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Learning GoalsAfter reading this chapter, youshould be able to answer thesequestions:

1 How does the financial-planning process facilitate

successful personal financialmanagement?

2 How do cash flow planningand management of liquid

assets contribute to your financialgoals?

3 What are the advantagesd di d f i

Managing Your Personal Finances

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In today’s highly competitive world, most people are aware of the need for early financial planning and its importance to their future security and success. Shifts in demographics have skewed the economic picture for many families, making proper financial planning essential. Some of these changes are:

More families (now called sandwich families) find themselves caught in the middle financially, responsible for both their children (couples are having children later in life) and their aging parents (increasing longevity), at a time in their own lives when they’re ready to retire.Increasing numbers of blended families result from divorce and remarriage.A significant number of single individuals are solely responsible for their own finances.The average cost to raise a child to age 17 ranges between $148,320 and $298,680 depending on family income levels and location.1

The average annual cost of a public college education is $6,185; at a private college its $23, 712 per year or more.2

More employees are responsible for their own retirement funds.People have an overwhelming amount of information to consider when choosing suitable financial products.Changing financial obligations and world economics bring new challenges in preparing for the future. They can also bring confusion, frustration, and worry about meeting financial goals.

This chapter provides an overview of the information and skills needed to meet the challenge of managing your own finances. We demonstrate how the personal financial-planning process can help you manage your cash flow and meet your financial goals. We describe various types of checking and savings instruments, and explain how to use consumer credit wisely, how to manage taxes, and how to select insurance. Then we outline how to set investment goals, develop an investment strategy, and make securities transactions. Finally, we review emerging trends in personal finance.

Financial Planning: The First StepsIn today’s world, financial planning is for everyone, not just the wealthy, whether you have too much money or too little. If you have enough money, planning can help you spend and invest it wisely. If your income seems inadequate, taking steps to control your financial situation could lead to an improved lifestyle.

Personal financial planning is the process of managing one’s personal finances to achieve financial goals. Once you have established those goals, you can begin gathering information, analyzing the information, and then developing, implementing, and monitoring a financial plan designed to meet your goals. Exhibit 1 illustrates the steps in the personal financial-planning process.

Personal financial planning is a lifelong process. As your personal circumstances change, so will your needs and goals. By creating flexible plans and revising them on a regular basis, you will build a solid foundation for your financial future.

Before you set goals and develop financial plans for your future, you should assess your current financial situation. Just as corporations summarize their financial position on their balance sheets, preparing a personal balance sheet will present a summary of your financial position on a given day. Assets, the things you own, are valued at current market value on your balance sheet. Liabilities are what you owe. They are recorded as the amount you would have to pay if you paid off the entire debt immediately. Net worth, total assets minus total liabilities, measures your wealth at a given point in time.

Completing a personal balance sheet at regular intervals, such as every six months or each year, will help you track your progress toward achieving your goals. You’ll be able to see how your assets are growing and your debt is—hopefully—going down. Exhibit 2 on page 4 is an example of the personal balance sheets for Jay Martin. As you can see in the “change” column, he has significantly improved his net worth during calendar year 2010 by saving and investing more and paying off his auto loan.

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successful personal financial management?

personal fi nancial planningThe process of managing one’s personal fi nances to achieve fi nancial goals.

personal balance sheetA summary of a person’s fi nancial position on a given day; provides information about assets, liabilities, and net worth.

net worthAn individual’s wealth at a given point in time, calculated as total assets minus total liabilities.


successful personal financial management?

personal fi nancial planningThe process of managing one’s personal fi nances to achieve fi nancial goals.

personal balance sheetA summary of a person’s fi nancial position on a given day; provides information about assets, liabilities, and net worth.

net worthAn individual’s wealth at a given point in time, calculated as total assets minus total liabilities.

2 Online Enrichment Chapter

What are the benefi ts of personal fi nancial planning?

Describe the six steps in the personal fi nancial-planning process. Develop four personal fi nancial goals for yourself, two short-term (1 to 2 years) and two long-term (5 to 10 years).


Cash Management: Where’s the Money?Cash management is defined as the day-to-day handling of one’s liquid assets. Liquid assets include cash, checking accounts, various savings instruments, and other assets that can be converted into cash quickly at little or no cost. A cash flow plan (often called a budget) is an important tool for cash management. It helps manage income and expenses, and the savings and investment contributions needed to accomplish one’s financial goals. The following steps will help you develop and use a cash flow plan:

Establish your goals and calculate the savings you need to meet them. It is helpful to prioritize your goals because you may have more goals than money. Identify each goal, estimate how much money is needed to accomplish that goal, and specify the time frame for achieving the goal.Estimate your income and expenses, including contributions to savings. Review your monthly income and estimate your monthly expenses. The monthly budget worksheet in Exhibit 3 on page 5 illustrates how to monitor your income and expenses, or you can create a spreadsheet covering several months.Track actual income and expenses for a one-month period. Carry a pad of paper with you so you don’t forget small expenditures you make, and record all income and expenses. At the end of the month, total the income and expenses for each category and enter them on the worksheet in Exhibit 3 on page 5 in the “actual” column.Compare planned and actual income and expenses. Analyze each category that was above or below your estimate in the “planned” column and determine whether this was unusual. For example, if you needed a new suit for an unexpected interview you may have exceeded your clothing allocation for the month. But if you find the situation to be normal, decide whether to cut back your spending or increase your budget for that item. Of course, if you add to that category, you will need to reduce another by the same amount.Modify estimates for the next month and repeat the process. Depending on your analysis, you may want to make changes to your original plan. It may take several months before you are able to live within your cash flow plan so it is important to be flexible. But within a short period you will be in control of your spending and saving.

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2 How do cash flow planning and

management of liquid assets contribute to your financial goals?

cash managementThe day-to-day handling of one’s liquid assets.

liquid assetsCash, checking accounts, various savings, instruments, and other assets that can be converted into cash quickly at little or no cost.

cash fl ow planA cash management tool that includes a plan for managing income and expenses, and the savings and investment contributions needed to accomplish one’s fi nancial goals; often called a budget.



cash managementThe day-to-day handling of one’s liquid assets.

liquid assetsCash, checking accounts, various savings, instruments, and other assets that can be converted into cash quickly at little or no cost.

cash fl ow planA cash management tool that includes a plan for managing income and expenses, and the savings and investment contributions needed to accomplish one’s fi nancial goals; often called a budget.

6. Monitoring your plan. Regularly review and adjust your plan. Track the performance of the savings/investment components of the plan, and review and adjust the plan and your goals as necessary. Keeping up-to-date on the financial environment will help you monitor your plan effectively.

5. Implementing the plan. Put your plan into action. Complicated plans may require the help of financial-planning experts.

4. Developing a plan. There may be several ways to achieve your goals, so consider various alternatives before arriving at the plan that works best for you.

3. Analyzing the information. Review the data you have collected and revise your goals if necessary.

2. Gathering information. Objective and subjective information are both important components of the decision-making process.

1. Establishing financial goals. Sound financial goals are the basis of your financial plan, a road map that guides spending, saving, and investment decisions.

EXHIBIT 1 Step Up to Achieve Your Financial Goals

Managing Your Personal Finances 3


Checking AccountsChecking and savings accounts are the most common liquid assets held by consumers, and a checking account is necessary to manage your income and expenses. A check is a written order, drawn on a depository institution by a depositor, ordering the depository institution to pay on demand a specific amount of money to a person or firm named on the check. Several types of checking accounts are available to meet the diverse needs of consumers. These were briefly noted in Chapter 15.

Electronic Fund Transfers Regardless of the type of checking account you select, you will probably be offered electronic fund transfer (EFT) services. EFT allows you 24-hour access to cash through an automated teller machine (ATM) and point-of-sale (POS) transfers for retail purchases with a debit card. With an ATM card and personal identification number (PIN), you can withdraw cash, make deposits, or transfer funds between accounts. You can pay for goods and services with a POS transfer using your debit card. It works very much like a credit card with one important exception: the money for the purchase is transferred immediately from your checking account to the vendor’s account.

Using these cards requires good management skills. With both ATM and POS transactions, be sure to enter withdrawals in your check register. Failure to maintain an accurate record of your account balance may result in bounced checks. Guard your cards carefully so they are not stolen or fraudulently used. This is especially important with POS (debit) cards because they can be used without a PIN.

Name Jay Martin

Date 12/31/09 Date 12/31/10 Change

ASSETSLiquid assetsChecking accounts $ 1,230 $ 895 $ (335)Savings/money market accounts 385 1,546 1,161Money market mutual funds Certificates of deposit (6 months) Cash on hand 76 153 77Other_________ Other investment assetsCertificates of deposit (> 6 months) 500 1,000 500Mutual funds 2,421 2,421Stocks Bonds Other_________ Personal assetsAutomobile 5,346 3,421 (1,925)Furniture and appliances 3,460 8,000 4,540Clothing 2,000 4,000 2,000Other_________ Other_________ (1) Total assets $ 12,997 $ 21,436 $ 8,439LIABILITIES Bills due Credit cards $ 857 $ 472 $ (385)Auto loans 2,569 (2,569)Appliance/furniture loans Mortgage loans Education loans 9,365 8,593 (772)Other_________ Other_________ (2) Total liabilities $ 12,791 $ 9,065 $ (3,726)NET WORTH (1–2) $ 206 $ 12,371 $ 12,165

EXHIBIT 2 Personal Balance Sheets



If your ATM or debit card is lost or stolen, federal regulations mandate that you may be responsible for up to $50 if the loss is reported within 2 business days, up to $500 if you report it between 3 and 60 days, and for an unlimited amount if the loss is reported after 60 days.

Be aware of ATM fees charged by your bank and the institutions that own the machines you use. Even small fees for withdrawing cash add up quickly if you make several withdrawals. You can usually reduce or eliminate ATM fees by using the ATMs at your own bank.

Overdraft Protection The Federal Reserve Board has been called upon to regulate banks that offer “bounced-check protection” or “overdraft protection” targeted almost exclusively to low- and moderate-income consumers. Overdraft protection products can be a deliberate attempt to encourage consumers to use overdrafts as a form of high-cost credit loans at outrageously high prices. Extremely expensive and often deceptively advertised, bounced-check protection can cost consumers as much as $2,000 a year.

Name:

Planned Actual Variance

Month of

Income Wages (take-home pay) Support from relatives Loans Withdrawals from savings Other Other (1) Total Available Income

Expenses Fixed Expenses Housing Automobile payment Insurance Loan repayment Savings for goals Tuition and fees Other Subtotal, Fixed Expenses Flexible Expenses Food Clothing Personal care Entertainment and recreation Transportation Telephone Utilities (electricity, gas, water) Cable TV Medical and dental Books, magazines, educational supplies Gifts Other Other Subtotal, Flexible Expenses

(2) Total Expenses

Cash Surplus (Deficit) [(1)-(2)]

EXHIBIT 3 Monthly Budget Worksheet




With bounced-check protection plans, banks advertise to consumers that they will cover overdrafts up to a set dollar limit. They then charge a bounced-check fee, often between $20 and $35 per transaction, as well as a per-day interest rate on the negative balance until the account has a positive balance. Bank customers are advised to view any overdraft protection offer from their bank very carefully before opting for what could be a very expensive way to borrow money.

