basics of personal financial planning [date] [venue] [contact information]

Basics of Personal Financial Planning[date][venue][contact information]

Personal Financial Planning Section

Introduction

About the PFP Section & PFS Credential• The AICPA PFP Section provides information,

resources, advocacy and guidance for CPAs who specialize in providing estate, tax, retirement, risk management and investment planning advice to individuals and their closely held entities

• The CPA/Personal Financial Specialist (PFS) credential distinguishes CPAs as subject-matter experts who have demonstrated their financial planning knowledge through experience, education and testing

2


Today’s Objectives

You gain an enhanced understanding of the basics of financial planning and how a company’s compensation and benefits programs add to your financial well-being

You gain an enhanced understanding of basic investing concepts and how to develop your investment plan

You gain an enhanced understanding of how a Company’s compensation and benefits programs can contribute to the success of your investing

You identify and commit to taking the actions you can to significantly enhance your financial well-being

3


Life Events: Will You Be Ready?

• Premature Death

• Retirement

• Serious Illness

• Death of Spouse

• Aged Parents

• Children Getting Married

• Second Home

• Remarriage

• Starting a Business

• Paying for College

• Divorce

• Job Loss

• Relocation

• Home Purchase

• Birth of Children

• Marriage

• Temporary Disability

4


Life’s Financial Trade-Offs CURRENT NECESSITIES FUTURE NECESSITIES

CURRENT EXTRAS FUTURE EXTRAS

Basic shelter, food

clothing, transportation

and medical care

Basic shelter, food

clothing, cash for emergencies

and nursing home care

Larger home, private

college, retirement travel,

bequests/charity

New kitchen, new car,

vacation, family gifts

Trade-offs

5


The Value of a Financial Plan

A financial plan will help you to clarify:

Your financial goals

Strategies to achieve the goals

Specific steps to implement the strategies

6


Areas to Explore

Saving

Managing debt

Insurance

Investing

Education funding

Retirement funding

Pre-retirement planning

Incapacitation planning

Estate planning

Company stock ownership

7


The Financial Planning Process

What do you want?

What will you have?

Will you have a shortfall?

What strategy will you employ?

What actions will you take?

8


What Do You Want?

These are your financial planning goals

Each goal will have its own horizon• For the period of accumulation• For the period over which it will be spent

Make a list and refine as you go along

Start with broad ideas and work toward increasingly specific and measurable goals

9


What Will You Have?

What you have now

What you will save from future income

Future investment earnings on the above if invested

Expected future benefits

10

Managing Debt


What Managing Debt Means

Conquering excessive debt

Using debt wisely:• Credit cards• 401(k) plan loans• Home mortgages• Home equity loans• Automobile debt

Maintaining a good credit history

12


Debt Ratios

Housing expense ratio• Housing expenses (mortgage, taxes and insurance) should not

exceed 28% of gross pay• Gross pay is before taxes and deductions

Debt to income ratio• Total consumer debt (not including mortgage) should be less

than 20% of take-home-pay• Take-home pay is after taxes and deductions

13


Warning Signs of Too Much Debt

Unable to save 10% or more of gross income

Habitually pay only the minimum monthly payments on your credit cards

Borrowed from one lender to pay another

Asked a friend or relative to co-sign a loan because credit record is weak

Unable to figure out how much you owe

Would be in immediate financial trouble if you lost your job tomorrow

14


Conquering Debt

Stop borrowing

Start using a debit card

Prioritize your debt repayment

Seek lower rates

Determine the maximum you can pay

Repay highest cost debt first

Continue paying the maximum

15


Decrease Debt or Invest?

Pay down debt when you can’t invest at a higher rate

401(k)Match*

Credit Card Investment Mortgage

Interest Paid / Received 100.0% 18.0% 8.0% 6.5%

Tax effect @ 25% -- 0.0% -2.0% -1.6%

Net Paid / Received 100.0% 18.0% 6.0% 4.9%

* 100% of first 3% of your pre-tax regular contributions for ABC Company.

16


Using Home Mortgages Wisely

Determining whether buying is appropriate

Choosing the right type of mortgage

Deciding if you should refinance

Knowing whether to pay points

Deciding whether to prepay mortgage principal

17


Is Buying a Home Right for You?

