Budgeting – Chapter 10. What is Personal Finance?

Budgeting – Chapter 10

What is Personal Finance?

Saving for the Future – T E R M S

• Budget• Discretionary income• Expense• Fixed expense• Discretionary expense• Principal• Interest• Compound Interest• Annual percentage yield

(APY)

• Securities• Stockbroker• Liquidity• Certificate of Deposit• Maturity Date• Money Market

Account• Share account• Gross income• Variable expense

Needs vs. Wants

• Needs are essentials– Food– Shelter– Clothing– Transportation

• Wants are extras– Eating out– Big, expensive house– Shop till you drop– Brand-new or

expensive car

• During this lesson you will learn more about personal values and how they impact your decision making.

What are Values?

• A value is a belief or practice of what is important, desirable and worthwhile to an individual. Everyone has different values that guide their daily decisions.

Values can be influenced by:• Family • Friends• Teachers • T.V.• Magazines • Work • Religious Affiliations

• Each person has different values which guide his/her daily decisions

Values

How Values Influence Decisions

• Think of an example of how values influence the decision making process.

• If health is valued, one may purchase a gym membership.

• If doing well in school is valued, a student may decide to stay home the night before a test to study rather than going to a friend’s house to watch television.

Best Friend Advertisement

• Write an advertisement for a best friend– Include at least five qualities or characteristics

you desire or value in a friend– Describe why those qualities are important

Example: Best Friend Advertisement

WANTED:• A friend who…. Is patient, kind, honest,

trustworthy and fun.• Friends who are patient and kind are able

to listen and help solve problems. A patient friend will be able to help with my math and science homework and not get frustrated with me. Kindness is also important because all people need to be treated nicely even if they don’t fit in to the popular group.

• I want a friend who is honest and trustworthy. I do not want to be lied to, and I want a friend I can trust. For example, if we make plans to meet at a basketball game, I want to be able to trust that he/she will be there.

• I also want to be able to trust my friend to keep private information secret and to have him/her not spread rumors about me.

• Finally, I want a friend who enjoys the same things as I do so we can have lots of fun together after school

Needs vs. Wants

• Need - something necessary or required for life• Brainstorm examples of needs

– Food, water, clothing and shelter

How Much Money Does A Person Need?

• Some families in India earn $5.00 to $10.00 a day.

• Could your family live off $5.00 to $10.00 a day?

• What do you think families in India think they NEED?

• How do values influence needs?– You need shelter, but do you NEED a

mansion?– You need clothes, but do you NEED designer

clothes?

Needs vs. Wants

• Want - something unnecessary but desired• May increase the quality of living or make a

person happier• Brainstorm examples of wants

– MP3 player, Play Station, designer clothes

• How do values influence wants?– If being popular or having all of the newest

gadgets is valued, a person may have a lot of wants

You Decide!

• Car

• Nike Sneakers

• Hot Tub

• Computer

• Food

• i-Pod

• Cell Phone

• Clothes

Spending Money

• How do values influence how people spend money and make financial decisions?– If an individual values helping others, he may

decide to give money to a church or other charitable groups

• How do needs and wants influence how people spend money and make financial decisions?

Remember…

• Value - Something that is desirable, worthwhile, and important

• Need - something necessary or required for life

• Want - something unnecessary but desired

• A person’s values and perception of needs and wants influence personal financial decisions!

A Life Choice - assignment

Setting Goals

Start Saving Young!

• Save $2,000 per year from age 19 – 26– $1,035,148 by age 65

• Save $2,000 per year from age 27 – 65– $805,185 by age 65

• Time value of money– Invest fewer dollars at

a younger age but have 25% more

– Based on 10% annual rate of return

Savings: Pay Yourself First

• Savings: unspent income• Types

– Emergencies: Plan to set aside three –six months’ living expenses

– Long-term: Large ticket items (house, car, college)

– Retirement: It’s never to early to start

– Short-term: Vacation, clothes, new skis

Personal Savings Rate Declining

• 1974 to 1984– 10%

• 1985-1994– Fell to 4.8%

• 2004– 1.8%

• 2005– -0.5%

• 2006– -0.7%

• Hasn’t been negative since the Great Depression

Why You Should Save

• What are some your Short-term needs? (monthly)