Balancing Your Checkbook This important task reveals possible mistakes you or the bank has made and helps you discover fraudulent debit card withdrawals. It also helps to avoid bouncing checks, which can be expensive and embarrassing. Exhibit 4 lists the steps to follow in balancing your checkbook. Computers have long been effective tools for managing personal (and professional) checking accounts. Read about the new generation of personal financial software in the Customer Satisfaction and Quality box above.

Savings InstrumentsChecking accounts are appropriate for money you may need to access on a day-to-day basis, but savings instruments are a more appropriate way to accumulate money for short-term goals (a new television or a vacation) and for unexpected expenses (emergencies and opportunities). Banks, thrift institutions, and credit unions offer a variety of savings instruments, as noted in Chapter 15.

Before selecting a savings vehicle, consider your goals and how you will use it. Compare the interest rate you will receive with those paid by other institutions. Rates are always changing, but financial institutions, the Internet, and magazines such as Kiplinger’s Personal Finance and Money are excellent sources of information.

Using Consumer CreditWhat if you want (or need) to make a purchase before you have accumulated the necessary money? You might use a credit card or a loan to make the purchase, paying interest to the lender for the

3 What are the advantages and disadvantages of

using consumer credit?3 What are the advantages

and disadvantages of using consumer credit?

What are the steps to follow when developing and using a cash fl ow plan?

How do checking and savings accounts help to manage cash?

What management skills are required to use electronic funds transfers, ATM cards, and POS (debit) cards wisely?

For years, Intuit’s Quicken software has been the market-leading personal-finance software. Quicken users can manage their bank accounts, pay their bills, and track their expenses, and updates every year or so offer new capabilities and easier use. Microsoft’s Money software does the same.

Not everyone wants the sophisticated tools these ubiquitous planning software packages offer. Those less enthusiastic about bookkeeping are finding a new gen-eration of Web-based finance applications more to their liking. Web sites like Mint, Wesabe, and Geezeo allow members to track their banking and budgeting online. Of these Mint, founded by Aaron Patzer, has the largest membership at 180,000. Patzer took meticulous care of his finances from the age of 16. Each week, he would sift through all his receipts, categorize all of his expenditures, and record his transactions in his Quicken software. After a particularly busy period in college, he found he had 400 transactions to sort and record. He spent a few hours trying to get his records up-to-date, wondered why there wasn’t a program that would do it for him, and decided to quit college and write one himself. The result was Mint.com.

Mint.com users need only key in the log-ins for the financial institutions they use (the average American uses 11). That is, users put in their account names and passwords for all their online banking accounts, and Mint aggregates everything into one complete financial picture. Mint even deciphers the vendor codes on credit card statements and assembles colorful pie charts so users can see cash balances, expen-ditures, and debts. Mint will e-mail users when their bank balances get low, bills are

due, and suspicious charges appear on their credit cards.

Because Mint’s service is free, some wonder if its business model is sustainable. Mint takes a user’s data and analyzes it to see if an offer from one of Mint’s financial partners, for example Citibank, will save the user more than $50. If so, the user will see an ad for the offer. Critics argue that paying about $30 for Quicken is a small fee for ad-free financial software.

Although Mint and Wesabe together have fewer than 300,000 users to Money’s 4 million and Quicken’s 15 million, Web-delivered finance tools are the newest way to provide customers with fast, simple ways to manage their money. When Quicken began offering an online version of its popular Turbo Tax software, the online version eclipsed the desktop version in five years. Quicken Online, launched in January 2008, is expected to do the same.3

Critical Thinking QuestionsWould you be more interested in using desktop or Web-based financial software? Why?Mint.com and other online services are targeted at younger, Gen Y customers. Do you think a user would ever “grow out of” Mint?

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Managing Your Money Online

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privilege of borrowing the money. We have discussed how to set goals and use various types of instruments to save for your future needs, but using credit to make purchases is the opposite of saving money to buy things. In this section, we will investigate the pros and cons of using consumer credit, look at various types of credit, and learn how to build a positive credit rating.

The Pros and Cons of Using CreditThere are a number of very good reasons for using consumer credit:

Convenience.Immediate use of a good or service.Bargain prices on sale merchandise.Opportunity to establish a credit rating.Convenient record keeping.Payment for financial emergencies.Perks such as rebates and frequent-flyer miles.

Although not as numerous, there are also important disadvantages to using consumer credit:

It’s easy to overspend.Most types of credit cost money in the form of interest charges.Merchandise may cost more.The legal commitment to repay debt reduces future discretionary income.

The ability to overspend, especially because credit cards are so convenient to use, can be the most devastating disadvantage. The financial and psychological stress created by this debt forces some students to drop out of college altogether, or work long hours, often causing their grades to suffer. For many Americans, getting out of debt is a top priority.

The secret to using credit responsibly is your cash flow plan. Don’t use credit to buy anything that does not fit into your plan. Use your credit card for convenience, using it instead of cash for purchases so that you have to write only one check for all you buy. Then be sure to pay the total bill at the end of the month. Use a credit card for credit (meaning that you will not pay it off monthly) only when really necessary, revising your cash flow plan to repay the debt as quickly as possible.

According to the Federal Reserve, in March 2008, Americans held nearly $2.6 trillion in consumer debt. If you currently have outstanding debt, use a form like Exhibit 5 on the next page to inventory your debt and develop a debt repayment strategy. For Becky Sampson, whose debt inventory is presented in this exhibit, an effective strategy might be to borrow from her personal line of credit (at 12 percent) to pay off her high-interest loans—the credit-card balances (18 percent and 21 percent). But she must be careful not to run up her credit card balances again after paying them off.

Credit CardsCredit cards are the most used type of open-end credit. Open-end credit is any type of credit where once your application for credit is approved you may use it over and over again. Your line of credit is the maximum amount you can have outstanding at any one time. Some cards require the entire

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open-end creditAny type of credit where the borrower applies for the credit and then, if approved, is allowed to use it over and over again; for example, credit cards.

line of creditFor credit cards, the maximum amount a person can have outstanding on a card at any one time.

open-end creditAny type of credit where the borrower applies for the credit and then, if approved, is allowed to use it over and over again; for example, credit cards.

line of creditFor credit cards, the maximum amount a person can have outstanding on a card at any one time.

1. If you receive canceled checks, place them in numerical order.2. Compare each check with the check entry on your bank statement and your checkbook record to make

sure the amounts agree. Check off each correct item. Repeat the same process for all other withdrawals such as ATM, debit card, and cash.

3. List and total all outstanding withdrawals (withdrawals deducted in your checkbook but not yet reflected on your bank statement).

4. Repeat Steps 2 and 3 for all your deposits.5. Subtract the total amount of any outstanding checks from your bank statement and add any outstanding

deposits to this balance to obtain your adjusted bank balance.6. Subtract bank service charges and add interest earned to your checkbook balance to find your adjusted

checkbook balance.7. Your adjusted bank balance and adjusted checkbook balance should be the same. If not, recheck your

math and the deposits and withdrawals listed in your checkbook. If you cannot find an error, you will need to consult with your bank to see if an error was made in your account.

EXHIBIT 4 Seven Easy Steps to Balancing Your Checkbook



balance to be paid upon billing, but most require a minimum monthly payment. Cards that do not require full payment upon billing are called revolving credit cards. Some credit cards carry an annual fee whereas others do not.

When you receive your monthly bill and do not pay the entire balance, you are charged interest. Some credit cards offer a grace period, a period of time after making a purchase when interest is not owed if the entire balance is paid on time. Cards with no grace period will charge interest even if you pay the entire bill monthly.

Depending on how they are used, credit cards can be either one of the most or one of the least expensive ways to make purchases. Individuals who pay off their entire credit card balance each month are called convenience users of credit cards. If they select cards with a grace period and no annual fee, they have free use of money for the period of time until the bill must be paid. On the other hand, credit card users who pay only the minimum monthly payment can incur high interest charges, as Exhibit 6 shows.

revolving credit cardsCredit cards that do not require full payment upon billing.

grace periodThe period of time after a purchase is made on a credit card during which interest is not owed if the entire balance is paid on time.

revolving credit cardsCredit cards that do not require full payment upon billing.

grace periodThe period of time after a purchase is made on a credit card during which interest is not owed if the entire balance is paid on time.

Name Becky Sampson Date 10/15/2010

Type of Debt CreditorAnnual Rate of Interest

Current Monthly Payment

LatestBalance Due Comments

Auto Loans 1 University Federal

Credit Union

2

3

8% $315 $6,893 Car will be repossessed if

loan is not repaid

Education Loans 1

2

Home Mortgage Loan

Home Improvement Loan

Other Installment Loans 1

2

Single-Payment Loans 1

2

Credit Cards 1 MasterCard 18% $22 $716 $1,000 credit line

2 Visa 21% $40 $1,608 $2,000 credit line

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4

5

6

7

Personal Line of Credit First National Bank 12% — — $3,500 credit line

Home Equity Credit Line

Overdraft Protection Line

Loan on Life Insurance

Margin Loan from Broker

Other Loans 1

2

3

TOTALS $377 $9,217

EXHIBIT 5 Debt Inventory



Here are some other tips to help you pay off those credit cards:

Don’t wait until the last minute. Many issuers now use a “hair-trigger” for assessing late fees. In some cases you could get hit with a penalty that can be as high as $40 if the payment is just a few hours late.Talk back. If you are a customer who carries a balance and pays on time, ask for a lower interest rate and elimination of any fees. Tell the issuer you are tempted to switch to another issuer who is offering zero percent interest. If the bank won’t bargain, shop for a new card.Check your statement. Credit card fraud is widespread, so it is important to protect your credit cards and review your monthly statement carefully. Federal legislation limits your responsibility up to a maximum of $50 per card before you report the problem. Even though your direct loss is rather low, the thief may tie up your total line of credit for months until the issue is resolved, and may use one card to get other cards. All credit card users pay indirectly for fraudulent charges with higher interest rates and fees.

Other Card Tricks Minimum monthly payments used to be around 4 percent of the outstanding balance. But today many credit card issuers set them so low they do not cover the interest or added fees such as late-payment penalties, or fees for exceeding your credit limit. So even though cardholders pay the minimum every month, their balance continues to grow.

Federal bank regulators have issued a new set of guidelines designed to prevent this “negative amortization.” The new rules, which apply to all banks, say that credit card issuers must set the minimum monthly payment at an amount that will allow the cardholder to pay off the debt within a “reasonable period of time.” So although monthly minimum payments may actually increase, straining the budgets of those cardholders who regularly pay the minimum due, it will free them of debt sooner.

