Interest Free Loan
• Know your billing date
• Grace period: 25-30 days
– Simplified Record Keeping
– Convenience
– Simplifies return of goods and resolution of
purchase disputes
– Emergencies
Debt (cont…)
2. Disadvantages
– Tendency to Overspend
• Undisciplined sense of buying power not
supported by available income
– High Interest costs
• 12% Annual Percentage Rate
• Minimum Payment: $30/month
– Assume $1000 Credit Card balance
– It will take 41 months to pay off your $1000
credit card balance with a total payment of
$1223.00
INTEREST RATES
Interest rates on credit cards are the highest of
any form of consumer credit.
Rates, 10.6-13.5%
–
–
–
–
National average nearly 12%
Variable rate, tied to prime leading rate
Rates will vary from Bank to Bank, so shop around
If you are carrying a balance, interest will be charged
on your old balance purchases
– On cash advances, interest begins on the day the
advance is taken
OTHER FEES:
–
–
–
–
Annual Fees
Late Payment Fees
Over-the-Limit Fees
Transaction Fees – Typically on Cash Advances
HOW MUCH CREDIT?
Be sure your monthly repayment burden does
not exceed 20% of your monthly take-home pay.
Recommended debt safety ratio
- 10% to 15% of your take-home pay
Debt Safety Ratio = Total Monthly Consumer Credit Payments @
Monthly Take-Home Pay
@ excludes monthly mortgage payment
• Remember, if credit is used properly, it can help
you manage your finances. Misuse it and it is
big-time trouble.
Average credit card holder has 11 cards
Approximately $3,300 in annual charges
Average unpaid balance of about $1,700
Danger Signs of Using Too Much Credit:
Regular Impulse buying
Postdating checks to keep them from bouncing
Regularly exceeding borrowing limit
Taking 60-90 days to pay bills that should be paid in 30
days
Borrowing to meet normal living expenses
Using one credit card to make payments on another
Using more than 20% of take home pay on consumer
debt, credit card bills
Dodging collection agencies
Having zero savings
Risk Management
Generally we deal with Risk Exposure by
Aquiring Related Insurance Products
1.
2.
3.
4.
5.
Health Insurance – employer provided
Disability Insurance – employer provided
Home Owner’s Insurance
Auto Insurance
Life Insurance
Life Insurance
Two Purposes for Life Insurance Coverage
1. Primary Purpose
Provide funds for our dependent beneficiaries in the
event of death
2. Secondary Purposes
Estate planning to provide needed liquidity to our
estate and our heirs
Types of Life Insurance
1. WHOLE LIFE
Includes an insurance feature and a
savings/investment feature
Premium costs are fixed and high
2. TERM LIFE
Remains in existence for a certain term (period) and
then expires
This is ‘pure’ insurance coverage and is less expensive
than whole life
You can get the most insurance coverage for the
lowest premium cost
Negative – premium costs will continue to rise as we
age
***IMPORTANT: Before you buy an insurance coverage check the financial stability
rating of the insurance company. Look for an A.M. Best rating of A++
Saving Vs. Investing
Saving: Primarily for funds we may need
in a short period of time.
Major Concern: Preservation of principle
Selection: choose saving investments of
low risk



Savings Accounts
Money Market Accounts
Short Term Certificates of Deposit
HOW MUCH SHOULD I
HAVE IN SAVING?
3 Months to 6 months
take home Pay
WHY?
To cover
unanticipated Financial
Shocks
 e.g.:
Employer downsizing –
lost our job
* WARNING: BE CAREFUL OF INFLATION
Inflation
What is it?
Why do you have to be concerned about it?
Example:
Assume
- We have $100
- Pizza (only consumer item available) costs $5 each. Therefore we can
purchase 20 pizzas.
- We can invest $100 @ 15.5%
- We will have $115.50, 1 year from now
- The inflation rate is 5%, so
- Pizza will cost $5.25 1 year from now.
Therefore $115.50 - $5.25 = 22 pizzas
Notice: We have a 15.5% return on our financial assets, however, the
number of pizzas we can consume only increased from 20 to 22 pizzas.
Inflation (cont…)
What if you invested your $100 and Received a 5% Rate of
Return, equal to the Inflation?
- 1 year later you have $105
- Pizza also increased 5%
$5.25/each
- You can buy 20 pizzas
This is exactly the same number of Pizzas you could have
purchased a year earlier for your $100.
You now have more dollars $105, but the quantity of Pizzas
you could purchase has remained the same.
-
STAGNATION!
Your standard of living has not changed.
Investing
Taking prudent, reasonable risks with your
money in order to earn the higher returns
that may be necessary to achieve your
financial goals.
Warning:
- All investments involve some risk
- The Value of Your Investment Portfolio may
decline
- No guarantee that you will have gains
Four Issues to Address Before
Beginning An Investment
Program
1.
2.
3.
4.
Determine
Determine
Determine
Determine
situation
your
your
your
your
financial goals
time horizon
risk tolerance level
personal financial
Individual Stocks Vs. Mutual Funds
Limited Funds to Invest?
- Do not invest in individual stocks!