• What are some your Long-term goals?– by the time you reach 25– by the time you reach 40

Why You Should Save

Short-Term Needs1. Emergencies (unemployment, sickness)

2. Vacations (weekend trips/long excursion)

3. Social Events (wedding, family gathering)

4. Major purchases (cars, appliances, remodeling)

Why You Should Save

Long-Term Needs1. Home Ownership – down payment, PMI2. Education – www.collegesavings.org3. Retirement – SS was never designed to

provide a comfortable retirement [supplement]4. Investing – because of risk, you should make

them in addition to—not instead of—regular savings

What is a Goal?

• Goal - something a person intends to accomplish

Why Set Goals?

• Would you set out on a cross-country adventure without a road map?

• Setting goals are like a road map– Provide direction– Focus on the important things– Keep the end result in mind

Goals• Goal – the end result of something a

person intends to acquire, achieve, do, reach, or accomplish sometime in the near or distant future

• Financial goals – specific objectives to be accomplished through financial planning

• Education goals - enable individuals to prepare for future success in the workplace

SMART Goals • Specific -State exactly what is to be done

• Measurable -Include how the goal can be measured

• Attainable -Determine steps to reach the goal

• Realistic - Do not set goals for something unrealistic

• Time Bound- State when the goal will be met

Education Goals• Help individuals prepare for success in the

workplace– Examples include:

• Earning an A on an upcoming quiz• Attending college• Participating in extra-curricular activities

– Include both short-term and long-term goals– Provide guidance and direction– Enable individuals to reach financial goals

SMART Education Goals

• Specific: state exactly what is to be done with the education aspect involved

• Measurable: Write the grade or class that the goal is for

• Attainable: Determine how it can be reached, which is often determined by academic work

• Realistic: Do not set the goal for something unattainable or unrealistic

• Time Bound: Specifically state when the goal needs to be reached

SMART Education Goal• Goal – “I want to attend college.”• SMART goal –

– Specific – I want to attend a four year college– Measurable – Because I want to attend a four year college, I will earn

a B in algebra– Attainable – Because I want to attend a four year college, I will earn a

B in algebra this semester– Realistic – Because I want to attend a four year college, I will earn a B

in algebra this semester to prepare me for the college entrance exam– Time Bound – Because I want to attend a four year college, I will earn

a B in algebra this semester to prepare me for the college entrance exam when I am a junior in high school

SMART Financial Goal

• Goal – “I want to buy a new car” • SMART goal –

– Specific – I plan to save for a down payment on a new car– Measurable – I plan to save $5,000 for a down payment on a new

car– Attainable – I plan to save $5,000 for a down payment on a new

car by saving $200 from every paycheck– Realistic – It is realistic to save $200 from each paycheck for a

down payment on a car because I usually waste the money on unnecessary items instead of saving it

– Time Bound – I plan to save $5,000 for a down payment on a new car by saving $200 from each paycheck for two years.

SMART Financial Goals• Goal – “I want to buy a new iPod.”• SMART Goal –

– Specific – I plan to save money for a new iPod.– Measurable – I plan to save $100 for a new iPod. – Attainable – I plan to save $100 for a new iPod by

saving $20 from each babysitting job. – Realistic – I plan to save $100 for a new iPod by

saving $20 from each babysitting job and putting it into a savings account.

SMART Goals

• How can setting SMART education and financial goals help a person reach future success?

• It is like following a road map– SMART goals provide direction– SMART goals allow a person to focus on important

things– SMART goals help people keep the end result in

mind

What is Missing? • Find the missing element (specific,

measurable, attainable, realistic, or time bound) in the following financial goals

• Financial Goal #1– I plan to save $5,000 for college living

expenses in four years.

What is Missing?• Financial Goal #1 Answer:

Attainable

What is Missing?• Find the missing element (specific,


• Financial Goal #2– I plan to save for a new computer by saving

$150 each month for one year.

What is Missing?• Financial Goal #2 Answer:

Measurable



• Financial Goal #3– I plan to save $2,500 by saving $105 each

month for 2 years.