LoansUnlike credit cards, loans are closed-end agreements. You borrow an amount of money, called the principal, for a specific period of time and agree to pay it back by the end of the term through installments or as a lump sum. Interest is charged on the amount of principal borrowed, and you may also be required to secure the loan with something of value. An auto loan is a good example of a secured installment loan: payments on the loan are due in equal monthly installments, and if you default on the debt, the lender, who initially files a lien against the auto, has the legal right to repossess the car. Loans are also used to finance a college education, fix up a home, or purchase appliances.

Before you apply for a loan, shop around to get the best deal just as you would for any product you are purchasing. There are numerous sources of consumer loans. Banks and savings and loan associations offer relatively low interest rates to low-risk borrowers. Credit unions generally offer even lower interest rates, but you have to be a member of the credit union to get a loan there. Consumer finance companies specialize in borrowers who are higher risk, and captive finance companies (Ford Credit Corp. and GMAC) offer credit when you are making a specific type of purchase. Read more about the changes facing an industry that caters to high-risk borrowers in the Managing Change box on the next page.

A family member may charge the lowest interest rate, but if you decide to borrow money from grandma, treat the transaction in a businesslike manner. Draft a loan repayment agreement specifying the amount being borrowed, the interest rate to be paid (if any), and how the debt

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principalThe total amount borrowed under a loan.

principalThe total amount borrowed under a loan.

Making minimum payments on your credit cards can cost you a bundle over a number of years. Here’s what would happen if you paid the minimum—or more—every month on a $2,705 card balance with an 18.38 percent interest rate.

Monthly Payments How Long to Pay Off Interest Paid

2% of balance 27 years, 2 months $11,0474% of balance 8 years, 5 months 2,7078% of balance 2 years, 1 month 594

EXHIBIT 6 Minimum Payments Don’t Pay



will be repaid. Both grandma and you should sign the agreement and keep a copy. This will help to avoid misunderstandings about the terms of the loan.

Three of the most important factors to consider when comparing loans are the dollar cost of credit (finance cost), the annual percentage rate of interest (APR), and the monthly payment. According to the federal Truth-in-Lending Law, lenders must calculate the APR in a standardized way, so, other things being equal, a loan with a lower APR will be less expensive.

But when the term of the loan varies, loans with the same APR will have different monthly payments and finance costs. As you can see from Exhibit 7, the longer the term of the loan, the lower the monthly payment but the higher the finance cost. Selecting a shorter repayment period will save you money in the long run.

In addition to these factors, check a loan for prepayment penalties, additional fees owed if you decide to repay the loan early, and security requirements, which allow the lender to take back the collateral if you do not repay the loan according to the terms of the agreement. Also beware of add-ons a lender may offer. For example, credit life insurance will repay the loan if you die while the loan is still outstanding. Although this sounds like a good idea, consider whether you really need life insurance for this purpose. And if you do, find out what the coverage would cost from an insurance agent rather than the lender. The lender offers convenience, but that convenience generally comes at a cost. It is not uncommon to pay far more for credit life insurance compared to a term life policy purchased through an insurance agent.

Credit History and Credit RatingsOne of the reasons for using credit is to build a good credit rating. Three national credit bureaus—Equifax (www.equifax.com, 800-685-1111), Experian (www.experian.com, 888-397-3742), and TransUnion (www.transunion.com, 800-888-4213)—collect credit information and make it available

prepayment penaltiesAdditional fees that may be owed if a loan is repaid early.

security requirementsProvisions that allow a lender to take back the collateral if a loan is not repaid according to the terms of the agreement.

credit life insuranceInsurance that will repay a loan if the borrower dies while the loan is still outstanding.

prepayment penaltiesAdditional fees that may be owed if a loan is repaid early.

security requirementsProvisions that allow a lender to take back the collateral if a loan is not repaid according to the terms of the agreement.

credit life insuranceInsurance that will repay a loan if the borrower dies while the loan is still outstanding.

Payday loans are $42 billion industry. At least they used to be. After a wave of new regulation, the future of the industry is in jeopardy. Payday loans are short-term loans made to high-risk bor-rowers. Because the borrowers’ credit ratings pre-vent them from getting credit through lower-risk vehicles, they can pay up to 1,000 percent interest on the principal of the loan. Some states have capped the interest payday lenders can charge; for example, Illinois caps the rate at 400 percent. At those rates, the industry generates $1.2 billion of fees annually.

Payday lenders aren’t as profitable as one would think, however. One study by a Vanderbilt University professor says that even at compounded rates of 7,295 percent, the per year return on equity for a payday lender is only 9 to 10 percent. That com-pares with a return of 12 to 15 percent for a traditional lender. The largest payday lender in the United States is Advance America Cash Advance Centers out of South Carolina. Advance America spends 20 percent of its revenue on collecting the 3 percent of loans that go into default after collections.

As the overall credit market declined, payday lenders began facing a tougher regulatory environment in a variety of states that passed interest-rate caps. Perhaps the strictest rate was passed by the Ohio state legislature: 28 percent annual interest rate. In addition, Ohio extended the minimum term length to 31 days (eliminating the two-week loan) and limited small loans to a maximum of $500. The strict legislation

produced the desired result of driving payday lend-ers out of the state. Advance America announced within days of the legislation passing that it would close its 246 Ohio branches. Cash America and Check Into Cash also plan to close their stores, but Dollar Financial announced it will keep its stores open and begin offering other (unspecified) financial services.

Arguing that they provide a service to high-risk borrowers who would otherwise not be able to get loans, the major payday-lending companies have increased their lobbying activities in an effort to cap rate legislation in other states. Political contri-butions exceed $4 million per year. Representative Jon Husted of Kettering, Ohio, is unfazed. “Some people shouldn’t get access to credit because they’ve demonstrated that they can’t handle it,” he says, adding, “like Congress.”4

Critical Thinking QuestionsWhat are the ramifications to high-risk, and otherwise uncreditworthy, borrowers of removing their access to credit?Do you think payday loans are as dangerous as legislators make them out to be? Why or why not?

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Payday Lending Caps Force Store Closings

Number of Payments Monthly Payment Finance Cost

36 $627 $2,572 48 488 3,424 60 406 4,360

EXHIBIT 7 Comparisons of a $20,000, 8 Percent Loan



for a fee to retailers, banks, and other organizations that are subscribers or approved recipients of this highly confidential information. Credit bureaus do not evaluate the data; they report the following types of credit information for each lender: the date the account was opened; the highest amount of credit extended; the current outstanding balance; the number of times the account has been 30, 60, and 90 days overdue; and the number of inquiries there have been for this account information. Negative account information can stay in the file for no more than 7 years, 10 years in the case of bankruptcy. Information from the three credit bureaus does not always match so you should check all three.

Lenders use information from your credit report as well as other information from your credit application to decide whether to grant credit and under what terms. The better “score” you receive, the more likely you are to be approved for a credit card or loan and to be offered lower rates of interest. Because the information in your credit bureau file is so important, you should periodically check your own file for accuracy. If you are applying for a loan, or have been in a dispute with a creditor, request a copy of your credit report from all three major credit bureaus.

If you find inaccurate information in your credit file, report it to the credit bureau. The credit bureau must investigate your dispute within 30 days or remove the disputed item from your file. If the investigation does not resolve your dispute, you may add a brief statement to your file, which must be included in future reports. In addition, credit bureaus must prevent deleted information from reappearing in a credit report, and creditors are liable if they neglect to correct errors.

Managing TaxesBecause the tax code is very complex and taxes represent the largest expenditure in the average American family’s budget, some knowledge of the subject is important. In this section we briefly discuss the four types of taxes that are paid directly by individuals: income, Social Security and Medicare, sales, and property taxes.

Income TaxesThe federal income tax is a progressive tax, meaning the higher your taxable income, the higher the percentage of your income that is paid in taxes. In 2008, taxpayers in the lowest tax bracket paid 10 percent on the first $8,025 of taxable income ($16,050 for married taxpayers filing jointly), whereas higher income taxpayers paid at rates of 15, 25, 28, 33, and 35 percent.5 Because of the progressive structure and certain tax deductions (the standard or itemized deduction and the personal exemption), people with low incomes may pay little or no federal income taxes.

Pay-as-You-Go System The federal government expects us to pay both federal income taxes and Social Security taxes (discussed later) as we earn income. This is accomplished through tax withholding by employers, or by filing quarterly tax estimates on self-employment income, investment income, and other income that is not subject to withholding. When you start a new job, your employer will ask you to fill out a W-4 form on which you report your filing status (similar to your marital status) and the number of withholding allowances you want to claim. The more withholding allowances you claim, the less your employer will withhold from each paycheck. However, the goal is to have the right amount withheld, so use the W-4 worksheet for guidance.

Minimum Filing Requirements The federal government does not require all income earners to file federal income tax returns. If your income is below the minimum filing requirement in a given year, you do not have to file. If you are entitled to a tax refund, however, you must file to receive the refund.

Most taxpayers can take the standard deduction from their gross income. In 2008 the standard deduction was $5,950 for single people and $10,900 for married couples filing jointly.6 As an alternative to the standard deduction, the taxpayer can elect to itemize deductions. Taxpayers can also claim personal exemptions that reduce the amount of their taxable income. You can take a personal exemption for yourself, your spouse, and each of your dependents. If you are a taxpayer who is claimed as a dependent by someone else, however, you cannot claim the personal exemption. In 2008 a personal exemption was worth $3,500.7 (These figures change every year.)

4 What types of taxes are individuals responsible

for?4 What types of taxes are

individuals responsible for?

progressive taxAn income tax that is structured so that the higher a person’s taxable income, the higher the percentage of income paid in taxes.

progressive taxAn income tax that is structured so that the higher a person’s taxable income, the higher the percentage of income paid in taxes.

fi ling statusThe marital status of a taxpayer specifi ed on the income tax return.

withholding allowancesAllowances claimed with an employer that determine the amounts of income that are withheld for taxes from each of the employees’ paychecks.

standard deductionAn amount that most taxpayers can automatically deduct from their gross income in computing their income tax; as an alternative the taxpayer is permitted to itemize deductions.

personal exemptionsDeductions that reduce the amount of income on which income tax is paid. Each taxpayer is entitled to a personal exemption, for himself, his spouse, and each of his dependents; a personal exemption can be used only once.

fi ling statusThe marital status of a taxpayer specifi ed on the income tax return.

withholding allowancesAllowances claimed with an employer that determine the amounts of income that are withheld for taxes from each of the employees’ paychecks.

standard deductionAn amount that most taxpayers can automatically deduct from their gross income in computing their income tax; as an alternative the taxpayer is permitted to itemize deductions.

personal exemptionsDeductions that reduce the amount of income on which income tax is paid. Each taxpayer is entitled to a personal exemption, for himself, his spouse, and each of his dependents; a personal exemption can be used only once.

What are the advantages and disadvantages of consumer credit?

How can an inventory of your debt help you make better decisions about debt repayment?

What is a credit bureau, and what function does it perform in the granting of credit?