Buying Renting

Change location frequently No Yes

Maintenance responsibilities Yes No

Ability to customize Yes Perhaps

Payment increases Perhaps Likely

Investment element Yes No

Tax benefits Yes No

Initial costs Yes Yes

18


Tax Benefits of Home Ownership

Mortgage interest $6,000

Property taxes 2,000

Other itemized deductions 4,250

Total itemized deductions 12,250Less: standard deduction you would have

received had you not owned a home -4,750Extra amount you can deduct 7,500

Times: your tax rate 25%Your tax savings $1,875

19


Types of Mortgages

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

1 5 9 13 17 21 25 29

Year

Rat

e Fixed Rate

Adjustable Rate

20


Consider a Fixed Rate Mortgage When:

You intend to live in your home for a significant period of time, or

You anticipate rising interest rates in the future

21


Consider an ARM When:

Fixed rate is at least 2% points greater than adjustable rate

You expect your income will increase enough to cover any potential payment increases

You expect to move before the rate increases (beware of prepayment penalties)

22


Prepaying Mortgage Principal

360

$170,257

210

$89,279

Number of Payments Total Interest Paid

Standard Payment

Additional $150 PerMonth

360

$0

210

$00

50

100

150

200

250

300

350

400

Number of Payments Total Interest Paid

Standard Payment

Additional $150 PerMonth

Assumes a 30 year fixed-rate mortgage of $100,000 at 8.25%

23


Consider Prepaying Principal When:

You use the standard deduction

You invest conservatively

24


Maintaining a Good Credit History

Establish a good credit history

Obtain your credit report

Understand your credit report

Correct mistakes in your credit report

25

Saving & Investing


Importance of Saving and Investing

If you don’t have the following• Sufficient assets fully devoted to your goal(s)• Expected future benefits from third parties• Expected future borrowing

Then you will need the following to reach your goal(s)• Future savings devoted to your goals• Future earnings from investing the above if you invest those

assets

27


Key Saving and Investing Concepts

Saving versus investing

Combining saving and investing

Saving and investing early

Tax-deferred saving and investing

Tax-deductible saving and investing

Saving and investing using employer contributions

28


Saving Versus Investing

Saving Investing

Means Not spending money

Doing something with

money to earn a return

Needs tobe done

In a regular, disciplined

manner

Carefully and with due

consideration

29


Combining Saving and Investing

Saves $2,000 per year

Starts at age 25

Saves in a non-interest bearing account


Starts at age 25

Invests and earns an 8.9% pretax and 6.68% after-tax return

VickieStan

30


Combining Saving and Investing

$30,000$50,000

$80,000$49,018

$120,748

$367,307

$0

$50,000

$100,000

$150,000

$200,000

$250,000

$300,000

$350,000

$400,000

In 15 Yrs In 25 Yrs In 40 Yrs

Save Only Save and Invest

Stan Vickie

31


Saving and Investing Early


Starts at age 35

Continues for 30 years

Invests and earns an 8.9% pre-tax and 6.68% after-tax return


Starts at age 25

Stops after 10 years

Invests and earns an 8.9% pre-tax and 6.68% after-tax return

VickieStan

32


$178,227

189,080

$168,000

$178,000

$188,000

$198,000

At 65 At 65

Save Later for 30 Years Save Early for 10 Years

Saving and Investing Early

Stan

Vickie

33


Tax-Deferred Earnings


Starts at age 25


Invests in a taxable account and earns an 8.9% pre-tax and 6.68% after-tax return


Starts at age 25


Invests in a Tax-Deferred account and earns an 8.9% pre-tax return

VickieStan

34


Tax-Deferred Earnings

$367,307

$493,435

$0

$100,000

$200,000

$300,000

$400,000

$500,000

$600,000

At Age 65 At Age 65

Taxable Account Tax-Deferred Account

Stan Vickie

35


The Saving Process

What do you want?

What will you have?




36


What Do You Want?

Identify your specific savings goals

Identify your time horizon

Quantify your saving goals

Prioritize your saving goals

37


Identify Your Specific Saving Goals

Pay down existing debt

Create an emergency fund

Save for retirement

Accumulate a down payment for a house

Build a college fund for your children’s education

Set aside money for a specific goal (vacation, fun and games, etc.)