What is Missing?• Financial Goal # 3 Answer:

Specific



• Financial Goal #4 – I plan to save $1,500 to buy a used car by

saving $75 from each paycheck


Time Bound



• Financial Goal #5 – I plan to save $2,000 to pay for a new

computer by saving my whole paycheck for the next 6 months


Realistic

Conclusion • Review the following:

– Goals • Financial goals • Short-Term goals • Long-Term goals • SMART goals

• Questions?

What is a Budget?

• A plan for spending and saving money

• Most people think

budgets are:– Rigid and inflexible

– Painful – who wants to

eat Top Ramen every

night!

– No fun!

A budget takes the fun out of money – Mason Cooley

Why Budgets Make Sense

• Budgets help you:– Set priorities

– Achieve what’s

important to you

• A good budget is:– Realistic– Ongoing– Clear and easy to

use – NOT 12 pages!– Flexible – changes

as needs change

Budget Categories

• Income– Gross– Net

• Savings– Emergencies– Long-Term– Retirement– Short-Term

• Expenses– Fixed– Variable– Discretionary

Income: Money Earned

• Gross income: An individual’s income before taxes.

• Net income: Income after taxes are paid.

• Taxes can range from 15% to 31%.

Taxes and Deductions

• First job pays $30,000/year. • Your salary is your gross income. Take off at least 25% for taxes

and other deductions. That’s what’s left for you to spend.• Example:

Gross salary = $30,000Minus 25% taxes and deductions - 7,500Net income $22,500

Why You Should Save

The best reason to save some of your income as you earn it is to provide for future needs, both expected and unexpected.

Can improve your standard of living

No matter how old you are, you will have financial goals

Why You Should Save

What works at 20 won’t necessarily work at 40

20’s – paying off student loans; trying to buy first house

70’s – goal may be trying to make sure your retirement funds last your lifetime

Expenses

• Expense: A cost to meet a need or pay a debt

• Types of expenses– Fixed– Variable– Discretionary

Fixed Expenses

A cost that occurs regularly and doesn’t vary in amount

– Rent

– Mortgage

– Car payment

– Insurance premium

– School loans

– Others?

Variable Expenses

A cost that occurs regularly but may vary in amount:

– Electricity

– Water and Garbage

– Telephone

– Gasoline

– Groceries

– Others?

Ways to Reduce your Grocery Bill•Make a shopping list

•Study grocery ads

•Use coupons

Buy store-brand products

Avoid impulse purchases

Learn the basic prices of your favorite foods.

Discretionary Expenses

A cost determined by personal wants that may be controlled

– Movies, videos, CDs

– Sports

– Eating out

– Grooming and clothes

– Concerts and plays

– Vacations

– Others?

Budget Summary

• Establish a budget:

– Income

– Savings

– Expenses

• Fixed

• Variable

• Discretionary

• End up with a budget

surplus and you’re a

success!

Financial Security

Amount of money you save will vary

according to several factors:

1. Discretionary Income – what you have left over after you have paid your bills

2. Importance you attach to savings

3. Anticipated needs and wants

4. Will power to restrict present spending

Balance Your Budget

3 R’s reality / responsibility / restraint

1) Determine surplus/deficit

2) Evaluate Budget – ways to reduce budget (increase income, coupons, luxuries) – spend less

3) Understand advertising influence – evaluate information

Budgets

Time value of money• Time value of money -- Money to be paid

out or received in the future is not equivalent to money paid out or received today.

Compounding interest• Compounding interest -- Earning interest on

interest.• “Make your money work for you.”

– Developed because compounding interest causes money to make money.

$1,000 Invested Compounded Annually at 10% Interest Rate

1 Year 2 Years

$1,104.71 $1,220.39

Simple interest• Simple interest -- Interest earned on the

principal investment.– Principal -- The original amount of money invested or

saved.