Filing a Federal Income Tax Return Individuals may use one of three basic forms when filing their income tax returns: the 1040EZ, the 1040A, and the 1040. The 1040EZ and the 1040A are limited to taxpayers with relatively simple finances. Taxpayers can also use the TeleFile system to file their returns by punching in their data on touch-tone phones, or file online at the Internal Revenue Service Web site at http://www.irs.gov/efile/.

When completing a tax return, you start by listing your gross income, which includes earned income, income earned through employment (wages, tips, self-employment income), and unearned income (interest, dividends, other investment income). Students must include scholarship and grant proceeds in their gross income if these exceed the direct cost of the education. After totaling your gross income from all sources, subtract any legal deductions you are eligible to take: adjustments to gross income, standard or itemized deductions, personal exemptions, and tax credits. You may claim adjustments for interest paid on student loans, job-related moving expenses, and contributions to Individual Retirement Arrangements (IRAs).

In 2009, the Alternative Motor Vehicle Credit provides for a tax credit valued at up to $3,000 to those taxpayers who buy a hybrid or alternative motor vehicles. A tax credit is subtracted directly from the total amount of federal tax owed, thus reducing or even eliminating the taxpayer’s tax obligation. The 2009 tax credit applies to vehicles purchased or placed in service on or after January 1, 2009. Hybrid vehicles have drive trains powered by both an internal combustion engine and a rechargeable battery. The credit is available to the original purchaser of a new, qualifying vehicle, and many currently available hybrid vehicles may qualify for the tax credit. Credit amounts vary depending on the model year and the make of the vehicle. And if the number of hybrid vehicles sold in the year exceeds 60,000, the credit is reduced or eventually eliminated.8

The tax-filing deadline is April 15. Tax returns filed on April 15, 2010, apply to income earned in the calendar year 2009. If the 15th falls on a weekend, the filing date is the next business day.

Tax Planning As long as your financial life is relatively simple, your biggest tax-planning issues will be having the correct amount of money withheld and keeping the appropriate tax records. However, once you purchase a home, begin investing, and earn a larger income, more sophisticated tax planning becomes important. You will probably need a good accountant, perhaps someone who specializes in taxation. You should also learn more about the federal income tax laws and keep up with the frequent changes made to those laws.

Social Security and Medicare TaxesLike income taxes, Social Security and Medicare taxes are payroll taxes—taxes deducted from each employee’s paycheck. Social Security taxes, often seen on a payroll stub as FICA (Federal Insurance Contributions Act), are paid at a uniform rate on a specified amount of earned income (the wage base). Both the percentage and the wage base can change annually.

Your employer matches your Social Security and Medicare paycheck withholding with company funds, and sends the total to the Internal Revenue Service (IRS). Self-employed people are responsible for paying both the employee’s and the employer’s share of this tax by making quarterly estimated payments. They are then allowed to deduct one-half of their Social Security tax as an adjustment to their gross income on their federal income tax returns.

Sales and Property TaxesTwo additional taxes are sales tax and property tax. All but five states (Alaska, Delaware, Montana, New Hampshire, and Oregon) currently have a sales tax on retail goods and some services. In certain states, items like food consumed in the home, prescription drugs, and services such as doctor’s fees, haircuts, and laundry bills are not taxed. Generally, sales tax rates range from 4 to 7 percent for the state’s share with an additional 1 to 2 percent added by some cities.

The biggest single property tax for most individuals is on real estate, including a home. Property tax (real estate tax) is generally divided among the city, the county, the school system (which gets the largest portion), and in some cases the state government. The annual

earned incomeIncome that is earned from employment such as wages, tips, and self-employment income.

unearned incomeIncome that is not earned through employment such as interest, dividends, and other investment income.

earned incomeIncome that is earned from employment such as wages, tips, and self-employment income.

unearned incomeIncome that is not earned through employment such as interest, dividends, and other investment income.

What is a progressive tax? Explain why the federal income tax is progressive.

What are the standard or itemized deduction and the personal exemption? How do these amounts diff er for tax-payers who are dependents as compared with independent taxpayers?

Briefl y describe three other types of taxes besides the income tax.



property tax (often paid in two installments) is calculated by multiplying the appraised (or assessed) value of the property by the tax rate. A house appraised at $100,000 could be taxed at 2 percent of its assessed value, resulting in an annual property tax of $2,000. Some state and local governments also impose personal property taxes on items such as automobiles, boats, and even the fixtures, furniture, and fittings belonging to a business.

Selecting InsuranceAlthough financial planning helps us meet our financial goals, we need to make provision for life’s other uncertainties. We could suffer major losses from a fire, a serious auto accident, an illness, or a premature death. Assessing these risks and purchasing the appropriate insurance to protect against them is an important part of a sound financial plan. Insurance planning involves learning about various types of insurance, such as property and liability insurance, health insurance, disability income insurance, and life insurance, and setting priorities for your individual insurance needs.

Setting Insurance PrioritiesBefore buying an insurance policy you should first identify, evaluate, and prioritize your insurance needs. Start by identifying the types of insurable risks you face. For example, if you own a car, you face the risk of being in an accident that is your fault, injuring the other driver and damaging his or her car. Your own car could also be damaged and you could be hurt. Some other everyday insurable risks people face include:

Damage to personal property such as automobiles, homes, and boats.Liability losses due to negligent actions.Medical expenses due to illness or accidents.Loss of income due to disability or premature death.

The key to managing your insurance needs in a cost-effective way is to budget (have funds set aside) to cover minor losses, and to purchase property, health, disability, and life insurance to cover potential major losses. Another way is to opt for higher deductibles. A deductible is the portion of a claim for which the insured, not the insurer, is responsible for paying. For example, imagine you have a $500 deductible on your car insurance policy and a tree limb falls on your roof. The repair estimate is $1,200. You would be responsible for paying the first $500 and your insurance company would pay the $700 balance. In general, the higher your deductible, the lower your insurance premium. Another way to manage your insurance costs is to inquire if your insurance company offers a discount for paying the full annual premium at once or paying in quarterly installments rather than monthly installments.

Property and Liability InsuranceProperty insurance covers financial losses from damage to or destruction of the insured’s property as a result of specified perils, such as fire or theft. Liability insurance covers financial losses from injuries to others and damage to or destruction of others’ property when the insured is considered to be the cause. It also covers the insured’s legal-defense fees. The property and liability policies most often purchased by individuals are automobile insurance and homeowners/renters insurance.

Automobile Insurance Auto insurance covers financial losses from such perils as accident, theft, fire, and liability lawsuits. The two main types of automobile insurance are liability coverage and physical damage coverage. Automobile liability insurance protects the insured from financial losses caused by automobile-related injuries to others and damage to their property. Each policy specifies maximum payment limits. For example, a $50,000/$100,000/$25,000 policy will pay up to $50,000 for each person injured in an accident but a total of no more than $100,000 per accident for personal injuries, no matter how many people are involved. In addition, it will pay a maximum of $25,000 for damage to other people’s property.

All 50 states have financial responsibility laws that require drivers to show proof of liability insurance, the ability to pay the costs (up to a limit) of any accidents for which they are responsible.

Automobile physical damage insurance covers damage to or loss of the policyholder’s vehicle from collision, theft, fire, or other perils. It includes collision coverage for damage caused by

••••

5 What factors should you consider in deciding what

insurance to purchase?5 What factors should you

consider in deciding what insurance to purchase?

deductibleThe portion of a claim for which the insured, not the insurer, is responsible for paying.

deductibleThe portion of a claim for which the insured, not the insurer, is responsible for paying.

automobile liability insuranceInsurance that protects the insured from fi nancial losses caused by automobile-related injuries to others and damage to their property.

automobile physical damage insuranceInsurance that covers damage to or loss of the policyholder’s vehicle from collision, theft, fi re, or other perils; includes collision coverage and comprehensive (other-than-collision) coverage.

automobile liability insuranceInsurance that protects the insured from fi nancial losses caused by automobile-related injuries to others and damage to their property.

automobile physical damage insuranceInsurance that covers damage to or loss of the policyholder’s vehicle from collision, theft, fi re, or other perils; includes collision coverage and comprehensive (other-than-collision) coverage.



crashing into another vehicle or object, and comprehensive (other-than-collision) coverage for losses due to perils such as fire, floods, theft, and vandalism.

Automobile insurance rates generally depend on the driver’s age, marital status, gender, area of residence, and driving record, as well as the characteristics of the automobile being insured. Young male drivers who live in cities, have more than one traffic ticket, and drive expensive, high-horsepower automobiles are charged the highest rates. Historically this group is involved in the most accidents.

Homeowners/Renters Insurance It is advisable for homeowners and renters to purchase insurance for protection against property damage and liability losses. These policies cover losses due to fire, riots, windstorms, lightning, hurricanes, vandalism, frozen water pipes, and even falling airplanes. Special federally subsidized insurance provides coverage for earthquakes and floods. Homeowners insurance covers both the dwelling and personal property (furniture, clothing, etc.) whereas renters insurance covers personal property but not the dwelling. A standard policy pays out the actual cash value (similar to market value), determined by subtracting the amount of depreciation from its replacement cost, for personal-property losses. Policies that provide replacement cost coverage, enough money to replace lost or damaged personal property, costs about 10 to 15 percent more. Homeowners coverage on the dwelling provides replacement cost coverage.

Homeowners and renters should also carry liability coverage to protect against financial losses arising from their liability for the injury of others. For example, if one of your inebriated guests was injured in a fall after attending a party where you served liquor, you could be legally liable for the subsequent medical expenses. Comprehensive personal-liability coverage purchased as part of a homeowners policy protects against a wide range of occurrences, both on and off your property. But it does not protect you when driving a motor vehicle, for slander or libel, or for professional malpractice.

Health InsuranceHealth insurance is a vital component of financial stability. Many families and individuals obtain health insurance coverage through group policies offered as part of employment fringe-benefit plans. Group policies usually include comprehensive coverage at low cost. If you leave your job, your group coverage will terminate, although a federal regulation called COBRA allows most employees and their families to continue group health coverage at their own expense for up to 18 months after leaving an employer. You should also be aware that coverage through a parent’s policy usually ends around ages 23 to 25.

There are two basic types of health insurance coverage, available in combination and with variations. Traditional health insurance plans, called indemnity (fee-for-service) plans, reimburse the insured for medical costs covered by the insurance policy. The policyholder may select the physician, hospital, and other health care providers to obtain the required services. The patient pays for the services and files for reimbursement from their health insurance company. The primary advantage of this type of plan is a greater choice of health care providers for the patient.

The fastest-growing segment of the health insurance market is managed care plans. They became popular in the late 1980s as a way to control the spiraling cost of health care. Unlike traditional health insurance plans, managed care plans generally pay only for services provided by doctors and hospitals that are part of the plan. They may pay a smaller portion of the cost if the insured uses providers that are not part of the plan.

Major Medical Insurance Major medical insurance can be sold as a stand-alone product or combined with a managed care plan. It typically covers a wide range of medical costs with few exclusions and high maximum limits ($250,000 to $1 million). The insured pays a deductible and a percentage of the covered expenses. This coinsurance (participation) is typically 15 to 25 percent. Most policies include a limit, or cap, on the total amount the insured must pay.

