2006 mcgraw-hill ryerson ltd. kapoor dlabay hughes ahmad prepared by cyndi hornby, fanshawe college...
TRANSCRIPT
2006 McGraw-Hill Ryerson Ltd.
Kapoor Dlabay Hughes Ahmad
Prepared by Cyndi Hornby, Fanshawe College
Chapter 1Personal Financial Planning:
An Introductio
n
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2006 McGraw-Hill Ryerson Ltd.
Learning Objectives – Chapter 1
1.Analyze the process for making personal financial decisions
2.Develop personal financial goals3.Assess personal & economic factors that
influence personal financial planning4.Determine personal and financial
opportunity costs associated with personal financial decisions
5.Identify strategies for achieving personal financial goals for different life situations
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Learning Objective # 1
Analyze the process for making personal financial decisions
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Financial Planning and Its Benefits
Personal financial planning is the process of managing your money to achieve personal economic satisfaction
Most people want to handle their finances so that they get full satisfaction from each available dollar
Financial goals include such things as a new car, a larger home, advanced career training, contributions to charity, extended travel, and self-sufficiency during working and retirement years
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Advantages of personal financial planning;
Increased effectiveness in obtaining, using, and protecting your financial resourcesIncreased control of your financial affairsImproved personal relationshipsA sense of freedom from financial worries
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The Financial Planning ProcessDetermine your current financial situationDevelop financial goalsIdentify alternative courses of actionEvaluate alternativesCreate and implement a financial action planReevaluate and revise your plan
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STEP 1DETERMINE YOUR CURRENT FINANCIAL SITUATION
Determine your current financial situation, regarding income, savings, living expenses, and debtsPreparing a list of current asset and debt balances and amounts spent for various items gives you a foundation for financial planning activitiesThe personal financial statements discussed will provide the information needed to match your goals with your current income and potential earning power
2006 McGraw-Hill Ryerson Ltd.
Step 1 Example
Within the next 2 months, Kent Mullins will complete his undergraduate studies with a major in international studiesHe has worked part-time in various sales jobsHe has a small savings fund ($1,700) and over $8,500 in student loansWhat additional information should Kent have available when planning his personal finances?
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STEP 2DEVELOP YOUR FINANCIAL GOALS
Periodically analyze your financial values and goals
Identifying how you feel about money and why you feel that way• Are your feelings about money based on factual
knowledge or on the influence of others? • Are your financial priorities based on social
pressures, household needs, or desires for luxury items?
• How will economic conditions affect your goals and priorities?
• The purpose of this analysis is to differentiate your needs from your wants
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Specific financial goals are vital to financial planningOthers can suggest financial goals for you. However, you must decide which goals to pursueYour financial goals can range from spending all of your current income to developing an extensive savings and investment program for your future financial security
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Step 2 Example
Kent Mullins has several goalsPaying off his student loansObtaining an advanced degree in global business managementWorking in Latin America for a multinational companyWhat other goals might be appropriate for John?
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STEP 3IDENTIFY ALTERNATIVE COURSES OF ACTION
Developing alternatives (best another way) is crucial when making decisionsMany factors will influence the available alternatives, possible courses of action usually fall into 4 categories:
Continue the same course of actionExpand the current situationChange the current situationTake a new course of action
When you decide not to take action (do nothing) which can be a dangerous alternative
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Continue the same course of actionYou may determine that the amount you have saved each month is still appropriate
Expand the current situationYou may choose to save a larger amount each month
Change the current situationYou may decide to use a money market account instead of a regular savings account
Take a new course of actionYou may decide to use your monthly savings budget to pay off credit card debts
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Step 3 Example
Kent Mullins has several options available for the near future
Work full time and save for graduate schoolGo to graduate school full time by taking out an additional loanGo to school part time and work part time. What additional alternatives might he consider?
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STEP 4EVALUATE YOUR ALTERNATIVES
Evaluate possible courses of action, taking into consideration your life situation, personal values, and current economic conditions
How will the ages of dependents affect your saving goals?How do you like to spend leisure time? How will changes in interest rates affect your financial situation?