38


Create an Emergency Fund

Set aside 2 to 4 months of living expenses

Use it for a crisis (i.e., roof leaks)

Use it and replace it

Don’t use it for discretionary spending (i.e., vacation)

39


Save for Retirement

Do everything possible NOW

Start early—you’ll end up with more

40


Identify Your Time Horizon

Identify number of months or years until goal

Allow as much time as possible:• You can accept a lower investment risk• Your monthly saving and investing commitment will be less

41


Examine Your Spending Habits

Keep a list of all spending for one month

Compare total spending to take-home pay

Examine closely if you have a substantial unexplained gap

Become highly knowledgeable about your expenses

42


Identify Ways to Save More

Save your next raise

Save your next bonus

Reinvest dividends and interest

Save all cash gifts

Rent instead of buying (books, videos, etc.)

Delay buying a new car upon paying off present car loan

Save the “donut money”—and lose weight!

Buy generic products

Trim your spending by 5%

Be creative

43


What About Investing?

Combined with savings, a key resource for achieving your financial goals

Investing skills are needed to prudently utilize• Company 401(k) investments• IRAs investments• Savings invested outside these plans

All investments involve risks

Approach investing carefully

44


What Investing Carefully Means

Phase I: Learn investing basics

Phase II: Develop your investment plan

Phase III: Implement your investment plan

45

Investing Basics and Planning


Why Learn Basic Investing Concepts?

ALL investments involve risks• Even so-called risk-free investments like a cash

As such, approach investing carefully

Learning basic investing concepts is part of investing carefully

47


What Are The Major Asset Classes?

Major Asset Class Characteristics Goals

HistoricalAverage Returns*

Cash Matures in less than one year

Capital preservation

Liquidity

3-4%

Bonds Fixed income

Varied maturities

Income

Capital preservation

5-7%

Stocks Company ownership Possible dividend income

Capital appreciation

10-13%

Hard assets Asset ownership Capital appreciation

Inflation hedge

Varies

* Pretax return over 75 years through 2008

48


What Risks are Involved in Investing?

Primary long-term risk

Inflation risk Loss of purchasing power

Primary short-term risk

Volatility risk Instability of investment

Other risks

Business risk

Market risk

Liquidity risk

Interest rate risk

Currency risk

Inherent risks of a particular business

Likelihood that the market as a whole will fall

Risk of not being able to access money when needed

Loss of principal on fixed-rate investments due to rising interest rates

Investment’s value will be affected by changes in exchange rates

49


How are These Risks Managed?

Primary long-term risk

Inflation risk Invest in stocks

Primary short-term risk

Volatility risk Hold investments for the long-term

Other risks

Business risk

Market risk

Liquidity risk

Interest rate risk

Currency risk

Diversify within an asset class

Diversify among asset classes

Diversify among asset classes

Have an emergency fund

“Ladder” portfolios

Diversify among countries or hedge

50


However, Stocks Have More Volatility Risk

Lower Deviation

HigherDeviationDegree of Volatility

HigherReturn

LowerReturn

AnnualReturn

5%

10%

15%

20%

Cash

Intermediate-TermGovernment Bonds

Large Company Stocks

Small Company Stocks

51


150%

Manage Volatility Risk by Investing Over Time

Small CompanyStocks

Large CompanyStocks

Long-TermGovernment

Bonds

Cash

One-Year Holding Periods

Five-Year Holding Periods

Twenty-Year Holding PeriodsAverage Return

3.7%10.4%12.7% 5.4%

-75%

-50%

-25%

0%

25%

50%

75%

100%

125%

Ran

ges

of

Ret

urn

Range of compound annual returns over the period 1926-2002. Source: Ibbotson Associates, 2004.

Volatility Risk Over Time

52


Managing Business and Market Risks

PortfolioRisk

Number of Holdings

3 5 7 9 11 13 15

Portfolio Risk=Market Risk + Business

Risk

Business Risk

Market Risk

53


Current

Bonds Real Estate

Money market funds

Convertible bondsSmall-company stocks

Certificates of deposit Large-company stocks

Utility stocks Zero coupon bonds

Return Deferred

Lower Liquidity Risk Higher

Manage Liquidity Risk by Diversifying

54


Managing Interest Rate Risk

Managed by “Laddering” Portfolio of Bonds

Price

Interest Rates

Bonds

Price

Interest Rates

55


Risk / Return Trade-Offs: Example 1Degree of Volatility

Lower Deviation

HigherDeviationDegree of Volatility

HigherReturn

LowerReturn

AnnualReturn

5%

10%

15%

20%

Cash

Intermediate-TermGovernment Bonds

Large Company Stocks

Small Company Stocks

56


Risk / Return Trade-Offs: Example 2Cash vs. Bonds vs. Stocks

Cash Bonds Stocks

Current yieldAppreciationTotal returnEstimated income taxes @ 30%After-tax returnInflation rateAfter-tax “real” rate of return