Managed Care Plans Unlike traditional health insurance, managed care plans cover preventive care. The insured typically pays a small copayment ($10 to $20) each time he or she needs care. There is generally no cost for hospitalization. The most common types of managed care plans are health maintenance organizations and preferred provider organizations.

comprehensive (other-than-collision) coverageAutomobile insurance that covers damage to or loss of the policyholder’s vehicle due to perils such as fi re, fl oods, theft, and vandalism; part of automobile physical damage insurance.

comprehensive (other-than-collision) coverageAutomobile insurance that covers damage to or loss of the policyholder’s vehicle due to perils such as fi re, fl oods, theft, and vandalism; part of automobile physical damage insurance.

actual cash valueThe market value, determined by subtracting the amount of depreciation from its replacement cost, of personal property; the amount paid by standard homeowners and renters insurance policies.

replacement cost coverageHomeowners and renters insurance that pays enough to replace lost and damaged personal property.

COBRAA federal regulation that allows most employees and their families to continue group health insurance coverage at their own expense for up to 18 months after leaving an employer.

indemnity (fee-for-service) plansHealth insurance plans that reimburse the insured for medical costs covered by the insurance policy. The policyholder selects the health care providers.

managed care plansHealth insurance plans that generally pay for services provided only by doctors and hospitals that are part of the plan

major medical insuranceHealth insurance that covers a wide range of medical costs with few exclusions and high maximum limits. The insured pays a deductible and a coinsurance portion.

coinsurance (participation)A percentage of covered expenses that the holder of a major medical insurance policy must pay.

health maintenance organizations (HMOs)Managed care organizations that provide comprehensive health care services for a fi xed periodic payment.

preferred provider organizations (PPOs)Networks of health care providers who enter into a contract to provide services at discounted prices; combines major medical insurance with a network of health care providers.



Health maintenance organizations (HMOs) provide comprehensive health care services for a fixed periodic payment. Primary-care physicians (PCPs), also known as “gatekeepers,” are responsible for decisions about their patients’ health care and for referrals to specialists when necessary. Except in the case of an emergency, the HMO will not pay for care that is given by non-HMO providers.

Preferred provider organizations (PPOs) combine major medical insurance with a network of health care providers, contracted to provide services at discounted prices. If you choose to go to a physician who is not a preferred provider, your out-of-pocket costs (deductibles and coinsurance) will be higher than if you receive care from a preferred provider. In some plans you pay only a small copayment (as with an HMO) if you use a preferred provider, thus reducing your paperwork as well as your out-of-pocket cost.

Disability Income InsuranceSome insurable risks, such as a long-term illness, can have devastating financial consequences. If you are unable to work due to illness or accident, disability income insurance will replace a portion of your earnings, typically 60 to 70 percent of your monthly income. There is generally a waiting period (elimination period) after the onset of the disability, ranging from 3 to 12 months, before insurance coverage payments begin. The shorter the waiting period, the more expensive the insurance premiums will be. The policy will have a stated duration of benefits, the length of time the insurance coverage payments will continue. Under short-term policies, benefits are paid for periods ranging from 13 weeks to two years; long-term policies provide payments for periods of five years through the insured’s lifetime.

One of the most important considerations in this type of insurance is the policy’s definition of disability. With some policies you are considered disabled if you cannot perform the functions of your own occupation; with others you are disabled only if you cannot work at all.

Life InsuranceLife insurance provides a specific amount of money upon the death of the policyholder, which is paid to a beneficiary of the policyowner’s choice, or to the deceased’s estate if there is no named beneficiary. The primary reason to purchase life insurance is to provide income for surviving family members, but life insurance can also be used to save for the future. The most common types of life insurance are term life, whole life, and universal life insurance.

Term life insurance provides the maximum amount of life insurance coverage for the lowest premium. It covers the insured’s life for a fixed amount and a specific time period, typically 5 to 20 years. It has no cash value (a dollar amount paid to the policy owner if the policy is canceled before the death of the insured). When the policy term ends, protection stops, unless the policy is renewed or a new policy is purchased.

Whole life insurance (also called straight life, cash value, or continuous pay) insurance covers the insured for his or her entire life, as long as the premiums are paid. In addition to death protection, it has a cash value that increases over the life of the policy. Whole life is much more expensive than term insurance and the interest rate used to determine its cash value is low—usually 4 to 6 percent. But it does provide a way to save for the future.

Developed in the 1980s to help insurance companies compete with other financial institutions for investment funds, universal life insurance combines term life insurance with a tax-deferred savings plan. The portion of the premium not used to pay for the term life coverage, commissions, and other business expenses, is invested in short- and medium-term securities. It earns interest at current market rates, which contributes to the policy’s cash value. Exhibit 8 on the next page offers some guidelines to consider when purchasing an insurance policy.

Making Investment DecisionsPeople invest money for a variety of reasons. Some want to save for a new home, their children’s education, or a vacation. Others invest to build up a nest egg to supplement their retirement income. Investing is the process of committing money to various investment instruments in order to obtain future financial returns. It should be considered a long-term strategy, and as Chapter 16 describes, the most common investment instruments individuals use are stocks, bonds, and mutual funds.

Distinguish between property and liability insurance cov-erage. Why should families and individuals have both?

What are the primary diff erences between traditional indemnity health insurance and managed care plans?

What are the two main reasons for buying life insurance? Which types of policies meet these needs?

disability income insuranceInsurance that will replace a portion of your earnings, typically 60 to 70 percent of your monthly income, if you are unable to work due to illness or accident.

waiting period (elimination period)In disability income insurance, the period between the onset of the disability and the time when insurance coverage payments begin.

duration of benefi tsIn disability income insurance, the length of time the insurance coverage payments will continue.

term life insuranceLife insurance that covers the insured’s life for a fi xed amount and a specifi ed time period and has no cash value; provides the maximum amount of life insurance coverage for the lowest premium.

cash valueThe dollar amount paid to the owner of a life insurance policy if the policy is canceled before the death of the insured; term life insurance has no cash value.

whole life (straight life, cash value, continuous pay) insuranceLife insurance that covers the insured for his or her entire life, as long as the premiums are paid; has a cash value that increases over the life of the policy.

universal life insuranceA combination of term life insurance and a tax-deferred savings plan. Part of the premium is invested in securities, so the cash value earns interest, at current market rates, that contributes to the policy’s cash value.

6 What personal goals are important when making

investment decisions?

investingThe process of committing money to various investment instruments in order to obtain future fi nancial returns.



Investment GoalsRealistic investment goals are based on the investor’s financial resources, age, family situation, and investment motives, so every investor needs to first ask themselves: “What do I want to achieve with my investment program?” Setting investment goals is the basis for developing a sound investment strategy. Your investment goals will relate to certain goals in your financial plan, such as saving for a home, your children’s education, and your retirement. Investment goals also play a role in determining how conservative or aggressive you want to be in making investment choices.

Investors can tolerate different levels of risk, and it is important to determine how much risk you can withstand when making investment decisions. The more risk you are willing to take, the higher the potential return on an investment. The investment risk pyramid shown in Exhibit 9 illustrates the relationship between risk and reward.

The most common investment goals are income, growth, and safety. Investors wishing to supplement their income will choose securities that provide a steady, reliable source of income from bond interest, stock dividends, or both. Good choices include low-risk securities such as U.S. Treasury issues, high-quality corporate bonds, preferred stock, and common stock of large, financially sound corporations that regularly pay dividends (called income stocks).

Another important investment goal is growth or increasing the value of the investment. Many investors look for securities that are expected to increase in price over time. Generally, they choose stocks that expect to continue above-average rates of growth in earnings and price. For instance, the earnings of so-called growth stocks might increase 15 to 20 percent or more at a time when the earnings of most common stocks are increasing only 5 to 6 percent.

Safety is yet another investment goal. Investors who opt for safety do not want to risk losing the money they’ve invested. They generally choose government and high-grade corporate bonds, preferred stocks, and mutual funds. They avoid common stock because of its frequent price fluctuations. Read the Catching the Entrepreneurial Spirit box on page 18 to find out about a company that offers investment vehicles—and financial education—targeted toward younger investors.

Developing an Investment StrategyThe secret to successful investing is to start investing early. But before putting money into investments, it is a good idea to establish an adequate emergency fund (liquid assets that are available to meet emergencies), obtain necessary insurance coverage, and reduce debt. Then diversify your investments and invest regularly.

Start Early to Enjoy the Benefits of Compounding Financial-planning prac-titioners and educators believe starting to invest early so returns can compound is the most important element in a successful savings/investment program. Consider Jennifer, a 27-year-old

emergency fundLiquid assets that are available to meet emergencies.

emergency fundLiquid assets that are available to meet emergencies.

When purchasing an insurance policy:Review your insurance needs and circumstances.Comparison shop. Contact several companies and/or agents to compare benefits, coverage, exclusions, and premiums.Be sure the insurance company you are considering is financially stable. To check on the stability of a company, visit the Insurer Ratings Directory.Do not make any quick decisions. Request a copy of the policy and compare it with policies from different insurance companies.Do not be fooled into thinking you need several policies for additional coverage. You need only one good policy.Be sure your application is complete and accurate, including all of your medical history, if applicable.Write a check, payable to the insurance company. Do not pay in cash.Your policy should arrive within 60 days. If you do not receive it, contact the company or agent.After you receive your policy, reread it to be sure everything is correct. Your agent or company should explain any terms that are not clear.

2006 by A.M. Best Company, Inc. All rights reserved. Reproduced by permission.

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•

•

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EXHIBIT 8 Insurance Buying Guide


Source: “Things to Consider When Purchasing an Insurance Policy,” http://www.ambest.com (July 27, 2006). Copyright ©


attorney who has already invested $32,000 for her retirement. With no additional contributions to this investment and assuming a 10 percent annual return, Jennifer’s $32,000 will grow to $1,196,939 by the time she is 65 years old! If Jennifer had waited until age 45 to start saving for her retirement, she would have to invest $20,898 a year for 20 years (a total of $417,960) in order to accumulate $1,196,939.

So start early and let your investments work for you, but remember that you need to protect your assets with the appropriate insurance. And because the interest you pay on debt is usually more than you can earn on your investments, it is important to reduce your debt first.

Diversify Another important element of a successful investment strategy is diversification. This means you should invest in different classes of assets—cash equivalents, stocks, bonds, real estate—and purchase securities with different risk patterns and rates of return. A diverse portfolio, or collection of investments, is more likely to meet your investment goals than a single security. A portfolio that includes preferred stocks paying high dividends and growth stocks paying modest dividends increases the potential of achieving both income and growth. Investing in 5 to 10 different companies in different industries is another way to diversify. Diversification is an important method of spreading your risk and increasing your potential for achieving your investment goals.

diversifi cationAn investment strategy that involves investing in diff erent classes of assets, such as cash equivalents, stocks, bonds, and real estate, and purchasing securities with diff erent risk patterns and rates of return.

portfolioA collection of investments.

diversifi cationAn investment strategy that involves investing in diff erent classes of assets, such as cash equivalents, stocks, bonds, and real estate, and purchasing securities with diff erent risk patterns and rates of return.

portfolioA collection of investments.