• Amount invested x annual interest rate x number of years = interest earned.– Ex. 1,000 x 0.10 x 2=$200

$1,000 Invested at 10% Simple Interest Rate

1 Year 2 Years

$1,100.00 $1,200.00

$1,000 Invested at 10% Simple Interest Rate

1 Year 2 Years

$1,100.00 $1,200.00

Three factors affecting the time value calculations

• Time

• Amount invested

• Interest rate

Time• The earlier an individual invests, the more

time their investment has to compound interest and increase in value.

A little goes a long way

• Sally Saver puts away $3,000 per year in her IRA account earning 10% - she does this for 10 years then stops.

• Sally accumulates $1,239,564 by the age of 65.

Ed Uninformed waits until he is 28. He must contribute $3,000 to his IRA account earning 10% for 38 years.

Ed accumulates $1,102,331 by the age of 65.

Amount invested• Investing only a small amount a month is

better than not investing at all.– Ex. At 8% interest, invested at age 17, one

dollar per day will become $17,865.52 by age 65.

• The larger the amount invested the greater return a person will earn.

• Always pay yourself first.– Savings should be a fixed expense.

Amount invested continued

• 70-20-10 Rule– 70% Spent– 20% Saved– 10% Invested

• Flexible expenses can be decreased in order to increase the amount a person is able to invest.

The costs add up

Item Average Yearly Expense

Future Value

Eating lunch out 5 days per week at a cost of $5-$10 each time

$1,300.00-$2,600.00 $55,140.60 - $110,281.21

Daily candy bar $365.00 $15,481.78

Monthly gym membership at $38.00

$456.00 $19,341.63

Monthly hair cut at $25.00 per month

$300.00 $12,724.75

The future value problems are calculated for an 18 year old person investing at 8% until age 65.

Interest rate• The percentage rate paid on the money invested

or saved.• Higher interest=more money earned

$1,000 Invested Compounded Monthly

Interest Rate

1 Year 5 Years 10 Years

4% $1,040.74 $1,221.00 $1,490.83

6% $1,061.68 $1,348.85 $1,819.40

Saving & Compound Interest

Risk

• A higher interest rate generally has a greater risk.– Risk -- The uncertainty of the outcome

of an investment.

Fixed interest rate• Fixed interest rate -- The rate will not change

for the lifetime of the investment.• Having a savings or investment plan with a fixed

interest rate guarantees a specific return but can provide a moderate risk.– If the average interest rates rise, the amount a person

earns from this type of investment will not increase.

Inflation

• Another consideration with interest rates is ensuring the interest rate is higher than the rate of inflation.– Inflation -- The steady rise in the general

level of prices.– Ex. If an individual has money invested at 4%

interest and the inflation rate is 4%, the individual’s wealth will stay the same.

– Nominal rate of Inflation = 7% (inflation is 4%)

– Real rate of Inflation = 3%

Time value of money calculations

• Present value – PV=(FV)(1+i)-N

• Future value – FV=(PV)(1+i)N

• Financial calculators may be used to complete these calculations.

Calculation components• Present value (PV) -- How much money a

person has today.• Future value (FV) – How much money a

person expects to have in the future.• Interest rate (i) – The percentage rate paid

on the money invested or saved.• Time (N) -- Length of investment

– Calculated by the number of compounding periods. (daily, monthly, or annually)

Review• Compounding interest

earns interest on interest.

• Increased time=more interest earned

• Higher principal=more interest earned

• Higher interest rate=more interest earned

What would you do?

$100.00 Invested at an 8% interest rate

Age Amount Earned

17 $100.00

25 $189.25

35 $420.06

45 $932.38

55 $2,069.54

65 $4,593.63

If participants choose to invest the money into an account earning 8% interest compounded annual at age 17 and leave the money invested until age 65, they will earn $4,593.63.

What would you do?

$100.00 Invested at an 8% interest rate

Age Amount Earned

17 $30.00

25 $56.77

35 $126.02

45 $279.71

55 $620.86

65 $1,378.09

What if the participant chooses to invest $30.00?

How Your Money Grows

• Principal – amount of money deposited by a saver

• Interest - money paid for the use of money; earnings on a savings acct.

• Compound Interest – interest computed on the original principal plus the accumulated interest

Compound Interest

• Interest can be compounded daily, monthly, or annually.

