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Copyright ©2004 Pearson Education, Inc. All rights reserved.
Chapter 1
Overview of a Financial Plan
Copyright ©2004 Pearson Education, Inc. All rights reserved. 1-2
Chapter Objectives
• Introduce the subject of personal finance
• Identify the key components of a financial plan
• Outline the steps involved in developing your financial plan
Copyright ©2004 Pearson Education, Inc. All rights reserved. 1-3
Definitions
• Personal finance: the process of planning your spending, financing, and investing so as to optimize your financial situation
• Personal financial plan: a plan that specifies your financial goals and describes the spending, financing, and investing plans that are intended to achieve those goals
Copyright ©2004 Pearson Education, Inc. All rights reserved. 1-4
Definitions
• Opportunity cost: what you give up as a result of a decision
Copyright ©2004 Pearson Education, Inc. All rights reserved. 1-5
How You Benefit From An Understanding of Personal Finance
• Make your own financial decisions– Every spending decision has an
opportunity cost
• Judge the advice of financial advisors– Make informed decisions
• Become a financial advisor– Many career opportunities available
Copyright ©2004 Pearson Education, Inc. All rights reserved. 1-6
Components of a Financial Plan
• 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
Copyright ©2004 Pearson Education, Inc. All rights reserved. 1-7
A Plan for Your Budgeting and Tax Planning
• Budget planning: The process of forecasting future expenses and savings
• Evaluate your current financial position– Assets: what you own– Liabilities: what you owe– Net worth: the value of what you own
minus the value of what you owe
Copyright ©2004 Pearson Education, Inc. All rights reserved. 1-8
Budgeting and Tax Planning
Exhibit 1.1: How a Budget Affects Savings
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A Plan to Manage Your Liquidity
• Liquidity: access to funds to cover any short-term cash deficiencies
• Money management: decisions regarding how much money to retain in a liquid form and how to allocate the funds among short-term investment instruments
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A Plan to Manage Your Liquidity
• Credit management: decisions
regarding how much credit to obtain to
support your spending and which
sources of credit to use
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Managing Your Liquidity
Exhibit 1.2: Managing Your Liquidity
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A Plan for Your Financing
• Loans often needed for large expenditures– College tuition, car, house
• Managing loans– How much can you afford to borrow?
– Determining maturity of the loan
– Selecting a loan with a competitive interest rate
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Financing Your Large Purchases
Exhibit 1.3: Financing Process
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A Plan for Your Investing
• Funds not needed for liquidity can be invested
– Stocks, bonds, mutual funds, real estate
• All investments have some level of risk
• Risk: uncertainty surrounding the potential return on an investment
Copyright ©2004 Pearson Education, Inc. All rights reserved. 1-15
A Plan for Your Retirement and Estate• This includes insurance planning, retirement
planning, and estate planning
– Retirement planning: determining how much money should be set aside each year for retirement and how those funds should be invested
– Estate planning: determining how your wealth will be distributed before or upon your death
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Exhibit 1.4: Components of Your Financial Plan
Components of Your Financial Plan
Copyright ©2004 Pearson Education, Inc. All rights reserved. 1-17
How the Text Organization Relates to the Financial Plan’s Components
• Each of the six parts of the text covers one specific component of the financial plan
• An effective financial plan enhances net worth and builds wealth
• Follow the steps to a complete financial plan at the end of the school term
Copyright ©2004 Pearson Education, Inc. All rights reserved. 1-18
How the Text Organization Relates to the Financial Plan’s Components
• How the components relate to your cash flows
– Cash inflows are cash that you receive
– Cash outflows are cash that you spend
– Budgeting balances income and spending
– Liquidity deals with cash excesses or shortages
Copyright ©2004 Pearson Education, Inc. All rights reserved. 1-19
How the Text Organization Relates to the Financial Plan’s Components
– Financing focuses on obtaining cash for large purchases or repaying loans
– Protect assets and income by using cash for insurance and retirement
– Investing uses cash to build wealth
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How Financial Planning Relates to Cash Flow
Exhibit 1.6: How Financial Planning Affects Your Cash Flows
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Developing the Financial Plan
• Step 1. Establish Your Financial Goals– Types of goals
• Car, home, college, wealth, charity
– Set realistic goals• Stronger likelihood of reaching goals
– Timing of goals• Short term (within one year)• Intermediate (between 1–5 years)• Long term (beyond five years)
Copyright ©2004 Pearson Education, Inc. All rights reserved. 1-22
Developing the Financial Plan
• Step 2. Consider Your Current Financial Position– How your future financial position is tied to
your education• Consider your skills, interests, and career paths
– How your future financial position is tied to your career choice
• Choose a career that will be enjoyable and suit your skills
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Developing the Financial Plan
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Developing the Financial Plan
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Developing the Financial Plan
• Step 3. Identify and Evaluate Alternative Plans That Could Achieve Your Goals– Plans could be conservative or aggressive
• Step 4. Select and Implement the Best Plan for Achieving Your Goals– The Internet has valuable financial
planning information
Copyright ©2004 Pearson Education, Inc. All rights reserved. 1-26
Developing the Financial Plan
• Focus on Ethics: Personal Financial Advice– Your objective is to get the best advice
appropriate to your needs
– Be wary of unethical behavior• Difficult to discern
– Be wary of incompetent advice• Be alert, ask questions, carefully consider advice
Copyright ©2004 Pearson Education, Inc. All rights reserved. 1-27
Developing the Financial Plan
• Step 5. Evaluate Your Financial Plan– Keep plan in an accessible place and
monitor your progress
• Step 6. Revise Your Financial Plan– Change plan as financial condition and
financial goals change
Copyright ©2004 Pearson Education, Inc. All rights reserved. 1-28
How the Internet Facilitates Financial Planning
• The Internet provides information on all aspects of financial planning– Bank deposit rates
– Prices of cars and homes
– Financing rates
– Prices of investments
– Insurance premiums
Copyright ©2004 Pearson Education, Inc. All rights reserved. 1-29
How the Internet Facilitates Financial Planning
• Provides updated information on all parts of your financial plan
– Current tax rates and regulations
– Investment performances
– Online calculators
Copyright ©2004 Pearson Education, Inc. All rights reserved. 1-30
How the Internet Facilitates Financial Planning
1.1 Financial Planning Online: Should You Pursue a Career in Financial Planning?
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Financial Planning Online: Financial Planning Tools for You
• Go to http://finance.yahoo.com
• This website provides much information and many tools that can be used for all aspects of financial planning.
• It also provides information for creating retirement plans and wills.
Copyright ©2004 Pearson Education, Inc. All rights reserved. 1-32
Integrating Key Concepts
Copyright ©2004 Pearson Education, Inc. All rights reserved. 1-33
Looking Ahead
• Part 1: Financial Planning Tools– Chapter 1 showed an overview of a financial plan
– Chapter 2 teaches personal financial statements
– Chapter 3 teaches time value of money
– Chapter 4 teaches tax planning
• Part 2: Liquidity Management• Part 3: Financing• Part 4: Protecting Your Wealth• Part 5: Investing• Part 6: Retirement and Estate Planning