Increasing risk of loss of principal

Increasing potential gain through appreciation

Growth stocks, growth mutual funds, income mutual funds Futures, derivatives,

commodities, naked puts/calls

Covered puts/calls, collectibles, speculative common stock, junk bonds

International mutual funds, global mutual funds, emerging market mutual funds, sector mutual funds, direct and indirect investment in real estate

Balanced mutual funds, blue chip stocks, zero-coupon bonds, high-grade preferred stock, high-grade corporate bonds, variable annuities

FDIC-insured accounts, MMMF, U.S. EE savings bonds, cash value life insurance, Treasury bills/notes/bonds

High-grade municipal bonds, personal residence equity, fixed annuities

EXHIBIT 9 Investment Risk Pyramid



Invest Regularly Make investing to achieve your goals part of your cash flow plan. Decide how much to invest, then purchase the investments monthly, quarterly, or annually. Or, better yet, set up automatic transfers from your checking account to a mutual fund or stock purchase plan

so that a preplanned amount is regularly invested in the investment vehicles of your choice.

Most mutual funds welcome monthly contributions of $50 or more through their automatic investment plans, and more stock can now be purchased regularly in small increments. Originally, stock dividend reinvestment plans (DRIPs) were set up to automatically reinvest dividend income paid on stocks, but many companies have also made stock purchase plans available to investors who own as little as one share of the company stock.

Securities Transaction BasicsThe traditional approach to investing in securities is through a stockbroker at a stock brokerage firm. Investors should seek a broker who understands their investment goals and who will help them pursue those objectives.

Investors can open two basic types of accounts at a brokerage firm: cash accounts and margin accounts. With a cash account, purchases of securities are paid for in full by the investor (cost of the securities plus brokerage commissions). In a margin account, the investor puts up as little as 50 percent of the cost of the securities, borrowing the balance from the broker and paying interest on the loan. The broker holds the securities as collateral for the loan.

When investors decide to buy or sell securities, they typically place an order with their broker who handles the transaction on their behalf. The broker transmits a buy or sell order to the appropriate stock exchange, like the New York Stock Exchange (NYSE), where it is sent to the

7 How do investors open a brokerage account and

make securities transactions?7 How do investors open a

brokerage account and make securities transactions?

Generations X and Y might be willing to take risks participating in extreme sports and disseminating personal information online, but one area where they are surprisingly conservative is in investing. The 401(k) is America’s most popular retirement vehicle, yet nearly half of younger plan partici-pants opt for safe, fixed-rate investments that return only 5 percent compared to the Dow Jones industrial average annual return of 11 percent.

Perhaps one of the reasons younger generations choose less risky investments for their plans is an overall disinterest in investing or the perception that investing is for older people. Entrepreneur James Perkins, Jr. wants to challenge that percep-tion and make investing cool for younger generations. Founder of New York City-based Thrasher Funds, Perkins wants to make investing relevant to Gen Xers and Yers. Thrasher’s main fund, GendeX (trading under the symbol GENDX), advertises on MySpace and Facebook and the company’s Web site shows a crowd of fash-ionable people with the tag line, “They invest. Do you?” Thrasher focuses on hip, fashion-forward stocks, like Hennes & Mauritz (H&M), American Apparel, and Louis Vuitton Moet Hennesey tempered by more traditional names like Archer Daniels Midland, Chevron, and Bank of America.

Another potential reason for the younger generation’s reluctance to jump head-long into investing upon receipt of their first paycheck is a general ignorance about personal finance. During the early 20th century, elementary students as young as fifth grade were given problems that introduced them to the concepts of simple interest, compound interest, discounting notes at a bank, foreign exchange, insur-ance settlements, taxation, partnership interests, and bankruptcy. By Grades 7 and 8, they added the concepts of profit and loss, issuance of stocks and bonds, premiums and discounts on bonds, and brokerage commissions to their repertoires. Today, less

than half of U.S. high school students can balance a checkbook, or answer correctly questions about earning, spending, saving, and investing money.

The founder of Thrasher may realize this: his company includes low-key financial education as a way to encourage clients to invest. Thrasher‘s site provides explanations of investment principles and glossaries, and it offers free 30-minute consultations over the phone and in person. “We don‘t make the whole thing ‘Dora the Explorer‘ or ‘Bob the Builder,‘” Perkins says. “If it‘s called ‘P/E ratio,‘ we‘ll call it ‘P/E ratio,‘ but we‘ll take the time to explain what that means.”

Regardless of whether younger investors hold back because of perceptions or ignorance, Thrasher is positioned to get them acclimated to the world of Wall Street. Perkins says Thrasher’s message is simple: “You can incorporate investing in a reason-able but profound way by starting now and devel-oping habits that are beneficial in the long run.”9

Critical Thinking QuestionsDo you think better financial education would prompt young investors to take greater risks? Explain.Is Thrasher’s offering that blends financial education and investment opportunity strong enough to attract a significant following?What impact does your own financial education (or lack thereof) have on the way you invest your money and in what amounts?

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Making Investing Cool

What is investment risk? What is the relationship between risk and return?

What steps should be taken before starting an investment program? Why?

Discuss three strategies for implementing a successful investment plan.

dividend reinvestment plan (DRIP)A program in which dividends paid by a stock are automatically reinvested in that stock along with any additional stock purchases submitted by the stockholder.



exchange trading floor for execution. To make transactions in the Nasdaq/OTC market, the broker must find out via computer who deals in the security and contact the dealer, offering the best price to make the transaction.

Stocks are usually bought and sold in blocks of 100 shares, called round lots. However, if an investor can’t afford 100 shares of a stock, he or she may purchase less than 100 shares, called an odd lot. Because only round lots are traded on the exchanges, odd lots are grouped together by brokers to make up a round lot. An extra fee is charged for odd-lot transactions.

Investors can place three types of orders when buying or selling securities. A market order is an order to buy or sell a security immediately at the best price available. A limit order is an order to buy a security at a specified price (or lower) or to sell at a specified price (or higher). The trade is executed only if the requested limit is reached. With a stop-loss order, the stock is sold if the market price reaches or drops below a specified level. A stop-loss order limits an investor’s losses in the event stock prices rapidly decline.

Brokerage firms receive commissions for executing clients’ transactions. Although brokers can charge whatever they want, most firms have fixed commission schedules for small transactions. The value of the transaction and the number of shares involved helps to determine the amount of brokerage commission you are charged. Today many investors are using online brokerage firms to execute their securities transactions.

Trends in Personal FinanceIn this section we examine some of the trends that shape the way people spend, save, and invest their money. Because they are new to managing their own lives and finances, students are especially vulnerable to falling into the credit card trap, but doing so could put an end to college and profoundly affect their future. Tighter controls on credit card companies attempt to curb unethical lending practices. Find out who the IRS is targeting with audits—and why. With the baby boomers starting to retire, Social Security and Medicare are poised to take over the entire federal budget. We also learn why Americans are spending so much and saving so little.

The Credit Card Drop-Out RateOn their own for the first time, college students suddenly have to manage their own finances. Funds may seem more than adequate with money from student loans, financial aid, personal savings, and financial support from family. And then there are the credit cards. You buy clothes, gas, beer, pizza, concert tickets—and before you know it, you are unable to pay your credit card bills without using money set aside for your books and tuition.

According to an adviser at a major university, more students drop out of college due to credit card debt than to academic failure. College students may be surprised at how much the little expenses add up. A cup of coffee at the local coffee shop before classes each morning can total $46 a month, or nearly $200 a semester. Smoking is even more costly—at $3.50 a pack, a pack-a-day habit can total over $400 a semester. It is easy to spend thousands of dollars a semester on incidentals.

The best way to prevent this is to adopt a budget early in your first semester and stick to it. Students who manage their spending and their available funds early on avoid the stress of being unable to pay their bills and working more and more hours between classes in order to get out of debt. Use the monthly budget worksheet (Exhibit 3) to prepare a realistic budget for yourself. A college degree does not guarantee an ability to manage money wisely. It takes determination and control—before credit card debt has you in its grip.10

Tighter Regulation on Credit CardsFor years, credit card companies have manipulated payment dates and agreement terms to increase interest and fee billings, but in 2008, the Federal Reserve Board, the Office of Thrift Supervision, and the National Credit Union Administration unveiled a proposal that would curtail those practices. Some provisions of the proposal would prohibit credit card issuers from:

charging a late payment unless the consumer has been provided with a bill at least 21 days prior to the due dateimposing finance charges on balances from previous billing cycles

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8 What emerging trends affect the way you

manage your personal finances?

8 What emerging trends affect the way you

manage your personal finances?

Diff erentiate between cash and margin accounts.

What are the three types of orders investors can place to trade securities?



increasing the interest rate without prior noticeapplying newer, higher interest rates to existing balances

These provisions and others in the proposal are the first outright bans in 20 years that a government agency has made affecting industry practices. Even though the proposal seems to have a positive affect on the consumer, some analysts believe that, should the new proposal be adopted, the credit market will tighten even more and borrowers with bad credit will have their limits cut or be denied cards. Still, the proposal will curb unfair and deceptive practices in the credit card industry.11

Taxing QuestionsMore taxpayers than ever are choosing to file their taxes electronically, and many wonder whether e-filing increases their chances of being audited. According to Internal Revenue officials, how you file your taxes doesn’t make a difference when they are selecting returns to audit. Each return is scored by the IRS based on secret formulas designed to spot problematical returns—such as those with a high probability of unreported income.

E-filing “actually reduces the chances of you hearing from us” because e-filed returns are more accurate than paper returns, says Nancy Mathis, an IRS spokeswoman. The error rate on e-filed returns is only about 1 percent, compared with about 20 percent on paper returns. The IRS’s e-filing system is designed to pick up common math errors and transposed Social Security numbers that might otherwise result in unwelcome communications from the IRS.

So just how likely are you to be audited these days, and what type of returns attract the IRS’s attention? The number of returns that are audited has surged in recent years. About 1.4 million individual tax returns were audited in 2007, which is an increase of 7 percent from the previous year, but represents only 1.03 percent of all the returns filed that year.