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CONSEQUENCES OF CHOICES Every decision closes off alternatives•For ex:
–A decision to invest in stock may mean you cannot take a vacation
–A decision to go to school full time may mean you cannot work full time
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Every Decision Has An Opportunity Cost (Trade-off)
Opportunity cost is what you give up by
making a choice The cost, referred to as the trade-off of a decision, cannot always be measured in dollars. Sometimes the cost is your timeConsider lost opportunities that will result from your decisions.Evaluate the risks facedRefer to the money you forgo by attending school rather than working. Then the resources you give up (money or time) have a value that is lost
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Decision making will be an ongoing part of your personal and financial situationTherefore, you will need to consider the lost opportunities that will result from your decisionsSince decisions vary based on each person’s situation and values, opportunity costs will differ for each person
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EVALUATING RISK
Uncertainty is a part of every decision• Selecting a college major and choosing a
career field involve risk• What if you don’t like working in this field
or cannot obtain employment in it? • Other decisions involve a very low degree
of risk, such as putting money in an insured savings account or purchasing items that cost only a few dollars
• Your chances of losing something of great value are low in these situations
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In many financial decisions, identifying and evaluating risk is difficult The best way to consider risk is to gather information based on your experience and the experiences of others and to use financial planning information sources
Information is required at each stage of the decision-making processChanging personal, social, and economic conditions will require that you continually supplement and update your knowledge
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Financial Planning Information Sources
Printed materials Financial institutions School courses and educational
seminars Computer software, World Wide
Web, and on-line information sources Financial specialists
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Step 4 Example
As Kent Mullins evaluates his alternative courses of action, he must consider his income needs for both the short term and the long termHe should also assess career opportunities with his current skills and his potential with advanced training What risks and trade-offs should Kent consider?
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STEP 5CREATE & IMPLEMENT FINANCIAL ACTION PLANInvolves developing an action plan that identifies
ways to achieve your goalsFor ex, you can increase your savings by reducing your spending or by increasing your income through extra time on the jobAs you achieve your short-term/ immediate goals, the next priority goals will come to focus
To implement your financial action plan, you may need assistance from others
For example, you may use the services of an insurance agent to purchase property insurance or the services of an investment broker to purchase stocks, bonds, or mutual funds
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Step 5 Example
Kent Mullins has decided to work full time for a few years while he
(1) pays off his student loans(2) saves money for graduate school(3) takes a couple of courses in the evening and on weekendsWhat are the benefits and drawbacks of this choice?
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STEP 6REVIEW AND REVISE YOUR PLAN
Financial planning is a dynamic process that does not end when you take a particular actionYou need to regularly assess your financial decisionsYou should do a complete review of your finances at least once a yearChanging personal, social, and economic factors may require more frequent assessments
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When life events affect your financial needs, this financial planning process will provide a vehicle for adapting to those changesRegularly reviewing this decision-making process will help you make priority adjustments that will bring your financial goals and activities in line with your current life situation
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Step 6 Example
Over the next 6 to 12 monthsKent Mullins should reassess his financial, career, and personal situationsWhat employment opportunities or family circumstances might affect his need or desire to take a different course of action?
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Economic or Product Risk
Interest Rate RiskChanging interest rates affect your costs when you borrow and your benefits when you invest
Inflation RiskRising prices cause lost buying power
Liquidity riskSome investments may be more difficult to convert to cash or sell without significant loss in value
Product RiskProducts or services flawed or not meet your expectationsRetailers may not honour their obligations
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Personal RiskRisk of Death
Premature death causes financial hardship to family members left behind
Risk of Income LossIncome stops because of job loss, illness or accident
Health RiskPoor health increases medical costsMay reduce working capacity or life expectancy
Asset and Liability RiskAssets stolen or damagedSued for negligence or damages caused by your actions
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Developing Personal Financial Goals
Financial goals are influenced byPersonal values and attitudes towards money (+ or -)Time frame in which you want to achieve your goals (How long)Type of financial need that
drives your goalsYour life situation
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Developing Personal Financial Goals
Timing of goalsShort-term, intermediate and long-term goals.
