Lasa psychology

Chapter 1

Personal Finance Basics and the Time Value of Money

Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Chapter 1

Learning Objectives

LO1-1 Analyze the process for making personal financial decisions.

LO1-2 Assess personal and economic factors that influence personal financial planning.

LO1-3 Develop personal financial goals.

LO1-4 Calculate time value of money situations associated with personal financial decisions.

LO1-5 Identify strategies for achieving personal financial goals for different life situations.

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The Financial Planning Process

Learning Objective 1-1:

Analyze the process for making personal financial decisions.

What is Personal Financial Planning? …..

The process of managing your money to achieve

personal economic satisfaction

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The Financial Planning Process

Advantages of Personal Financial Planning are:

Increased effectiveness in obtaining, using,

and protecting financial resources

Increased control of one’s financial affairs

Improved personal relationships

Sense of freedom from financial worries

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Six Steps in the

Financial Planning Process

Continued…

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Six Steps in the

Financial Planning Process

Step 1:

DETERMINE YOUR CURRENT FINANCIAL SITUATION

Evaluate income, savings, living expenses, and debts

Prepare a list of current asset and debt balances and amount spent for various items

Match financial goals to current income and potential earning power

Continued…

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Six Steps in the

Financial Planning Process

Step 2:

DEVELOP YOUR FINANCIAL GOALS

Identify feelings about money and the reasons for those feelings

Determine the source of your feelings about money

Determine the effects of the economy on your goals and priorities

Make sure that your goals are your own and are specific to your situation

Continued…

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Six Steps in the

Financial Planning Process

Step 3:

IDENTIFY ALTERNATIVE COURSES OF ACTION

Possible courses of action can be:

Continue the same course of action

Expand the current situation

Change the current situation

Take a new course of action

Continued…

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Six Steps in the

Financial Planning Process

Step 3:

IDENTIFY ALTERNATIVE COURSES OF ACTION (continued)

Creativity in decision making is vital to effective choices

“Do nothing” can be a dangerous alternative

Continued…

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Six Steps in the

Financial Planning Process

Step 4:

EVALUATE YOUR ALTERNATIVES

CONSEQUENCES OF CHOICES

Opportunity cost

What you give up when you make a choice

The cost or trade-off of a decision cannot always be measured in dollars. Sometimes the cost is your time

Continued…

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Six Steps in the

Financial Planning Process

Step 4:

EVALUATE YOUR ALTERNATIVES

EVALUATING RISK

Uncertainty is a part of every decision

FINANCIAL PLANNING INFORMATION SOURCES

Best way to analyze and minimize risk is to gather information from financial planning information sources (Exhibit 1-3)

Continued…

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Six Steps in the

Financial Planning Process

Step 5:

CREATE AND IMPLEMENT YOUR FINANCIAL ACTION PLAN

Develop an action plan that identifies ways to achieve financial goals

Possible action plans can be increasing savings, reducing spending, or making provisions for taxes

To implement action plans you may need assistance from others

Continued…

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Six Steps in the

Financial Planning Process

Step 6: REVIEW AND REVISE YOUR PLAN

Financial planning decisions need to be assessed regularly

Complete review should be done at least once a year

More frequent reviews may be required for changing personal, social, and economic factors

Regular reviews of decision-making process can help in making priority adjustments to achieve financial goals

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Influences on Personal Financial Planning

Learning Objective 1-2:

Assess personal and economic factors that influence personal financial planning.

LIFE SITUATION AND PERSONAL VALUES

Adult life cycle stage

Marital status, household size, and employment

Major events

Graduation, engagement, career change, children, retirement, etc

Values influence spending and saving decisions

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Influences on Personal Financial Planning

THE FINANCIAL SYSTEM (how money flows)

Providers of funds (savers and investors)

Financial Intermediaries

Financial Markets

Users of funds (borrowers and spenders)

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Influences on Personal Financial Planning

ECONOMIC FACTORS

Forces of Supply and Demand on setting prices

Economics is the study of how wealth is created and distributed

The economic environment includes different institutions

Federal Reserve Bank and it’s role in the economy

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Influences on Personal Financial Planning

GLOBAL INFLUENCES

Global marketplace influences financial activities

American companies compete against foreign companies for US dollars

Balance of exports and imports

Foreign investments and their role in the US Money Supply

The level of Money Supply affects interest rates

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Influences on Personal Financial Planning

CHANGING ECONOMIC CONDITIONS

Consumer prices

Consumer spending

Interest rates

Money Supply

Unemployment

Housing Starts

Gross domestic product (GDP)

Trade balance

Stock market indexes

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Influences on Personal Financial Planning

SELECT A PATH TO FINANCIAL SECURITY

Save for emergencies and the future

Maintain a low level of debt

Have a risk management plan

Avoid investment scams

Communicate with others

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Developing Personal Financial Goals

Learning Objective 1-3:

Develop personal financial goals.

