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1
Spring 2015, BUS-121Financial Planning & Money Management
Frank Paiano – “Paco”Professor, School of Social Studies, Business, and Humanities
Financial Planning and Money Management
Welcome, Everyone!
2
First – A Perspective
“It is a gloomy moment in history. Never has the future seemed so dark and incalculable. The United States is beset with racial, industrial and commercial chaos, drifting we know not where. Of our troubles, no one can see the end.”
Harper’s Magazine, 1847
3
CHAPTER 1Personal Financial Planning in Action
“It is not money that brings happiness, it is lots of money.” – Old Russian Proverb
4
Financial Planning, Definition Personal financial planning is the process of
managing your money to achieve personal economic satisfaction (our book’s definition)
Other definitions: The ability to use knowledge and skills to manage one's
financial resources effectively for lifetime financial security The process of realizing more enjoyment from income and
improving one’s standard of living while making adequate arrangements for a secure and comfortable retirement
The process of identifying assets, determining the classification of those assets in regard to both current and future needs, analyzing debt, expenses, and consumption patterns, reviewing tax status, and addressing a host of other issues and concerns
How would you define personal financial planning?
5
The Benefits of Financial Planning There are several advantages of effective
personal financial planning Increased effectiveness in obtaining, using, and
protecting your financial resources Increased control of your financial affairs A sense of freedom from financial worries obtained
by being able to look optimistically toward the future
Improved personal relationships What is the number 1 reason for divorce in America?
6
Developing a Flexible Financial Plan
A financial plan is a formalized report that... Summarizes your current financial situation Analyzes your financial needs Recommends future financial activities
Your financial plan can be created by you, done with assistance from a financial planner, or made using a money management software package
7
The Financial Planning Process
1. Determine your current financial situation
2. Develop your financial goals
3. Identify alternative courses of action
4. Evaluate your alternatives Keep in mind opportunity costs and risks
5. Create and implement a financial action plan Write it down!
6. Reevaluate and revise your plan
“My Goodness! Does anybody really do all this?!”
8 What is a More Realistic and TypicalFinancial Planning Process?
1. Make money2. Spend it3. Make some more money4. Spend that …
… and then spend some more
5. Go into debt6. Panic! 7. Take BUS-121, Financial Planning and
Money Management
“Lots of anybodies have done this!”
9 Simply Put, It All Comes Down to the Choices We Make!
Opportunity cost What you give up by making a choice
The opportunity cost is sometimes referred to as the trade-off of a decision
It cannot always be measured in dollars. Sometimes the cost is your time or your health
Consider the lost opportunities that will invariably result from your decisions
Example/Discussion: “There is no such thing as a free lunch!”
What are the opportunity costs of attending college?
10 Opportunity Costs and Financial Results Evaluated When Making Decisions
PersonalOpportunity Costs
(time, effort, health)
Financial
Opportunity Costs
(interest, liquidity,
safety)
Financial
Acquisitions
(automobile, home, college education,
investments, insurance,
retirement fund, lifestyle)
versus
Your Money or Your Life, Joe Dominguez & Vicki Robinwww.simplelivingforum.net
11 Every Financial DecisionInvolves Evaluating Types of Risk Inflation risk
Rising prices cause lost buying power
Interest-rate risk Affect costs of borrowing and rate of return
Income risk The loss of a job
Personal risk Health or safety
Liquidity risk Higher return may mean less liquidity
Culture of Consumerism risk a.k.a. Die-Working-and-in-Debt-Up-to-Your-Eyeballs risk
Discussion:
Can you guard against all risks?
Should you try?
12
Implementing Your Financial Plan
Developing good financial habits Use a well-conceived spending plan to help you
stay within your income, while allowing you to save and invest for the future
Have appropriate insurance protection to prevent financial disasters
Become informed about tax and investment alternatives
Achieving your financial objectives requires… A willingness to learn, and Appropriate information sources
13
Financial Planning Information Sources
Printed materialsBooks, magazines
Financial institutionsCredit unions, banks, brokerages, etc.
School courses and educational seminars Computer software and on-line information
sourcesThe Internet is an inexhaustible supply
Sometimes useful, sometimes not… Financial specialists
Taking this course is a great start!
14
Influences on Personal Financial Planning
Marital status, household size, and employment Major events
Marriage, Birth or adoption of child, Divorce!, Bankruptcy Values
What are the ideas and principles you consider correct, desirable and important?
Where are you in the Adult Life Cycle stage? “Traditionalist / Mature” – Pre 1946 – 45 million “Baby Boomer” – 1946 to 1964 – 76 million “Gen Xer” – 1965 to 1981 – 59 million “Millennial” – 1981 to 2000 – 76 million
(a.k.a. Digital Generation, Gen Y) The next generation? – After 2001 – 60 million
Life situation and personal values
Source: U.S. Census
15
Millennial tee-shirt worn by an SDSU student.
Influences on Personal Financial Planning(continued)
16
Market Forces Supply and demand Production costs and competition
Financial institutions Influence of the Federal Reserve Bank and the
global financial markets Global influences
Level of exports and imports Economic conditions....
