Slides by Pamela L. Hall

Western Washington University

An Overview of Personal Finance

Chapter 1

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Meaning and Importance of Personal Finance

Can improve your standard of livingToday’s environment has impacted personal

finance over the years Sluggish growth in personal income

After adjusting for inflation and taxes, personal income growth has only been about 2% a year for the last 2 decades

Charges in the labor market Most people starting jobs today will work at

numerous companies during their career(s) More options

Many more options available today in investments, retirement planning, banking, etc.

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Personal Financial Planning—A Lifelong Activity

No matter how old you are, you’ll have financial goals

What works when you’re 20, won’t necessarily work when you’re 40 In your 20s your goals may be paying off

student loans, buying your 1st house In your 70s your goal may be making

sure your retirement funds last your lifetime

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Personal Financial Toolbox

Once you graduate from college (and now have a ‘real’ job) Figure out your current financial

standing How much do you owe? What assets do you have?

Prepare an income statement and balance sheet Put yourself on a budget Insure yourself against financial ruin

Life, health, property

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Personal Financial Toolbox

Get your debts under control (if they’re not already) Pay off high-rate loans (or roll over into

lower-rate loans)Start saving for retirementSet up a regular savings program (pay

yourself) Have money automatically transferred from

checking to savings Treat this like a fixed expense

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Getting Professional Help

Many colleges & universities offer credit counseling

May use services of a CPA or professional investment advisor

Dozens of financial self-help booksOnline financial information is

availableIf you use a financial planner make

sure they are qualified

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Web Links

www.moneycentral.com www.quicken.com www.motleyfool.com

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A Personal Financial Management Model

Financial plan is a guide to help you reach your targeted future goals Step 1: Develop short and long-term

goals Influenced by your personal values &

current financial situation Step 2: Establish financial strategies Step 3: Put plan in action & monitor

performance

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A Personal Financial Management Model

All financial plans revolve around: Maximizing income and wealth

The amount of money you earn is a vital past of any plan

Using money more effectively Spend (and save) your money wisely

Little things add up

Monitoring expenditures Use a budget to help control expenditures The more you know about loans, investments, etc.,

the more likely you are to make a good decision

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A Personal Financial Management Model

Pitfalls of Poor Financial Planning Missed or late payments will be

noticed Creditors may:

Repossess your property Garnish your wages Force you to file for personal bankruptcy

A bad credit record can last for years

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Setting Personal Goals

Your values will influence your financial goals What things in life are important to you?

Your financial goals are influenced by your current financial situation

Prepare current financial statements Review them to determine what you own, what you

owe, & where you’re spending your money Prepare a budget Prepare a list of short and long-term goals

Make sure they are realistic and obtainable Write down your goals and periodically review them

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Your Personal Financial Decisions

Career choice Most of your income comes from salaries/wages–

determines your lifestyle

Basic money management Prepare a budget Select the right bank Establish a regular savings plan

Credit management Don’t bite off more than you can chew Find a good credit card Learn how to compute interest charges/monthly payments Find out your credit history (report) Learn what to do if you get into trouble

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Your Personal Financial Decisions

Tax Planning How can you reduce your taxes?

Effective Buying Real estate, cars, etc.

Renting vs. owning

Insurance How much insurance should you have (if any)?

Life Health Property Disability Liability

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Your Personal Financial Decisions

Investment Management Invest to increase your future wealth

Difficult to substantially increase future wealth without investing

Investments are risky, choices include: Mutual funds Stocks Bonds Options and futures Real estate Art Coins Metals (gold, silver, etc.)

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Your Personal Financial Decisions

Financial Planning for Tomorrow Planning for your children’s college education

Becoming more and more expensive

Retirement Planning How do you want to live your retirement? How much (if any) do you want to pass along

to your heirs? How long remains until you retire? Will Social Security be enough?

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External Factors

External Factors to consider Government policy

Tax rates, credits, deductions, etc. Will the capital gains rate increase? Interest on student loans

Changes to Social Security Will the retirement age be increased? Will payroll taxes increase? Will benefits to ‘wealthy’ retirees be reduced?

Health insurance reform The cost of health insurance will probably rise over

the years

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External Factors

Economic Conditions The Business Cycle

Shorter-term sequences of expansions and contractions (recession)

Typical business cycle has four stages: prosperity, decline, recession, and recovery

Gross Domestic Product Represents the total value of goods and services

produced by a nation’s economy Important determinant of personal income

Disposable personal income—what remains after income taxes

Discretionary personal income—what remains after all necessary living expenses have been paid

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External Factors Unemployment rate:

The percentage of workforce currently looking for a job Inversely related to economic activity

Inflation Inflation decreases the purchasing power of the dollar Inflation has been about 3% in recent years Income sources with cost-of-living increases are tied to

inflation Interest Rates

If you think interest rates are going to rise sharply, buy that house/car now instead of waiting

Interest Rates are tied to inflation Nominal interest rates are those that you pay or receive

where as real interest rates are nominal rates less the rate of inflation

For instance, if a six month CD pays a 5% nominal rate, but inflation is 2%, then you are earning a real rate of 3%

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External Factors

Government Policy and Economic Activity Government influences economy

If taxes increase and government spending remains unchanged, economic growth will slow

Federal Reserve Board can increase or decrease the supply of money

Impacts interest rates, inflation, and economic growth

Recession/Expansion If you think a recession is in the near future,

save more now (in case you get laid off)

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Figure 1.5: Real GDP

1,000.0

2,000.0

3,000.0

4,000.0

5,000.0

6,000.0

7,000.0

Re

al G

DP

($

bill

ion

s)

Notice generally that the U.S. economy has grown over the past 30 years.

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Figure 1.6: Breakdown of Personal Income