The IRS is targeting high-income taxpayers with incomes of $100,000 and more, seeking abusive tax shelters or other tax avoidance schemes. Unreported income parked illegally in offshore accounts is another red flag. Self-employed workers who deal mainly in cash and file their taxes under Schedule C also come under close IRS scrutiny. If you find yourself facing an audit, go to the IRS Web site at (http://www.irs.gov) and type “frivolous” in the search box to learn which arguments to avoid when defending your return.12

10,000 New Retirees a DayIn 2008, the baby boomers started to retire and at a rate of roughly 10,000 per day.13 They have begun withdrawing from Social Security and becoming eligible for Medicare. The federal government expenditures have for decades accounted for roughly 18 percent of GDP, but as the baby boomers retire, expenditures on Social Security and Medicare (particularly Medicare) will begin to explode. If the average rate of 18 percent and how the United States handles these social programs hold constant, then by 2070, when today’s kids are ready to retire, the federal budget will only be able to pay for Social Security, Medicaid, and Medicare. There will be no budget for education, national defense—nothing but those three social programs. Even today, the problem is striking: if Medicare had to be accounted for like a corporate pension account, the social service would be underfunded by $34 trillion!14 “I‘ve spent a professional lifetime worrying about the federal budget and fiscal responsibility. And I‘ve never been more worried than now,” said Alice Rivlin, former director of the Congressional Budget Office, at a recent Brookings Institution symposium in Washington.15

Negative or Nearly No SavingsFrom 2005 to 2006, government statistics showed the national savings rate stood lower than at any time since the Great Depression, a period of enormous unemployment and soup lines. The Commerce Department reported that Americans’ personal savings plummeted into negative territory in 2005. That means people not only spent all their after-tax income, but also borrowed and dipped into their savings to finance their spending.16

In 2007, however, savings inched out of negative territory. Americans saved an average of 0.5 percent of their income, according

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How does credit card debt aff ect college drop-out rates? How can students prevent credit card debt from causing them to drop out of college?

How does the IRS select returns to audit? How does e-fi ling aff ect the chance of being audited?

What’s happening to America’s personal savings rate? Why?



to the Bureau of Economic Analysis. That’s far below the robust 11 percent in 1984, and is generally insufficient to weather a job loss or other unforeseen catastrophe. It’s also not enough to ensure a decent standard of living in retirement. Americans continue to overspend, according to the American Savings Education Council and America Saves, a coalition of nonprofit, government, and corporate groups.17 The America Saves report says that Americans should be saving 10 percent of their incomes and that only half of Americans are taking advantage of retirement savings opportunities at their work. The report further suggests that savings, rather than spending, could actually be the stronger economic stimulus. As more Americans save and spend within their means, fewer will need to go into debt to support their spending habits.

Financial planning is a six-step process that includes establishing financial goals, gathering objective and subjective information, analyzing the information, developing a financial plan, implementing the plan, and monitoring your plan. The process starts with your goals and provides a road map to meet those goals.

A cash flow plan manages income and expenses. Based on your financial goals, it includes saving for those goals. With money set aside regularly to pay for these goals, you are more likely to achieve them. Liquid assets such as checking and savings accounts are important for day-to-day spending, to meet short-term goals, and for unexpected or emergency expenditures. Liquid assets can be held in safe, accessible accounts so the money is readily available when needed.

The benefits of consumer credit include convenience, the ability to purchase a good or service when you need it or want to take advantage of bargains, the opportunity to establish a credit rating, convenient record keeping, paying for financial emergencies, and perks such as rebates and frequent-flyer miles. Using consumer credit has some important disadvantages, including the ease of overspending, the cost of credit (interest charges), the possibility that merchandise may cost more, and the reduction in future discretionary income due to the legal commitment to repay debt.

The major taxes paid by individuals are income, Social Security and Medicare, sales, and property taxes. Income and Social Security and Medicare taxes are called payroll taxes because they are based on income and deducted from an employee’s paycheck. Sales tax is assessed on purchases made, and property tax is based on the value of property owned, usually real estate.

The key to managing your insurance needs in the most cost-effective way is to budget to cover minor losses and purchase insurance to cover potential major losses. Set aside money in savings so that you can pay for a minor loss when it happens, and buy good insurance policies to cover major losses.

Investment decisions should be based on your goals and your risk tolerance. Examples of investment goals include the desire for income from interest and dividends, the need for growth (capital gains), and the need for safety.

Investors must choose a brokerage firm and a stockbroker in that firm. Then they open a cash account or a margin account. In a cash account, all securities transactions are paid in full by the investor. Margin accounts allow investors to put up as little as 50 percent of the price of the securities and borrow the rest from the broker. The investor gives an order to buy or sell securities to the broker, who sends it to the stock exchange to be carried out or, in the case of a Nasdaq/OTC stock, finds the dealer with the best price. Today many investors are using online brokerage firms to execute their securities transactions.

Credit card debt can do more than just get a student into financial trouble. Some students are forced to quit school entirely and get a job to pay off their debt, a decision with a far-reaching impact on their lifelong earning potential and quality of life. Credit card companies are faced with government prohibition of certain industry practices that are detrimental to consumers.

1 How does the financial-planning

process facilitate successful personal financial management?

1 How does the financial-planning

process facilitate successful personal financial management?





3 What are the advantages and

disadvantages of using consumer credit?

3 What are the advantages and

disadvantages of using consumer credit?

4 What types of taxes are individuals

responsible for?4 What types of taxes

are individuals responsible for?

5 What factors should you


5 What factors should you


6 What personal goals are important

when making investment decisions?

6 What personal goals are important

when making investment decisions?

7 How do investors open a brokerage

account and make securities transactions?

7 How do investors open a brokerage

account and make securities transactions?

8 What emerging trends affect the

way you manage your personal finances?

8 What emerging trends affect the

way you manage your personal finances?

Summary of Learning Goals



E-filing is the wave of the future, but taxpayers worry about whether it raises red flags at the IRS. An IRS spokeswoman explains why it is less likely to do so and explains what you can do to remain under the IRS auditing radar. With baby boomers retiring at the rate of 10,000 per day, funding for Social Security and Medicare will consume the federal budget by 2070. Medicare today is underfunded when viewed like a corporate pension account. Americans are spending more and saving less, especially as they get older and need their nest egg for retirement.

actual cash value 14automobile liability insurance 13automobile physical damage insurance 13cash flow plan 3cash management 3cash value 15COBRA 14coinsurance (participation) 14comprehensive (other-than-collision)

coverage 14credit life insurance 10deductible 13disability income insurance 15diversification 17dividend reinvestment plan (DRIP) 18duration of benefits 15earned income 12emergency fund 16filing status 11grace period 8health maintenance organizations

(HMOs) 14, 15indemnity (fee-for-service) plans 14investing 15line of credit 7

liquid assets 3major medical insurance 14managed care plans 14net worth 2open-end credit 7personal balance sheet 2personal exemptions 11personal financial planning 2portfolio 17preferred provider organizations

(PPOs) 14, 15prepayment penalties 10principal 9progressive tax 11replacement cost coverage 14revolving credit cards 8security requirements 10standard deduction 11term life insurance 15unearned income 12universal life insurance 15waiting period (elimination period) 15whole life (straight life, cash value,

continuous pay) insurance 15withholding allowances 11

Key Terms

Preparing for Tomorrow’s Workplace: SCANS

1. Use the six-step financial-planning process to develop a financial plan for yourself. List your financial goals and gather the appropriate information needed to analyze your situation. Develop your plan and explain how it will be implemented. (Resources, Information)

2. Use the steps detailed in this chapter to balance your most recent checking account state-ment. After completing this process, analyze your use of the checking account, EFT services, and so on. Are you satisfied with the way you are handling your account? If not, what changes would you make in how you use it? (Information)

3. Team Activity College junior Andy Jung overused his credit cards last year. He currently has the following outstanding debt on two credit cards plus an auto loan and a student loan:

MasterCard—$984 outstanding debt, $40 minimum monthly payment, 18 percent inter-est rate, no annual fee, $25 late-payment fee, 2 percent cash-advance fee ($20 maximum), $1,000 line of credit.Visa—$569 outstanding debt, $17 minimum monthly payment, 14 percent interest rate, $20 annual fee, $20 late-payment fee, 1.5 percent cash-advance fee ($20 maximum), $800 line of credit.Auto loan—$3,490 outstanding balance, $257 monthly payment, 8 percent interest, 15 more payments.Student loan—$15,490 outstanding balance, deferred payments, 7.5 percent interest (unsubsidized).

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Andy has $450 a month available for debt repayment. Divide into small groups and advise Andy on how best to pay off his debt obligations. Start by completing a debt inventory for Andy. Then write a one- to two-page memo explaining how Andy should allocate the $450. Support the rationale for your recommendations. (Interpersonal, Information)

4. How do you choose the best credit card and use it wisely? Compare three different credit cards. If you already have a credit card(s), use your own in addition to those offered through local banks or flyers you see on campus. Compare annual fees, APRs, methods of calculat-ing finance costs, grace periods, and other terms. Get a written copy of the credit card terms if possible. Which one would be best for you given your needs and the way you intend to use a credit card? Be sure to discuss your needs as well as the characteristics of the cards. (Information)

5. Team Activity Form a team of four or five classmates to evaluate employer fringe-benefit plans. Gather written information on the insurance and retirement benefits offered by at least two employers. This information may be available directly from an employer, from your parents, or from senior classmates who are interviewing with companies. After reviewing the information, write a brief summary evaluating the insurance and retirement plans offered, and what investments are available through the retirement plans. Present your findings to the class. (Interpersonal, Information)

6. Select three different financial institutions: one that you actually use for checking and/or sav-ings and two others. Determine what checking and savings accounts are available that suit your needs and find out how these accounts are structured (minimum opening deposits, mini-mum required balances, fees, and other limitations). Look at the institution’s complete list of fees, not just the cost of the checking account. Get a written copy of all account descriptions and fees if possible. Which one would be best for you given your needs? Be sure to discuss your needs as well as the characteristics of the institutions. (Information)

7. You have just won $100,000 in your state lottery. In light of your personal situation (age, finances, family status, and so on), what types of securities would you choose, and why? Now you also have to find a broker to execute the transactions. Should you use a traditional full-service brokerage, a discount broker, or an online brokerage? Using the Internet and per-sonal-finance publications to gather information, compare the services of these types of firms. Summarize the pros and cons of each and decide which best meets your needs. Justify your choice. (Information, Resources)

You are transferred into the auto insurance division of the large property and casualty insurance company you work for in California. After a successful three-month trial period, you are assured of a substantial promotion and raise.

You quickly realize that an important criterion used by the department in evaluating and quoting prospective clients on their auto insurance policies is their zip code. This means that poor and minority drivers pay more for their insurance than wealthier drivers, regardless of their driving record. You also know this is in direct contravention of a 1988 California proposition that stipulates that auto insurance rates should be based primarily on three factors: the driver’s age and driving record, the driver’s annual mileage, and the number of years of driving experience. Other factors, including zip code, should be taken into account only after the driver’s experience is considered.

Because you live in one of the city’s less wealthy neighbor-hoods, you realize that you are probably paying more for your auto insurance than drivers in wealthier neighborhoods with

worse driving records than you. You are upset at what you con-sider unfair discrimination, nothing less than a form of insurance company “redlining.” Do you have the courage to rock your pro-fessional boat or should you take the path of least resistance and turn a blind eye to what is going on?

Using a Web search tool, locate articles about this topic and then write responses to the following questions. Be sure to support your arguments and cite your sources.

