Personal Financial Personal Financial PlanningPlanning

H. Swint Friday, Ph.D., CFP

Associate Professor of Finance

College of Business

Texas A&M University – Corpus Christi

Island Views 

Why Plan?

“If you don't know where you are going,

you'll probably end up somewhere else.”

 Yogi Berra

Millionaire Success Factors

Allocate time, energy and money efficiently Strive for financial independence rather than

social status by Living below your means Investing 20% of your annual income

Choose the right occupations

*The Millionaire Next Door

The Benefits of Financial Planning

Get control of your time, energy and finances Improved financial position Increased future financial security Accumulate wealth for heirs Reduced stress and better state of mind

The Financial Planning Lifecycle

Age

Income

10 20 30 40 50 60 70 80

Income Stream

Retirement/Estate

Tax

Savings/Investment

Benefits

Employment Periods

The Financial Planning Process

Assess current financial condition Develop realistic and measurable goals Prioritize financial goals Identify strategies to achieve goals Enact goal achieving strategies in rank order Monitor financial progress Reassess goals and priorities at different life

events

Controlling Expenses

"Diligence is the basis of wealth,

and thrift the source of riches."

Chinese proverb.

Living Below Your Means

How We Spend Our Income

Food 13.5%

Housing 33%

Transportation 18.6%

Apparel & services 4.7%

Health care 5.4%

Entertainment 4.9%

Personal insurance 1.1%

Pensions/Social Security 8.4%

Other 10.4%

A $ Spent is a Lot of $’s Not Saved

Monthly spending choices from age 30 to 65 One soft drink a day ($15) @ 8% return

$34,408

Dinner for 2 once a month ($60) @ 8% return $137,633

A Café Latte a day ($100) @ 8% return $229,388

The monthly payments on a Intrepid versus a Navigator ($348) @ 8% return $798,271

The Law of Large Numbers

Look to the large numbers to find savings Big Ticket Items

Housing Transportation

• Buy less than you can afford• Diversify portfolio by investing the difference

High Volume Expenditures Dining and Café Latte’s Entertainment and Clothing

• Cut back on the numbers• Find more cost effective substitutes

Pitfalls in Retirement Planning

Starting too late.

Putting away too little.

Investing too conservatively (especially when you are younger).

Investing too aggressively (at any age) Rule of Thumb at retirement (7 to 10 years of low

risk investments to cover living expenses)

Sources of Retirement Income

10%

29%

20%

41%

Government stillprovides the largestportion—right now.

Government Assistance, including Social Security

Income-Producing Assets

PensionsOther

Don’t Count on Social Security

The Baby Boomers Born between 1945 and 1964 The largest population segment Median Age of workforce is rising fast

• 1980 – Just below 35 years of age• 2005 – Projected to be 41 years of age

The Social Security Trust fund is projected to run out of funds within the next 3 decades

Long-term care and healthcare costs will continue to rise as population ages

Be Prepared for a Long Retirement

Life Expectancy and Retirement Age for the Average American Early 1950s

• Retire in late 60s• Live another 1.6 years

Late 1990s• Retire in Early 60s• Live another 14 years

Source: “Stocks for the Long Run” by Jeremy Seigel

Time is Money $$$

Who will have the most at retirement (65)? Little Lisa: Parents put $3000 into retirement

account at birth with no additional contributions

Prudent Paul: Starts investing $3000 a year at 18 making his last contribution at age 25

Procrastinating Pete: Pete waits until age 26 to start putting away $3000 a year until age 65.

• Assume 10% tax deferred return on investments• What about at a 7% tax deferred return?

It’s About Timing Too

Which investment will provide the best return?

Fund Annual Return

Standard Deviation

Growth of $10k over 20 Years

A 16.69%

18.19% $172,813

B 7.86% 15.74% $36,341

Things Are Not Always Rosy

News from the Financial Times When the index broke 10,000 points, investors

celebrated, brokers toasted each other … economist talked about new market paradigms where stocks could achieve unheard of valuations

Just months later, the dream ended as the index plunged a stomach churning 80% destroying the hopes of thousands of amateur investors drawn to the markets by years of easy profit.

• Taiwan during the bubble

Sound Familiar? (Nasdaq)

The Secret is Time

And Controlling Risk

Volatility creates uncertainty and eats up returns

Which Investment has the highest compound return?

Fund 1 2 3 4 Mean Std. Dev.

Period

Return

A 10% 10% 10% 10% 10% 0% 46%

B 20% 0% 20% 0% 10% 12% 44%

The Answer - Asset Allocation

The process of putting your eggs into a number of carefully selected baskets

– When some baskets fall as inevitably occurs, other baskets still have eggs

Source: Standard & Poor’s Micropal

1970s 1980s 1990s

U. S. Stock 5.88% 17.55% 17.90%

Bonds 5.52% 12.62% 9.70%

Foreign Stock 8.80% 21.99% 5.00%

Commodities 21.25% 10.67% 0.48%

Performance of Global Stock Index: 1921-1996

(Nominal Returns in U. S. Dollars, Percentage per Annum)

Index Arithmetic Return

Risk Monthly

Sharpe Ratio Geometric Return

Ending Wealth

U. S. Index 8.04% 16.19% 0.1433 6.95% $171.20

Non-U. S. Index - All Markets

7.28% 12.08% 0.1740 6.75% $146.20

Global Index - All Markets

7.76% 12.14% 0.1728 7.25% $211.20

Arithmetic Return: The monthly average return multiplied by 12.

Risk: The monthly standard deviation multiplied by the square root of 12.

Monthly Sharpe Ratio: The ratio of the monthly average return to the monthly standard deviation.