TYPES OF FINANCIAL GOALS

a) Can be influenced by the time frame in which you want to achieve your goals

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Developing Personal Financial Goals

TYPES OF FINANCIAL GOALS

b) Can be influenced by the financial need that drives your goals

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Developing Personal Financial Goals

TYPES OF FINANCIAL GOALS

TIMING OF GOALS

Short-term, intermediate, and long-term goals

Long-term goals should be planned in coordination with short-term and intermediate goals

GOALS FOR DIFFERENT FINANCIAL NEEDS

Consumable-product goals

Durable-product goals

Intangible-purchase goals

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Developing Personal Financial Goals

GOAL-SETTING GUIDELINES

Goals should be SMART:

Specific: know what your goals are to create a plan

Measurable: with a specific amount

Action-oriented: identify the personal financial activities

Realistic: utilizing your income and life situation

Time-based: identify the time frame to achieve the goal

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Opportunity Costs and the Time Value of Money

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Learning Objective 1-4:

Calculate time value of money situations associated with personal financial decisions.

Opportunity Costs and the Time Value of Money

Every financial decision involves giving up something to obtain something else

PERSONAL OPPORTUNITY COSTS

Time

Other personal opportunity costs can be related to health, leisure etc.

Personal resources like financial resources require careful management

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Opportunity Costs and the Time Value of Money

FINANCIAL OPPORTUNITY COSTS

Time Value of Money

Increases in an amount of money as a result of interest earned

Saving today means more money tomorrow. Spending means lost interest

Saving and spending decisions involve considering the trade-offs. Current needs can make spending worthwhile

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Opportunity Costs and the Time Value of Money

Time Value of Money (continued)

INTEREST CALCULATIONS

Three amounts are required to calculate the time value of money

Principal (the amount of savings)

Interest rate (annual)

Time

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Opportunity Costs and the Time Value of Money

Time Value of Money (continued)

COMPUTING SIMPLE INTEREST

=Amount in savings x annual interest rate x time period

=interest amount

For Example:

=$100 x 5% x 1 (1 year)

=$100 x .05 x 1

=$5.00

In one year, you have $100 in principal plus $5.00 in interest for a total of $105 at the end of the year.

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Opportunity Costs and the Time Value of Money

1) FUTURE VALUE OF A SINGLE AMOUNT

Future value is the amount to which current savings will increase based on a certain interest rate and a certain time period

Future value is also call compounding - earning interest on previously earned interest

See Exhibit 1-8A

2) FUTURE VALUE OF A SERIES OF DEPOSITS

Future value can be computed for a single amount or for a series of deposits called an annuity

See Exhibit 1-8B

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Opportunity Costs and the Time Value of Money

3) PRESENT VALUE OF A SINGLE AMOUNT

Present Value is the current value of a future amount based on a certain interest rate and a certain time period

Present value calculations are also called discounting

The present value of the amount you want in the future will always be less than the future value

See Exhibit 1-8C

4) PRESENT VALUE OF A SERIES OF DEPOSITS

Present value can be computed for a single amount or for a series of deposits

See Exhibit 1-8D

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Opportunity Costs and the Time Value of Money

METHODS FOR COMPUTING TIME VALUE OF MONEY

Formulas

Time value of money tables

Financial calculators

Spreadsheet software

Time value of money web sites

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Achieving Financial Goals

Learning Objective 1-5:

Identify strategies for achieving personal financial goals for different life situations.

COMPONENTS OF PERSONAL FINANCIAL PLANNING

Obtaining (chapter 2)

Planning (chapters 3, 4)

Saving (chapter 5)

Borrowing (chapters 6, 7)

Spending (chapters 8, 9)

Managing risk (chapters 10-12)

Investing (chapters 13-17)

Retirement and estate planning (chapters 18, 19)

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Achieving Financial Goals

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, with assistance from a financial planner, or made using a money management software package

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Achieving Financial Goals

IMPLEMENTING YOUR FINANCIAL PLAN

Develop 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

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Achieving Financial Goals

STUDYING PERSONAL FINANCE

Resources

Personal Financial Planner sheets

Website www.mhhe.com/kdh

Practice Quizzes and end-of-chapter activities

Online sources for current finance information

Talk to others

Achieving your financial objectives requires a willingness to learn and appropriate information sources

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