Relative risk

3.3%0.0%3.3%

(1.0)%2.3%

(3.1)%(0.8)%

Low

4.8%0.0%4.8%

(1.4)%3.4%

(3.1)%0.3%

Medium

2.2%6.5%8.7%

(2.6)%6.1%

(3.1)%3.0%

High

57


Risk / Return Trade-Offs: Example 3Sub-Categories Within Major Asset Classes

Cash

Bonds

Stocks

Hard Assets

InternationalSmall Company

StocksLarge Company Stocks

Long TermIntermediate Term

Short Term

High Risk/High Return Potential

Low Risk/Low Return Potential

58


Risk / Return Trade-Offs: Example 4Taxable vs. Tax-Exempt Investments

Tax-Exempt Returns

Tax-Rate 3.0% 4.0% 5.0% 6.0% 7.0%

Tax-Equivalent Returns

10.0% 3.3% 4.4% 5.6% 6.7% 7.8%

15.0% 3.5% 4.7% 5.9% 7.1% 8.2%

25.0% 4.0% 5.3% 6.7% 8.0% 9.3%

28.0% 4.2% 5.6% 6.9% 8.3% 9.7%

33.0% 4.5% 6.0% 7.5% 9.0% 10.4%

35.0% 4.6% 6.2% 7.7% 9.2% 10.8%

59


Risk / Return Trade-OffsBetween Differing Portfolios

Large Cap Eq.22%

Small Cap Eq.6%

Inter'l Eq.14%

Fixed Inc.58%

Cash0%Large Cap Eq.

25%

Small Cap Eq.25%Inter'l Eq.

0%

Fixed Inc.25%

Cash25%

Large Cap Eq.27%

Small Cap Eq.7%

Inter'l Eq.18%

Fixed Inc.48%

Cash0%

Portfolio A

6.61% Return

4.25% Risk*

Portfolio B

6.61% Return

3.60% Risk*

Portfolio C

7.06% Return

4.25% Risk*

* Risk = one standard deviation

60


What One Factor Most Influences Your Return?

Asset Allocation(91%)

Specific Bond &Stock Selection (6%)

Market Timing (2%)

Other (1%)

Source: Brinson, Singer, Beebower

Your Asset Allocation

61


Your desired rate of return

Your risk tolerance

Your time horizon

What Most Influences Your Asset Allocation?

Stan Vickie

Stan and Vickie are different…their asset

allocations will be different too.

62


Importance of Your Desired Rate of Return

The higher the rate of your desired return, the higher the risk you will most likely will have to take

Desired Return Likely Risk

63


Importance of Your Risk Tolerance

The higher your risk tolerance the more aggressive you can be

Risk Tolerance

Be More Aggressive

Be More Conservative

64


Importance of Your Time Horizon

Longer time horizons (5 or more years) can absorb the ups and downs of investing more heavily in stocks

Shorter time horizons warrant investing more heavily in less volatile investments

Time horizon

Use more volatile stocks

Use less volatile investments

65

Developing Your Investment Plan


Use This Investment Planning Process

What do you want?

What will you have?




Note: this process is applied to each of your investing goals

67


What Do You Want?

• Take into account

• Your goal in today’s dollars• Number of years to your goal• Expected inflation rate

• To arrive at

• What you want

Be sure to include important others in deciding what you want.

68


How do You Define Your Goals?

Each goal will have its own time horizon• For the period of accumulation• For the period over which it will be spent

Make a list and refine as you go along

Start with broad ideas and work toward increasingly specific and measurable goals

69


What Will You Have?


• Current assets set aside for your goal

• Number of years to your goal• Future saving• Expected return on your

invested assets• Expected future benefits

• To arrive at

• What you will have

70


Where Should You Save First?

1. Your Employer 401(k) Plan (at least to the % that gives you the maximum employer match – free money for you)

2. Roth IRA using after-tax contributions or Traditional IRA using pre-tax contributions, depending on your circumstances*

3. Taxable accounts

* Only Traditional IRAs can accept pre-tax contributions. Although both Traditional and Roth IRAs can accept after-tax contributions, it is generally preferable to use Roth IRAs. We will be covering IRAs in more detail later. You can use a Financial Calculator to determine which type of IRA is best for your particular situation.