ETHICAL DILEMMA: Should you express your outrage to man-agement, quit, and hope to find a job with a more ethical company that offers similarly promising prospects as your current position? Would you report your company to the Insurance Commission? Or should you keep quiet and just do your job, as you don’t know if you will be able to easily find another job?

Sources: Dean Calbreath, “Ruling Rejects ZIP Codes As Primary Criterion,” San Diego Union-Tribune, August 10, 2006, http://www.signonsandiego.com; Brendan Coyne, “Report Finds Car Insurance Redlining Rampant in California,” The New Standard, December 21, 2005, http://newstandardnews.net.

Ethics Activity



Working the Net

1. Financial planning was once considered a luxury for those wealthy enough to pay fees for advice from a financial professional. Today, financial advice is just a click away courtesy of specialized Web sites that provide advice on student loans, saving, budgeting, and scholar-ships. Use the site’s calculators at FinAid (http://www.finaid.org) to plan your college living expenses.

2. At Bankrate (http://www.bankrate.com) you will find the current average rates on standard, gold, and platinum credit cards. To find the best rate for you, fill in the required information based on your wants and needs in a credit card. Planning to move? Use the site’s calculator to compare the cost of living between two cities. Summarize your findings.

3. Wells Fargo (https://www.wellsfargo.com/student/index) offers one-stop shopping for all student banking needs. Click on “Banking” and “Loans & Credit” to see a full range of college finance options. What features are especially useful for students? Would this account suit you? Why or why not?

4. Go to Tax Cut (http://www.taxcut.com) for information on taxes and tax preparation software. Click on Tax Tips for information regarding tax planning, deductions, how to treat investment and dividend income, and family dependents. Also find and analyze one other topic that is of interest to you. Summarize your findings for the class.

5. Personal Investing 101: SmartMoney (http://www.smartmoney.com) provides information to assist with personal investing. Go to Portfolio to create your own investment portfolio. Click on Tools to find the information you need to track your investments. Prepare a summary of your investment holdings for the class.

Creative Thinking CaseMining the Family

FortunesWhen Mita Sanghavi Goel and her husband wanted to buy a home, they borrowed $100,000 from her mother—at 4 percent interest. A loan from her mother saved Ms. Goel, a 33-year-old physician, from getting a jumbo mortgage, which carries a higher interest rate, and provided her mother with additional income to supplement her modest earnings as a teacher’s aide. With home prices then approaching record levels, relatives at that time were more frequently being called upon to provide the cash necessary to help kids buy their first home. Currently, about one in four first-time buyers receives the down payment for a home from a relative or friend, up from one in five more than a decade ago, according to a National Association of Realtors survey.

But what was once an informal practice—a gift or loan of a few thousand dollars with a promise of repayment—is getting trickier. Rather than simply handing over cash, families are setting up structured, secured loans similar to bank mortgages, complete with filings at the county clerk’s office, and they are finding new ways to maximize the tax and estate-planning advantages of such loans.

Intrafamily mortgages, as they are known, were once the exclusive domain of wealthy families who could afford the advisory services needed to structure these loans. Now a small industry of financial advisers and mortgage experts that help parents act as mortgage bankers for their children has changed all that. The additional costs to structure a private loan—attorneys, accountants, and others outside the bank—should be offset against the benefits. Paying part or all of a home down payment can help kids avoid expensive private mortgage insurance, or PMI, that banks generally require when borrowers can’t come up with 20 percent of a home’s sales price.

In the case of Ms. Goel, a payment plan was set up through Virgin Money, at a cost of $599 and a $9 monthly administration fee after the first year. Virgin Money provides all necessary financing documents (such as a promissory note and mortgage paperwork), records the mortgage with the local County Registry of Deeds, and sets up the payment schedule, which can be seasonal or gradu-ated if parents think the child will earn more later.



One thing to be aware of when giving kids money is family misunderstandings. Ensuring that other siblings don’t feel slighted is critical. “You need to be fair with all your children, even if one needs more money immediately, or you’ll end up with someone hating you,” says Buck Schottland, 59, a retired businessman in Hobe Sound, Florida. Schottland recently gave his son several hundred thousand dollars to build a new home nearby, but his daughter in Virginia needed only a third as much. So he is working with financial advisers to combine a gift plan with other payments that will give the two children equal amounts at the end of 20 years.

Critical Thinking QuestionsWhat socioeconomic factors make intrafamily mortgages necessary?What are the advantages to both parents and children of an intrafamily mortgage?Assume you are the recipient of such a loan from your parents. How you would structure the loan, including the length of the loan, interest rate, and other repayment terms, and why?

Sources: Diya Gullapalli, “When Mom And Dad Are the Bank,” Wall Street Journal, January 21, 2006, p. B1; Robert S. Bridges, “Parents as Bankers,” Financial Advisor, http://www.fa-mag.com, July 2006; Sam Ali, “Round Numbers,” The Star Ledger, http://www.nj.com, March 26, 2006; Virgin Money corporate Web site, http://www.virginmoney.com, July 31, 2008.

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Mark RitziHorizon Bank

Exploring Business Careers

At some point in your life, you may not want to live in that cramped dorm room. You might look to leave your parents’ house, where curfew is still 11:00 P.M. The fraternity or sorority, with secret meetings and weekend parties, might not be as appealing as it once was. Even apartment living can wear thin, as friends imply you are throwing money away. After all, they say, a house is an invest-ment, but an apartment? Not so much. However, even a starter home can cost $100,000 or more, and you are feeling guilty about that $15 CD you bought last week. How can you—or anyone—ever make that leap? Mark Ritzi can help.

As Vice President of Mortgage Banking at Horizon Bank in Northwest Indiana, Ritzi has been help-ing people figure out how to buy homes for 15 years. A purchase as large as a home requires careful personal financial planning, and as Ritzi will tell you, this planning often starts long before you start paging through the real estate section of your local paper.

One financial-planning key is to establish good credit early on and maintain it throughout your life. Many people understand that although using credit has benefits, such as convenience, increased purchasing power, and establishment of a credit rating, it can be dangerous if not used properly. Credit makes it very easy for people to spend beyond their means, and problems with credit can lead to a poor credit rating. What people may not be as familiar with, however, is that a credit rating might affect things like getting a mortgage or homeowners insurance. Ritzi helps people under-stand how credit rating—a score that tells financial institutions how reliable you are at paying back credit—affects everything from interest rates on credit cards to car loans to mortgages. “You have to educate people. Here’s your credit score, here’s what it probably should be, here’s where it needs to be, and here’s how you can help it.”

Ritzi knows disclosing your financial mistakes can be painful, so he tries to set potential mortgage applicants at ease. He wants them to know that he is on their side in the application process. And, ultimately, he wants to help them correct any past errors, avoid future pitfalls, and end up in the home they want. “The most fulfilling time is when I have a recent graduate, someone who has never purchased a home before, come to me and trust me with their decision about how to do it. It is not a decision you take lightly. My job is to provide people who haven’t done this the opportunity to understand that by making this decision now, other things can happen down the road.”

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1. “The Cost to Raise a Child Today: Less for Food, More for Daycare and Education,” U.S. Department of Agriculture, Center for Nutrition Policy and Promotion, March 24, 2008, online at http://www.cnpp.usda.gov/Publications/News-Media/News3– 24–08.pdf.

2. “2007–2008 College Costs: Keep Rising Prices in Perspective,” The College Board, online at http://www.collegeboard.com/student/pay/add-it-up/4494.html (May 26, 2008).

3. Aaron Ricadela, “Mint’s Fresh Take on Personal Finance: Gen Y Is Flocking to a Free Site for Managing Bank and Credit Accounts and Household Budgets,” BusinessWeek Online, April 18, 2008; “Mint.com Money Management Makes Holiday and New Year’s Budgeting Easy,” PRNewswire, December 21, 2007; Claire Cain Miller, “Making a Mint,” Forbes, May 5, 2008, p. 74; Anthony Malakian, “Personal Finance: Web Tools Make Waves: Banks Face a Dilemma by the Rise of Money Management Websites,” Banking Wire, April 4, 2008, p. 1.

4. William Launder, “Evidence Backing Payday Lenders’ Risk Argument,” American Banker, May 19, 2008, p. 6; Jim Siegel, “House Passes Payday-Lending Bill 70–24: Strickland Expected to Sign It Next Week,”

Columbus Dispatch, May 21, 2008; “Editorial: Payday Consensus,” Akron Beacon Journal, May 16, 2008; Warren Bolton, “Opinion: Payday Lenders Pulling Out All Stops to Head Off Regulation,” State, May 15, 2008; Stephen Frankin, “Payday Loan Industry Increases Political Contributions in Illinois, Other States to Make Its Case,” Chicago Tribune, May 24, 2008.

5. 2008 Federal Tax Rate Schedules, Internal Revenue Service, http://www.irs.gov (May, 26, 2008).

6. “2008 Inflation Adjustments Widen Tax Brackets,” Internal Revenue Service, http:// www.irs.gov, (October 18, 2007).

7. Ibid.8. “Tax Credit for Hybrid Vehicles,” Internal

Revenue Service, http://www.irs.gov (May 26, 2008).

9. Jeffrey R. Kosnett, “Designing Your First 401-K Plan,” Kiplinger Personal Finance Magazine, February 2008, p. 20; Jessica Jones, “The Next Generation: James Perkins, Jr. Aims to Make Investing Cool,” Black Enterprise, March 2008, p. 40; “Wealth Management Media Scan,” American Banker, April 1, 2008, p. 9; Suzanne N. Cory and Andrew D. Pickard, “2 + 2 = ? It’s Time for Americans to Become More Financially Literate, and Accountants Can Help Them Do So,” Strategic Finance, May 2008,

pp. 49–53; Penny Crosman, “Attracting Young Investors: Financial Firms Are Embracing Mobile Technology, Web 2.0 Tools and Social Networking Principles to Reach Gen X and Gen Y,” Wall Street & Technology, January 2008, pp. 16–19.

10. Deborah Fowles, “Money and the College Student,” About.com, http://www.financialplan.about.com (July 31, 2006).

11. Jessica Silver-Greenberg, “The Brewing Credit-Card Storm,” BusinessWeek Online, May 26, 2008, p. 34; Kevin DeMarrais, “Your Money’s Worth,” Record, May 11, 2008.

12. Tom Herman, “What Gets You Audited,” Wall Street Journal, April 16, 2006, p. H7.

13. Peter Grier, “U.S. Deficit at Record High and Rising,” Christian Science Monitor, April 23, 2008, p. 1.

14. Geoff Colvin, “The $34 Trillion Problem,” Fortune, March 17, 2008, p. 40.

15. Grier, “U.S. Deficit at Record High and Rising.”

16. Suzanne N. Cory and Andrew D. Pickard, “2 + 2 = ? It’s Time for Americans to Become More Financially Literate, and Accountants Can Help Them Do So,” Strategic Finance, May 2008, pp. 49–53.

17. Paul Wenske, “Most Americans Are Saving, but Still Not Enough,” Kansas City Star, March 16, 2008.

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