Diversification
- Easier to achieve by buying mutual funds
What Are Mutual Funds And How
Do They Work?
The idea behind Mutual Funds Is Simple:
 Many people pool their money together into a fund
 The investment advisor invests their money in various


securities
Each investor shares proportionality in the fund’s
investment returns
The investment returns consist of the dividend or
interest income paid on the Securities, and any capital
gains or losses caused by sales of the securities
Advantages of Mutual Funds
Diversification
Professional Management
Liquidity
Convenience:
- Fund shares can be bought/sold (mail, telephone,
internet)
- Easy to move money from one fund to another
- Automatic Investing
- Automatic Transfers from a fund to your bank account
- Record Keeping Services
Disadvantages of Mutual Funds
No Guarantees
Diversification “Penalty”
Potentially High Costs
Tax Impact
General Risk Levels & Types of
Investments
Lowest Risk:
- Money Market Mutual Funds
- Large Certificates of Deposit, US Treasury Bills, Commercial Paper
Low Risk:
- Short Term Bond Funds
- Gov’t and Corporate
Medium Risk:
- Mid-Term Bond Funds
- Gov’t and Corporate (Investment Grade)
- Balanced Funds
- Equity Income Funds
- Index Funds
General Risk Levels and Types of
Investments (cont…)
Higher Risk:
- Growth & Income Funds
- Growth Funds
- Long-Term Bond Funds
Highest Risk:
- Aggressive Growth Funds
Morning Star Style Boxes
For Equity Funds
VALUE
LARGE CAP
GROWTH
Meridian Value
Fund
S & P 500
Index
American Funds
- Euro Pacific
Growth
- Growth Fund of
America
Mid Cap Value
Index
American Funds
- Capital Income
Builder
Mid Cap Growth
Index
Small Cap Value
Index
American Funds
- Small Cap World
Fund
Small Cap Growth
Index
MID CAP
SMALL
CAP
BLEND
Morning Star Style Boxes
For Bond Funds
CREDIT QUALITY
SHORT
MEDIUM
Money Market
Mutual Fund
American
Funds
- US Gov’t
Securities
Fund
American
Funds
S-T Bond Fund
Of America
American
Funds
- Bond Fund of
America
American
Funds
- Capital World
Bond Fund
LONG
High – Treasury &
Agency
Medium – Corporate
Investment
Grade
Low – Below Investment
Grade
What to Look For Before Buying
Any Particular Mutual Fund
1. The Investment Company that Manages the
Fund
–
Examples: The three largest Fund Companies
• Fidelity
• Vanguard
• American Funds
2. Long-Term Track Record
–
–
5 yr, 10 yr, Life of the Fund
How they performed through both up and down
markets
What to Look For Before Buying
Any Particular Mutual Fund – cont…
3. The Fund Manager
–
One Individual
• Longevity
– Committee
4. Loads and/or Fees
–
–
–
Front end or Backend Load (Sales Charges)
No Loads
Operating Expense
• Investment Advisory Fees, Legal Frees, Accounting Fees,
•
Administrative Expenses
Marketing (12b.1 Fees)
What to Look For Before Buying
Any Particular Mutual Fund – cont…
5. Volatility
– Equity Funds
• Beta
• R – Squared
– Bond Funds
• Duration
Asset Allocation
How you allocate your investment portfolio
between different classes of financial assets.
Various studies have found that the asset
allocation is more important than the actual
selection of securities/investments in
determining your overall investment results.
Experts argue you should hold a mix of
investments from among the asset classes to
help reduce the volatility of your portfolio.
Asset Allocation cont…
Diversification spreads the risk around. A good
performance in one area can temper a sub par
performance in another.
STRATEGY #1
EQUITY
BONDS
CASH
80 %
15%
5%
100%
STRATEGY#2
STRATEGY #3
60%
30%
10%
100%
50%
40%
10%
100%
Individual Retirement Accounts
(IRA)
Roth
Earnings grow tax-free
Retirement withdrawals are free of federal
income taxes
Your contributions are not tax deductible
You can continue to make contributions after
age 70.5.
IRA (cont…)
Contributions
Who can contribute:
- Anyone with earned income and spouses of wage
earners who don’t have any insurance of their own
Income limitation, Single filers - $101000 and
under. Married Filing Jointly - $159,000 and
under. Contribution amounts are phased out at
Modified Adjusted Gross Income Levels above
these amounts
IRA (cont…)
Distributions
Withdraw contributions anytime penalty-free
Withdraw earnings beginning at age 59.5
penalty-free
Income tax on earnings does apply if you’ve
held account for less than 5 years
No required minimum distributions
Roth IRA
Contributions allowed each year,
 2008 - $5000
Assumptions
 Monthly Contributions $416.66
 Term 40 yrs or 480 months
 Rate of Return 10%/yr or .8333%/month
 Future Value = $2,634,991
Change the Assumptions
 Monthly Contributions $250.00
 Term 40 yrs or 480 months
 Rate of Return 10%/yr or .8333%/month
 Future Value = $1,581,020
Remember
 Withdrawals from your Roth IRA are free from Federal Income Taxes