basics of personal financial planning

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

Personal Financial Planning Section

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-beingYou gain an enhanced understanding of basic investing concepts and how to develop your investment planYou gain an enhanced understanding of how a Company’s compensation and benefits programs can contribute to the success of your investingYou identify and commit to taking the actions you can to significantly enhance your financial well-being

Paying off a credit card- Credit Card Calculator

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http://www.bankrate.com/calculators/credit-cards/credit-card-minimum-payment.aspx


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

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The Value of a Financial Plan

A financial plan will help you to clarify:Your financial goalsStrategies to achieve the goalsSpecific steps to implement the strategies

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Areas to Explore

SavingManaging debtInsuranceInvestingEducation funding

Retirement fundingPre-retirement planningIncapacitation planningEstate planningCompany stock ownership

5


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?

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What Do You Want?

These are your financial planning goalsEach 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 alongStart with broad ideas and work toward increasingly specific and measurable goals

Fill out your goals worksheet

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What Will You Have?

What you have nowWhat you will save from future incomeFuture investment earnings on the above if investedExpected future benefits

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Managing Debt


What Managing Debt Means

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

Maintaining a good credit history

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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

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Warning Signs of Too Much Debt

Unable to save 10% or more of gross incomeHabitually pay only the minimum monthly payments on your credit cardsBorrowed from one lender to pay anotherAsked a friend or relative to co-sign a loan because credit record is weakUnable to figure out how much you oweWould be in immediate financial trouble if you lost your job tomorrow

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Conquering Debt

Stop borrowingStart using a debit cardPrioritize your debt repaymentSeek lower ratesDetermine the maximum you can payRepay highest cost debt firstContinue paying the maximum

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Using Home Mortgages Wisely

Determining whether buying is appropriateChoosing the right type of mortgageDeciding if you should refinanceKnowing whether to pay pointsDeciding whether to prepay mortgage principal

Buying a house in San Francisco- Check out this article

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http://sanfrancisco.cbslocal.com/2014/05/20/how-much-more-does-it-cost-to-live-in-san-francisco-bay-area-than-other-cities-sf-real-estate-housing-prices-expensive-cheap-cost-home-mortgage-income-salary/


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

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Tax Benefits of Home OwnershipMortgage interest $6,000Property taxes 2,000Other itemized deductions 4,250Total itemized deductions 12,250Less: standard deduction you would have

received had you not owned a home -4,750Extra amount you can deduct 7,500Times: your tax rate 25%Your tax savings $1,875

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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

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Consider a Fixed Rate Mortgage When:

You intend to live in your home for a significant period of time, orYou anticipate rising interest rates in the future

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Consider an ARM When:

Fixed rate is at least 2% points greater than adjustable rateYou expect your income will increase enough to cover any potential payment increasesYou expect to move before the rate increases (beware of prepayment penalties)

Buy a home and finance it.Bankrate Mortgage Calculatorhttp://www.realtor.com/

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http://www.bankrate.com/calculators/mortgages/mortgage-calculator.aspx



http://www.realtor.com/


Maintaining a Good Credit History

Establish a good credit historyObtain your credit reportUnderstand your credit reportCorrect mistakes in your credit report

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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

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Key Saving and Investing ConceptsSaving versus investingCombining saving and investingSaving and investing earlyTax-deferred saving and investingTax-deductible saving and investingSaving and investing using employer contributions

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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

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Combining Saving and Investing

Saves $2,000 per yearStarts at age 25Saves in a non-interest bearing account

Saves $2,000 per yearStarts at age 25Invests and earns an 8.9% pretax and 6.68% after-tax return

VickieStan

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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

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Saving and Investing Early

Saves $2,000 per yearStarts at age 35Continues for 30 yearsInvests and earns an 8.9% pre-tax and 6.68% after-tax return

Saves $2,000 per yearStarts at age 25Stops after 10 yearsInvests and earns an 8.9% pre-tax and 6.68% after-tax return

VickieStan

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$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 EarlyAARP Calculator

Stan

Vickie

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http://www.aarp.org/work/retirement-planning/retirement_calculator.html


Tax-Deferred Earnings

Saves $2,000 per yearStarts at age 25Continues for 40 yearsInvests in a taxable account and earns an 8.9% pre-tax and 6.68% after-tax return

Saves $2,000 per yearStarts at age 25Continues for 40 yearsInvests in a Tax-Deferred account and earns an 8.9% pre-tax return

VickieStan

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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

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The Saving Process


Identify your specific savings goalsIdentify your time horizonQuantify your saving goalsPrioritize your saving goals

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Identify Your Specific Saving Goals

Pay down existing debtCreate an emergency fundSave for retirementAccumulate a down payment for a houseBuild a college fund for your children’s educationSet aside money for a specific goal (vacation, fun and games, etc.)