Goals for different financial needsConsumable products goals
Food, clothingDurable product goals
Appliances, cars, sporting equipment
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Developing Personal Financial Goals – Your Life Situation
Life Situation takes into consideration personal factors
Age, income, marital status, household size, personal beliefsInfluences your spending and savings patterns
Social ChangesMarried at later ageMore households with two incomesSingle parentsLiving longer
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Developing Personal Financial Goals – Your Life Situation
Other events that influence your life situation include
GraduationEngagement and marriageBirth or adoption of a childCareer change or move to a new areaDependant children leaving homeChanges in healthDivorceRetirementDeath of spouse or other family member
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Developing Personal Financial Goals
Financial goals should...Be realisticBe stated in specific, measurable termsHave a time frameIndicate the type of action to be taken
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Learning Objective # 3
Assess personal and economic factors that influence personal financial planning
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Influences on Personal Financial Planning
Market ForcesSupply and demandProduction costs and competition
Financial institutionsInfluence of the Bank of Canada
Global InfluencesLevel of exports, foreign investors, competition
Economic conditions....Recession, Expansion
Economic factors: the study of how wealth is created and distributed
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Changing Economic Conditions Consumer Prices
Inflation is a rise in the general level of pricesMainly caused by increase in demand without increase in supplyHarmful to people on fixed incomesCan adversely affect people who lend moneyRate of inflation varies
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Changing Economic Conditions
Consumer SpendingDemand for goods and services influences employment opportunitiesReduced spending causes unemployment
Interest RatesRepresent the cost of moneySaving and investing increase the supply of money and interest rates decreaseBorrowing increases demand and interest rates rise
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Learning Objective # 4
Determine personal and financial opportunity costs associated with personal financial decisions
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Opportunity Costs and Financial Results Evaluated When Making Decisions
PersonalOpportunity Costs
(time, effort, health)
FinancialOpportunity Costs(Interest, liquidity,
safety )
Financial
Acquisitions
(automobile, home, college education, investments, insurance, retirement fund)
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Financial Opportunity Costs
(discounting)Present
AmountNow
FutureValue(compounding)
ValueAmount
Later
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Time Value of Money• Increases in an amount of money as a result of interest earned•Every time you spend, save, invest or borrow money you should consider the time value of money as an opportunity cost
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How Simple Interest is ComputedSimple Interest: interest compounded on the principal, excluding previously earned interest
$100 x 6% x 1 (1 year) 100 x .06 x 1 = $6.00
In one year you have $106
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(P) (r) (T) (I)
Amount x Annual x Time = Interest
in Savings Interest Rate Period
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How Compound Interest is Computed
Compound Interest: Interest that is earned on previously earned interest
Each time interest is added to the principal, the next interest is computed on the new balance
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1st year: $100 x 6% x 1(year) = $106.00
2nd year: ($100 + $6) x 6% x 1(year) = $112.36
3rd year: ($106 + $6.36) x 6% x 1(year) =$119.10
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Future Value of Money
Is the amount to which current savings will increase based on certain interest rate and certain time periodCalculations involve compounding since interest is earned on previously earned interestCan be computed for a single amount or a series of depositsStart investing now to take advantage of the future value of money
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Present ValueThe current value of a future amount
based on a certain interest rate and a certain time period Present value calculations are also called discountingAllows you to determine how much to deposit now to obtain desired future amountCan be computed for a single amount or a series of deposits
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Learning Objective # 5
Identify strategies for achieving personal financial goals for different life situations
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Components of Financial Planning Obtaining (chapter 1)
Planning (chapters 2,3)Saving (chapter 4)Borrowing (chapters 5,6)Spending (chapter 7)Managing Risk (chapters 8,9)Investing (chapters 10-13)Retirement and Estate Planning (chapters 14,15)
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Developing a Flexible Financial Plan
A financial plan is formalized report thatSummarizes your current financial situationAnalyzes your financial needsRecommends future financial activities
You financial plan can be created by you, done with assistance from a financial planner, or made using a money management software package
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Implementing Your Financial PlanDevelop good financial habits
Use a spending plan to stay within your income, allowing you to save and invest for the futureHave appropriate insurance protection to prevent financial disastersBecome informed about tax and investment alternatives
Achieving your financial objectives requires
A willingness to learnAppropriate information sources
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Chapter 1 - Appendix
Financial Planners and Other Financial Planning Information SourcesCurrent PeriodicalsFinancial InstitutionsCourses & SeminarsPersonal Finance Software
SpreadsheetsMoney Management & Financial Planning ProgramsTax SoftwareInvestment Analysis Programs
The Internet
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Chapter 1 - Appendix
Financial Planning SpecialistsAccountantsBankersCredit counselorsCertified Financial PlannersInsurance agents/brokersInvestment BrokersLawyersReal Estate AgentsTax Preparers
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Chapter 1 - Appendix
Financial planners are categorized based on the method of compensation
1. Fee-only planners2. Fee-and-commission planners3. Commission-only planners
Do you need a financial planner?Your incomeYour willingness to make independent decisions
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Summary of Learning Objectives
Analyze the process for making personal financial decisions
Determine current financial situationDevelop financial goalsIdentify alternative courses of actionEvaluate alternativesCreate and implement a financial planRe-evaluate and revise the financial plan
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2006 McGraw-Hill Ryerson Ltd.
Summary of Learning Objectives
Develop personal financial goalsGoals should be realisticBe stated in specific, measurable
termsHave a time frameIndicate the type of action to be takenAffected by person’s values, attitudes towards money and life situation
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Summary of Learning Objectives
Assess economic factors that influence personal financial planning
Consumer pricesInterest ratesEmployment opportunities
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Summary of Learning ObjectivesDetermine personal and financial opportunity costs associated with personal financial decisions
Every decision involves a trade off• Personal opportunity costs include time,
effort and health• Financial opportunity costs based on time
value of money
Future and present value calculations measure increased value or lost interest from saving, investing, borrowing or purchasing decisions
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Summary of Learning ObjectivesIdentify strategies for achieving personal financial goals for different life situations
Requires specific goals combined with spending, saving, investing and borrowing strategiesBased on your personal life situation and various social and economic factors
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