Lesson 3

Announcements

Financial Planning and Its Benefits• Personal financial planning - Process of managing money to

achieve personal economic satisfaction.

• Advantages of personal financial planning:

1) Increased effectiveness in obtaining, using, and protecting your financial resources.

2) Increased control / awareness of your financial affairs.3) Improved personal relationships (know what to expect, fewer

surprises, less stress)4) A sense of freedom from financial worries obtained by looking

to the future.

The Financial Planning ProcessDetermine your current financial situation.

A personal balance sheet will work.Develop your financial goals.Identify alternative courses of action.Evaluate your alternatives.Create and implement your financial action

plan.Review and revise your plan frequently The

markets change quickly. Do not be caught on vacation when the market takes a dive!

Consequences of Choices: Opportunity CostOpportunity costWhat you give up when you make a choice

Less expensive house = ownership sooner / no mortgage and no interest charges

More expensive house = longer mortgage / continue paying interest

Opportunity Cost of Bigger House = less money for later in life.

The cost, or trade-off of a decision, cannot always be measured in dollars. Sometimes the cost is your time. What opportunity costs do you have from being a college student?1.Lost income while in university (4 – 7 years) equals 20,000 RMB * 7 = 140,000 RMB2.Lost social recreational and leisure time because a true student does not have the money AND is working all the time. 3.Other ?

Every Financial Decision Involves Evaluating Types of Risk

• Inflation risk.– Rising prices cause lost buying power.

• Interest-rate risk.– Effect costs of borrowing and rate of return.

• Income risk.– If I do not invest and I lose my job, how will I feed

myself and my family?

• Personal risk.– If I have partial or no health benefits, how will pay for

costly medical procedures for myself or my children (Emma)

Liquidity risk (Higher return may mean less liquidity)

Examples: 1) 60 days to get money2) Penalty for taking it early3) Share price may be down4) Real Estate: 6 months to sell a

house is not unheard of.

Financial Planning Information Sources

• Printed materials.• Financial institutions.• School courses and educational seminars.• The internet, online sources, computer software.• Financial specialists.

– Financial planners, bankers, accountants, insurance agents, lawyers and tax preparers.

Financial goals include those influenced by:

The time frame in which you want to achieve your goals.

Short-term, intermediate and long-term goals.

Goals for different financial needsConsumer product goals (television, car, new suit),

vacation, children’s education, retirement, etc.

Mutual Funds are a group of investments commonly offered by North American Banks

Mutual Funds quote past / historic rates of return because they can not tell us what is going to happen in the future.

They take a historical mean (average).

Mutual Funds (continued)

We buy mutual funds based on their good performance in the past.

In theory, if they performed well in the past, they were likely managed well and will be more likely to perform well in the future.

Discount Rate

Discount Rate is the rate of return that is applied to an investment whose future value is known.

For example, if you require a 10% rate of return, you will need to invest $909.09 today, to be paid $1,000 in one year.

Therefore, $909.09 is the value of $1,000 discounted at 10% for one year.

Future Value

The Future Value is computed when you know what you have to invest and at what rate and the length of the time period. The future value shows you the final compounded value.

Time Value of Money considers CompoundingInvesting: Compounding gives a return on your

original investment plus a return on previous returns. (interest earned on interest)

What annual rate compounds $100 to $120 in two years? Is it 10% ? No.

Answer = 9.5445%If the rate was 10%, the value would be $121 in

two years.Think of these investments as 2 investments,

each being 1 year in duration.

Year 1 $100 x 9.5445% = $9.545= 109.5445

Year 2 $109.5445 x 9.5445% = $10.456

Value of money after 2 years = $120

We call the $120 the future value.

Year 1 $100 x 10% =$10 $100 + 10

Year 2 $110 x 10% = $11 + 11 $121 Value of money after 2 years is $121

It is important to know the difference because when borrowing and paying interest, compounding increases the total interest paid.

HomeworkAnswer these questions in your notebook.

Include the date and a short explanation

1. Find out the approximate annual income of a front line worker in Walmart.

2. You have $100 to invest. Which will bring you more profit, investing it at 10% daily or annually? In your notebook, write the answer with an explanation that demonstrates you understanding.