Buy a car and finance it.Bankrate Auto Calculator

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http://www.bankrate.com/calculators/auto/auto-loan-calculator.aspx

http://www.bankrate.com/calculators/auto/auto-loan-calculator.aspx


Create an Emergency Fund

Set aside 2 to 4 months of living expensesUse it for a crisis (i.e., roof leaks)Use it and replace it Don’t use it for discretionary spending (i.e., vacation)

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Save for Retirement

Do everything possible NOWStart early—you’ll end up with more

Figure out what you need for retirement.Bankrate Retirement Calculator

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http://www.bankrate.com/calculators/retirement/retirement-plan-calculator.aspx

http://www.bankrate.com/calculators/retirement/retirement-plan-calculator.aspx


Identify Your Time Horizon

Identify number of months or years until goalAllow as much time as possible:• You can accept a lower investment risk• Your monthly saving and investing commitment will be less

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Examine Your Spending Habits

Keep a list of all spending for one monthCompare total spending to take-home payExamine closely if you have a substantial unexplained gapBecome highly knowledgeable about your expenses

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Identify Ways to Save More

Save your next raiseSave your next bonusReinvest dividends and interestSave all cash giftsRent instead of buying (books, videos, etc.)

Delay buying a new car upon paying off present car loanSave the “donut money”—and lose weight!Buy generic productsTrim your spending by 5%Be creative

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What About Investing?

Combined with savings, a key resource for achieving your financial goalsInvesting skills are needed to prudently utilize• Company 401(k) investments• IRAs investments• Savings invested outside these plans

All investments involve risksApproach investing carefully

Take the Rutger’s Risk QuizRutger's Risk Quiz

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http://njaes.rutgers.edu/money/riskquiz/

http://njaes.rutgers.edu/money/riskquiz/


What Investing Carefully Means

Phase I: Learn investing basicsPhase II: Develop your investment planPhase III: Implement your investment plan

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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

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What Are The Major Asset Classes?

Major Asset Class Characteristics Goals

HistoricalAverage Returns*

Cash Matures in less than one year

Capital preservationLiquidity

3-4%

Bonds Fixed incomeVaried maturities

IncomeCapital preservation

5-7%

Stocks Company ownership Possible dividend incomeCapital appreciation

10-13%

Hard assets Asset ownership Capital appreciationInflation hedge

Varies

* Pretax return over 75 years through 2008

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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 businessLikelihood that the market as a whole will fallRisk of not being able to access money when neededLoss of principal on fixed-rate investments due to rising interest ratesInvestment’s value will be affected by changes in exchange rates

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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 riskMarket riskLiquidity risk

Interest rate riskCurrency risk

Diversify within an asset classDiversify among asset classesDiversify among asset classesHave an emergency fund“Ladder” portfoliosDiversify among countries or hedge

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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

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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 R

etur

n

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

Volatility Risk Over Time

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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

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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

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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 A6.61% Return

4.25% Risk*

Portfolio B6.61% Return

3.60% Risk*

Portfolio C7.06% Return

4.25% Risk*

* Risk = one standard deviation

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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

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Your desired rate of return Your risk toleranceYour time horizon

Review Handout-Financial Market Indicators

What Most Influences Your Asset Allocation?

Stan Vickie

Stan and Vickie are different…their asset

allocations will be different too.

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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

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Importance of Your Risk Tolerance

The higher your risk tolerance the more aggressive you can be

Risk Tolerance

Be More Aggressive

Be More Conservative

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Importance of Your Time HorizonLonger time horizons (5 or more years) can absorb the ups and downs of investing more heavily in stocksShorter time horizons warrant investing more heavily in less volatile investments

Time horizon

Use more volatile stocks

Use less volatile investments

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Developing Your Investment Plan


Use This Investment Planning Process


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

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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.

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

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What Will You Have?

• Take into account

• 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

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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 accounts4. Review handout

* 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.

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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 $50,000Pre-tax $ $2,667 $2,667 $2,667 $2,667Tax at 25% $667 $667After-tax $ $2,000 $2,000Employee contribution $2,000 $2,000 $2,667 $2,667Employer 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

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Why These Priorities?

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

Traditional IRA Using Pre-Tax Contributions

Employer 401(k) Plan

Account Balance in 30 Years

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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.

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Key Points to Remember

Financial planning will help you clarify goals, strategies and action stepsDetermine whether you have too much debt and develop a plan to conquer itMake wise decisions about using debtCommit to saving and investingSave and invest earlyPay yourself firstLearn as much as you can about investing to develop a plan and invest according to your “comfort level”

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basics of personal financial planning

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