71


Why These Priorities?

TaxableAccount

Roth IRA Using After-Tax Contributions

Traditional IRA Using Pre-Tax Contributions

Employer 401(k) Plan

Salary $50,000 $50,000 $50,000 $50,000

Pre-tax $ $2,667 $2,667 $2,667 $2,667

Tax at 25% $667 $667

After-tax $ $2,000 $2,000

Employee contribution $2,000 $2,000 $2,667 $2,667

Employer match – assume 3% n/a n/a n/a $1,500

Total contribution $2,000 $2,000 $2,667 $4,167

% of salary contributed 4.00% 4.00% 5.33% 8.33%

Outcome $178,227 What Happens?

Vickie

72



Vickie

$178,227

$267,580

$356,819

$557,504

$0

$100,000

$200,000

$300,000

$400,000

$500,000

$600,000

Taxable Account Roth IRA Using After-Tax Contributions



Account Balance in 30 Years

73



Vickie

$178,227

$267,580 $267,614

$418,128

$0

$100,000

$200,000

$300,000

$400,000

$500,000

Taxable Account Roth IRA Using After-Tax Contributions



Available After-Tax in 30 Years

74


Consider Tax-Advantaged Accounts First

Features Available Employer 401(k) Plan IRAs 529

PlanTax-Deferred contributions (1) No (2)Tax-Deferred earnings (1) Employer contributions No NoUnlimited contributions No No (3)Automatic saving and investing Wide-array of professionally managed funds Varies

Self-direction of fund allocation NoImmediate penalty-free withdrawal No No (1) No

(1) Depends on the type of IRA used.

(2) Some states allow you to deduct your contributions.

(3) Some states limit contributions.

75


Then Consider Taxable Accounts

Features Available Employer DESPP (1)

EmployerDTP (2)

Mutual Funds

Brokerage Accounts

Tax-Deferred contributions No No No NoTax-Deferred earnings No No No NoEmployer contributions No No No NoUnlimited contributions No No Automatic saving and investing No Wide-array of professionally managed funds No No No

Self-direction of fund allocation Buy Emplyr stock at a discount No No NoBuy Emplyr stock without fees No NoImmediate penalty-free withdrawal

(1) Discounted Employee Stock Purchase Plan (2) Direct Transaction Program

76


Now Develop Your Preliminary Plan

Question Answers = PlanYour goal?

Your risk tolerance?

Your expected rate of return?

Your time horizon?

Current assets set aside for your goal?

Future periodic savings/investing?

Expected future benefits?

Types of account(s) you’ll use?

Asset allocation within account(s)?

77


Then Calculate Your Expected Return*

Major Asset Class

Asset Allocation

Historical Return

Estimated Return

Cash

Bonds

Stocks

Hard assets

__________%

__________%

__________%

__________%

X 4%

X 6%

X 12%

X 8%

__________%

__________%

__________%

__________%

Total 100%__________%

* Calculated for each account you are using to invest your savings.

78


And Then the Future Value of These Items*

Contribution Toward Goal Future Value Calculation

Current assets set aside for your goal

Calculate the future value of this amount invested at your expected rate of return over your time horizon

Future periodic savings/investing

Calculate the future value of these payments at your expected rate of return over your time horizon

Expected future benefits

Calculate the future value of this amount invested at your expected rate of return from the date of receipt to the end of your time horizon

* Calculated for each account you are using to invest your savings.

79


The Result is What You Will Have


• Current assets set aside for your goal

• Number of years to your goal• Future saving• Expected return on your

invested assets• Expected future benefits

• To arrive at

• What you will have

80


Key Points to Remember

Financial planning will help you clarify goals, strategies and action steps

Determine whether you have too much debt and develop a plan to conquer it

Make wise decisions about using debt

Commit to saving and investing

Save and invest early

Pay yourself first

Learn as much as you can about investing to develop a plan and invest according to your “comfort level”

81

Questions?[insert contact information here]

Special thanks to Kevin Roach, CPA/PFS of Texas A&M University for contributing content.

basics of personal financial planning [date] [venue] [contact information]

Documents

financial planning goals

basics of financial

financial planning process

financial planning knowledge

financial wellbeing

financial goals strategies

investment planning

managing debt slide