• Not all savings accounts are created equal! Let’s see why.

Compound Interest5 Years 10 Years

No Interest $1,000. $1,000.

Annual Compounding at 5%

$1,276. $1,629.

Monthly Compounding at 5%

$1,283. $1,647.

Daily Compounding at 5%

$1,284. $1,649.

Saving $1 a DayNo Interest 5% Daily

Compounding

Year 1 $365 $374

Year 5 $1,825 $2,073

Year 10 $3,650 $4,735

Year 30 $10,950 $25,415

How your money grows

Earnings on savings can be measured by the rate of return or yield

YIELD – percentage of increase in the value of your savings due to earned interest (APY)

--takes compounding into consideration also allows consumers to compare rates among banks

WHERE You Can SAVE

COMMERCIAL BANKS

-- widest variety of banking services Checking Savings ATM’s Overdraft protection Loans

Almost all insured by FDIC

WHERE You Can SAVE

SAVINGS BANKS

Usually referred to as mutual savings banks - fewer in number

Savings Real Estate Loans Home-improvement Loans Checking accounts

WHERE You Can SAVE

SAVINGS & LOAN ASSOCIATIONS

Organized primarily to lend money for home mortgages

Checking accounts Special Savings Business loans ATM’s / credit cards Many today have merged with Banks

WHERE You Can SAVE

CREDIT UNIONS

Not-for-Profit organizations established by groups of employees in similar occupations who pool their money

-- higher interest rates on savings

-- lower interest rates on loans

-- IRA’s

-- checking accounts, CD’s

WHERE You Can SAVE

CREDIT UNIONS

Owned by their members – must be a member of the group

SHARE ACCOUNT – savings account at a credit union

Provides insurance up to $100,000

WHERE You Can SAVE

BROKERAGE FIRMS

SECURITIES – stocks, bonds issued by corporations or by the gov’t.

STOCKS = equity BONDS = debt

STOCKBROKER – a licensed employee of a brokerage firm who buys/sells securities for investors

SAVINGS OPTIONSREGULAR SAVINGS ACCOUNT

Major advantage - high liquidityfree to make deposits/withdrawalsATM card available

LIQUIDITY – ability of an asset to be converted into cash quickly without loss of value

Disadvantage - pays least amount of interest of the savings optionsMonthly fee assessed if balance falls below a minimum amount

WHERE You Can SAVE

CERTIFICATE OF DEPOSIT (CD)

a/k/a time deposit – earns a fixed interest rate for a specified length of time

-- requires a minimum deposit

-- interest rate slightly higher than Savings (less liquid)

-- penalty for early withdrawal

What are some personal factors that help determine the amount of money you will save?

NAME 4

• (a) amount of discretionary income,

• (b) the importance you attach to savings,

• (c) anticipated wants and needs,

• (d) will power or ability to forego present spending in order to provide for your future

Why might people choose to save their money in a commercial bank when another type of financial institution

offers a higher interest rate?

• People choose commercial banks mainly because of the many services they offer

• C O N V E N I E N C E !

Is a credit union “for profit” or “not for profit”?

• Credit unions are not-for-profit organizations established by groups of employees in similar occupations who pool their money.

Why types of loans do savings and loan associations primarily provide for their customers?

• Savings and loan associations are organized primarily to lend money for home mortgages.

How much is an account insured for by the FDIC?

• Accounts are insured for up to $250,000 per depositor per financial institution

Why does a regular savings account pay less interest than a certificate of deposit?

• A regular savings account has complete liquidity; therefore, the interest rate is low.

What FOUR (4) things should you consider when choosing a financial institution for your savings?

• (a) safety,

• (b) liquidity,

• (c) convenience,

• (d) interest earning

Describe two (2) ways you can force yourself to save.

• (a) automatic deductions

• (b) savings clubs

If two savings accounts offered 5 percent interest, but one was compounded quarterly and other was compounded daily, which

account would have the higher APY?

• The more often interest is compounded, the greater your earnings. You earn more interest with quarterly compounding than with annual compounding, and more interest with daily compounding than with quarterly compounding.

Documents

Budgeting – Chapter 10. What is Personal Finance?