Economic factors:
Influences on Personal Financial Planning(continued)
17
Changing Economic Conditions
Consumer Prices and Inflation Consumer Spending Interest Rates Money Supply Unemployment Housing Starts GDP: Gross Domestic Product Trade Balance (a.k.a. Trade Inbalance!) Budget Deficit Financial Markets
But since none of us has much, if any, control over these matters, we will focus on the things that we can and do have control over.
18
Components of Financial Planning
Planning (chapters 1, 2) Taxes (chapter 3) Saving (chapter 4) Borrowing (chapter 5) Spending (chapters 6, 7) Managing risk (chapters 8, 9, 10) Investing (chapters 11, 12, 13) Retirement and estate planning (chapter 14)
19
Developing Personal Financial Goals
Types of financial goals include those... Influenced by the time frame in which you want to
achieve your goals Influenced by the financial need that drives your
goals
Timing of goals must be identified Short-term, intermediate-term and long-term goals
Financial goals should... Be realistic, be stated in specific, measurable
terms, have a time frame, have a priority, and indicate the action or actions to be taken
20
Timing of Financial Goals
Short-term – up to 1 year “or so” Intermediate-term – 2 to 5 yearsLong-term – more than 5 years
The above are the book’s time frames. Here are mine: Short-term – 1 to 3 years Intermediate-term – 3 to 5, 6 or even 7 years Long-term – 7 years or longer (10 to 30 years)
The book’s time frames are more in line with the general consensus within the financial industry (brokerage firms, mutual funds, etc.)
My time frames are more common in the life insurance industry.
21
Financial Goal: Example
Pay off VISA Balance: $3,500 Time frame: Within 12 months Actions to be taken
Reduce dating and clubbing to twice a month Cancel cable service and mobile phone Stop buying coffee at FiveBuck$
Pay extra $300 per month Priority: High
Which time frame does this belong to?How would you measure the success of the goal?
Is the goal reasonable?
22
Financial Goal: Example
Save up for a Home Theater system Amount needed: $2,000 Time frame: Within 12 months Actions to be taken
Take part-time job at Home Cheapo Put $150 per month into a special savings
account at the bank Priority: Medium
23
Financial Goal: Example
Save for down payment on a condo Amount needed: $15,000 Time frame: 5 years Actions to be taken
Set up $200 automatic investment per month to be taken from our checking account
Expected rate of return: 7% Priority: High
Will $200 per month at 7% be enough to reach this goal?We are going to learn how to calculate the future value of
this stream of investments.
24
Non-Financial Goal: Example
Be able to do 15 “good” push-ups Can currently only do 7 “good” push-ups Time frame: Within 3 months Actions to be taken
Start with 7 push-ups, three times a day Increase by 2 or 3 push-ups every three to four
weeks Work up to 15 push-ups within 3 months
Priority: Medium
Is this goal reasonable?
25
Goal Setting
Which of the following goals would be the easiest to implement and measure its accomplishment?
A. Spend less so we can save more each month
B. Save $10,000 for a down payment on a condo
C. Save $100 each month to create a $4,000 emergency fund in 40 months by canceling the cable service
D. Save enough for a $4,000 vacation next year
The correct answer is (C).
26
The Financial Goal of Most Americans
Spend everything that you earn!And then spend some more!
Most Americans Live Beyond Their Means
Discussion: How do we do it? Why do we do it?
“Honey, Can We Make It to the Next Paycheck?”
27
The Most Important Financial Goal!
Spend less than you earn!
“MAKE L VE, NOT LOAN$!”
“Pay Yourself First” – 10%?
“Live Beneath Your Means”
28
Is 10% a reasonable goal?
The Most Important Financial Goal!(continued)
Pay Yourself First By having the money come out of your
paycheck or checking account automatically, most individuals easily adjust to investing
Works like a pay raise, only in reverse
The 10% Solution Many financial planners recommend saving at
least 10% of your income for long-term, compounded growth
The Wealthy Barber, David Chilton
29
The Wealthy Barber, David Chilton
“The magic of compound interest. Thirty dollars a month, a dollar a day, can magically turn into over a million dollars. And do you know what is even more impressive? You know someone who has done it,” Roy, our barber, said proudly.
“Thirty-five years ago, I started my savings with thirty dollars a month, approximately 10% of my earnings. I have achieved just under 13% return per year. In addition, as my income rose, my savings rose accordingly. Thirty dollars a month became sixty dollars, then a hundred, and eventually hundreds of dollars a month.”
“You three are looking at a very wealthy man.”
The Most Important Financial Goal!(continued)
30
The Wealthy Barber, David Chilton
“One of my early students only followed the ‘Pay Yourself 10% First’ lesson. He bought the wrong life insurance, abused credit cards, overpaid for his mortgage, did not take advantage of his 401(k) at work, and lost all $15,000 of an inheritance playing the commodities market.” “This is a real upbeat, encouraging story, Roy,” said Tom.“Today, his net worth is $850,000, Tom. $300,000 of it is the equity in his house but the rest is his 10% savings.”“He did everything else wrong but –” Cathy started.“Because he had saved 10% of each paycheck and invested it for long-term, compounded growth, today he is in great shape,” Roy finished.