Geometric Return: Annualized holding period rate of return (Effective annual rate).

Ending Wealth: Reports value of $1 invested on December 1920 and held to December 1996.

All Markets: To account for the closure of several international stock exchanges during the sample period, a 75% loss is imputed in the month a market permanently disappears.

Table 7: Goetzmann and Jorion, (Journal of Finance, 1999)

**This is for illustrative purposes only and not indicative of any investment. Past performance is no guarantee of future results.

Gather Little By Little

“Wealth hastily gotten will dwindle, but those

who gather little by little will increase it.”

King Solomon

Dollar Cost Average Out the Bumps

Year Deposit

Total

Deposits Price

Shares

Bought

Total

Shares

Acct.

Value

1 $3,000 $3,000 $10 300 300 $3,0002 $3,000 $6,000 $7 429 729 $5,1003 $3,000 $9,000 $4 750 1479 $5,9144 $3,000 $12,000 $7 429 1907 $13,3505 $3,000 $15,000 $10 300 2207 $22,071

An Easy Solution - Mutual Funds

Dollar Cost Average Out the Bumps Mutual funds pool investor money and have a professional money manager invest for their benefit Financial returns

Advantages of mutual funds Diversification Convenience Generally low fees Professional management ???

Mutual Fund Categories

Aggressive Growth Growth Value Growth & Income Balanced Bond Money Market

Index International Global Sector Socially

Responsible

Mutual Fund Fees

Loads = sales commissions Front load – Max 8.5% Back load and CDSC – Max 6% No Load fund

12(b) – 1 Fees: Advertising and promotion Max: 1% of assets

Management and Operating Fees: Cover manager and ongoing expenses of operation funds Typically 0.25% to 1.5%

The Cost of Mutual Fund Fees Bill plans to invest $500 a month for his

retirement in 30 years and is considering the following funds.

Fund Load 12b - 1 Mgt Fee Gross E(R)

A 5% .25% 1.00% 10%

B 0% 1.00% 1.00% 10%

NL 0% 0% 1.00% 10%

And the Results are

Fund A Fund B Fund NL

Investment

Months

360 360 360

Monthly Return 8.75%/12 8.00%/12 9%/12

Monthly Contribution

$475 $500 $500

Future Account Value

$825,603 $745,180 $915,372

Basic Retirement Accounts

Roth IRA Contribution: $3,000 max per person up to earned

income. Increase in the future No deduction but tax free withdrawals Phase-outs: 95k-110k single & 150k-160k married 10% penalty and tax on earnings for early

withdrawal before age 59 ½ or permanent disability

Penalty free withdrawal for first time home buyer or higher education expenses

Rule of thumb: Current tax rate < Retirement tax rate

Basic Retirement Plans - continued

Regular IRA Contribution: $3000 max per person up to earned

income. Increases in the future Contribution tax deductible; withdrawals fully taxed Ineligible if company offers retirement plan unless

lower income 10% penalty and taxes on all withdrawals for early

withdrawal before age 59 ½ or permanent disability Penalty free withdrawal for first time home buyer or

higher education expenses Rule of thumb: Current tax rate > Retirement tax rate

Basic Retirement Plans - continued

SEP (Simplified Employee Pension) Tax rules basically the same as a Regular IRA For small business owners Contributions: Up to lesser of 25% of income or

$40,000 401k

Tax rules basically the same as a Regular IRA For employees of companies Contributions: Up to $12,000 rising to $15,000 in

2006 Some have employee matching or loan features

Risk Management

Shield family from economic loss resulting from unanticipated events through insurance Life

• Key considerations– Income and debts

– Dependants and marital status

• Rule of Thumb– 7 times annual income

• Financially Prudent– Provide for last expenses and grieving period

– Eliminate major debts

– Replace income until dependants are self sufficient

» Assume reasonable return (5% to 6%)

Risk Management - continued Health

• Major medical expenses• Disability• Optional coverage

– Comprehensive medical– Eye, dental, and dread disease (adverse selection)

Home and Auto• Necessary coverage

– Minimum required by lender– Amount required to maintain similar lifestyle in tragedy

Liability• Needs depend on assets to shield• Cover reasonable levels of potential liability

Taxes, Taxes and More Taxes

"Excessive taxation ... will carry reason and reflection to every

man's door, and particularly in the hour of election.“

And

"Taxes should be proportioned to what may be annually spared by

the individual."

Thomas Jefferson

Tax Planning Strategies

Practice tax avoidance not evasion Employ all appropriate deductions or credits. Use tax-sheltered and deferred savings vehicles

• 401K• Roth and Regular IRA• Municipal bonds and variable annuities

Shift income to family members in lower tax brackets

Start a business in your spare time

Estate Planning

Accumulating assets for Dependents in event of death Family in event of disability Special considerations include

• Dependent ages• Education needs

Provide plan for family in event of Death Disability

Your Counsel Is Key

"The wisdom of a ruler is measured

by the wisdom of his counsel..." 

King Solomon

Don’t be a horror story, select your advisor carefully

The broker of a disabled teacher traded her account while she was incapacitated after surgery holding many positions less than a week Churning losses exceeded $100,000

Advisor selection Must be qualified with the appropriate education,

designations and licensures Come with good recommendations and

credentials

Steps to Success

Seek competent financial advice or become educated regarding money management and investing

Set realistic performance expectations and understand rationale behind strategies

Review your plan to make sure your portfolio has the appropriate risk levels and is on track

Closing Slide

H. Swint Friday, Ph.D., CFP

E-01 Personal Financial Planning

Please return your completed session survey

to the room monitor or the collection boxes

near the exit