The Most Important Financial Goal!(continued)
31
The Rule of 72
But let us get more precise…
A Quick ‘n’ Dirty Method for Calculating Compound Interest (or Inflation) Divide the interest (or inflation) rate into 72 That is approximately how long it will take the
amount to double Example: 10% Interest Rate
72 / 10 = 7.2 years – It will take about 7 years for your investment to double if you earn 10%
Example: 3% Consumer Price Index (inflation) 72 / 3 = 24 years – It will take about 24 years for
prices to double if inflation runs about 3%
32
Simple versus Compound Interest
Simple InterestInterest = Principal * Rate * TimeInterest = $100 * 6% * 1 year = $6.00In one year you have $106 ($100 + $6.00)
Compound InterestBut the next year, you will earn interest on your interest…$106 x 6% x 1 = $6.36After the next year, you will have $112.36
I know what you are thinking, “Big Deal, Paiano!”
33
Time Value of Money
(discounting)
Present
AmountNow
Future
Value(compounding)
ValueAmount
Later
Increases in an amount of money as a result of interest earned
34
Future Value of Money
The amount to which a sum you invest now will increase based on a specified interest rate and time period Future value is also called compounding Future value can be computed for a single
amount – a.k.a. a lump sum or principal Future value can also be determined for a series
of deposits – a.k.a. stream of investments, “annuity”
Start investing now to take advantage of the future value of money.
35
Future value formula for Lump Sum Principal
(continued)
Future Value = Principal * (1 + Rate)Time
Future value formula for Series of Deposits
(1+Rate)Time - 1Future Value = Deposit * ──────────
Rate
Do not worry about the math. We use the future value of money tables.
Future Value of Money
36
Present Value of Money The current value for a future amount
based on a certain interest rate and a certain time period Present value is also called discounting Present value of a single lump sum Present value of a series of withdrawals
Not only is present value harder to comprehend, it is also not as important for
personal finance. (We use present value extensively in the BUS-123, Introduction to
Investments, class.)
37
Present value formula for Lump Sum
(continued)
Lump SumPresent Value = ───────────
(1 + Rate)Time
Present value formula for Series of Withdrawals 1
1- ───────
(1+Rate)Time
Present Value = Deposit * ─────────── Rate
Please do not drop the class. We are not going to do any present value calculations.
Present Value of Money
38
Future Value of Money
Okay, let us do some exercises…
Future value handouts
39
Hope For Your Future
Data as of December 31, 2014
40
Financial Aspects of Career Planning
A Job – An employment position obtained mainly to
earn money, without regard for interests or opportunities for advancement
A Career – A commitment to a profession that requires
continued training and offers a clear path for occupational growth
Do you have a Job or a Career?
“A job is something you do for a paycheck. A career is something you do regardless of the paycheck.”
41
How Education Relates to Income
Source: U.S. Census Bureau, 2010http://www.census.gov/hhes/www/cpstables/032011/perinc/new03_028.htm
Level of Education Annual Lifetime
High School Graduate $35,035 $1,401,400
Associate’s Degree $42,419 $1,696,760
Bachelor’s Degree $55,864 $2,234,560
Master’s Degree $68,879 $2,755,160
Doctorate Degree $91,492 $3,659,680
Professional Degree $101,737 $4,069,480
42 Service Industries Expected to Havethe Greatest Employment Potential
Computer Technology Health Care Business Services Social Services Sales and Retailing Hospitality and Food Services Management and Human Resources Education Financial Services
“Biotechnology.”
43
But What Is Your Career Goal? Most people believe you must become a
doctor or lawyer or high-powered executive to become wealthy But what if you want to be a writer or a teacher
or an artist or a janitor or mechanic or plumber? Can you become wealthy while doing what
you love... Even if it does not command a large salary?
As we saw, the answer is, “Yes!”
The key is to set a goal for yourself & start investing early.In fact, your career is not your most important financial decision.
But if your career is not your most important decision, what is?
44 What is Your Most Important Financial Decision?
Who You Marry!
And then subsequently divorce …
“Marriage is grand. Divorce is more like $100 grand.” – Anonymous
45
The Millenials Go To Work
“They are ambitious, they are demanding and they question everything, so if there is not a good reason for that long commute or late night, do not expect them to do it. When it comes to loyalty, the companies they work for are last on their list – behind their families, their friends, their communities, their co-workers and, of course, themselves.
But there are a whole lot of them. And as the baby-boomers begin to retire, triggering a … worker shortage, businesses are realizing that they may have no choice but to accommodate these curious Gen Y creatures. Especially because if they do not, the creatures will simply go home to their parents, who in all likelihood will welcome them back.”
http://money.cnn.com/magazines/fortune/fortune_archive/2007/05/28/100033934/index.htm
Fortune says…
46
The March of Civilization
Hunting & Gathering
AgrarianSimpleAdvanced
Industrial
Information (?)
60 to 80 hours per
week
40 hours per week
25 hours per week?
25 hours per week
47
Our Secret Weapons!
48
“Choose a job you love, and you will never have to work a day in your life.”
Confucius
Could not have said it better myself…