What are the five steps in the personal finance process?
Decide why you are doing this.
Educate yourself to the available options. This is the “what” – where we understand and prioritize the principles.
Determine the goals that will most likely take us to where we want to be.
We must believe that we can accomplish the things we set out to accomplish.
We must work to achieve the goals that we set.
What are the four key principles for using wealth wisely?
1. Ownership – everything that we have or are is a gift from God.
2. Stewardship – We are stewards over the things the Lord has blessed us with.
3. Agency – the gift of “choice” is man’s most precious inheritance.
4. Accountability – we are accountable for our choices.
What are the six steps in the PFP process?
1. Decide what you want
2. Evaluate your financial health
3. Define your personal and financial goals
4. Develop a plan of action
5. Implement your plan
6. Revise your plan as necessary
What are the 4 objectives of finances?
1. Know what you want out of life
2. Develop and live on a budget
3. Pay the Lord first, yourself second, and invest wisely
4. Learn to give
What is financial planning?
The process of planning how to make use of your available resources to achieve your personal and family goals.
What are the three types of goals?
1. Identity Goals – relate to our long-term view on how we see ourselves.
2. Integrity Goals – relate to the characteristics and standards you want to achieve in the work and services you provide.
3. Temporal goals – relate to the temporal measures of success that we hope to accomplish.
9 Principals of Goal Setting
1. Strive to learn what the Heavenly Father wants you to do or be.
2. Seek Heavenly Father’s help in setting goals
3. Start with the end in mind
4. Write down your goals
5. Keep your goals SMART
6. Review your goals often
7. Remember your goals will change
8. Set fun goals
9. Remember, success is not measured by achievement, but by striving
Goal Setting: Start with an end in mind
How do you want to be remembered – Starting with an end in mind will help you prioritize your goals and realize what things are important to you.
Goal Setting: Write down your goals
A goal not written is only a wish. Write them down as you think about them
Goal Setting: Keep your goals SMART
S – Specific
M – Measurable
A – Achievable
R – Reportable
T – Time-bound
Goal Setting: Review your goals often
Review your goals will remind you what you want to accomplish and will make it more likely to be acheived
Goal Setting: Your goals will change
Keep your major goals in mind and remember things change and so might your goals.
Goal Setting: Set fun goals
Fun goals are important too
Goal Setting: Success is not measured by Achievement, but by striving
We should not make the achievement of goals our only criteria for success
What are the principles of budgeting?
1. Spend less than you earn
2. Keep good records for spending, taxes and other purposed
3. Use a budgeting method that meets your individual and family needs and objectives
What are the 5 types of budgeting?
1. The envelope method
2. The 60% Rule (Spend 60% or less of gross income…20% to taxes and 20% to savings)
4. Budgeting Software
5. Do nothing and hope
Steps to creating an effective budget:
1. Know what you want to accomplish
2. Track spending
3. Develop a cash budget
4. Implement your goal
5. Compare your budget to your actual expenses and make changes when necessary to achieve your goals.
Liquidity Ratio: Current Ratio
How many times you could pay off your current liabilities with your current cash on hand.
Current Assets / Current Liabilities
A ratio of >2 is recommended
Liquidity Ratio: Month’s living expense covered ratio
How many months your could survive financially if you lost all current sources of income.
Monetary assets / (annual living expenses/12)
Living expenses do not include charity, taxes or paying yourself
3-6 months is recommended
Debt Ratio: Debt Ratio
Tells you whether or not you could pay off all your debts if you liquidated all of your assets.
Total Liabilities / total assets
Should be downward trending as you get older
Debt Ratio: LT Debt Coverage
Tells you how long you could continue to make payments on your LT debt based on the amount of money you available for living expenses
Amount available for living expenses / the amount of your LT debt payments
Should be upward trending
Savings Ratio: Net Savings Ratio
Tells you what proportion of your after tax income you are saving.
amount of income saved / the amount of income you use to cover living expenses
10-20% is recommended
Savings Ratio: Gross Savings Ratio
Tell your what proportion of your before tax income you are saving.
total savings / by total income
10-20% is recommended
Four Strategies to minimize your tax liability
1. Maximize your deductions
2. Maximize LT capital gains and stock dividend income
3. Earn Tax-exempt income
4. Defer taxes to the future or eliminate future taxes
Three trade-offs of cash management
1. Risk-return trade off – higher liquidity means less risk and lower returns
2. Spending investment risk trade off – cash on hand is easier to spend than other financial assets
3. Return time expended trade off – since returns are small, the amount of time spent on them is less
Types of cash management investments
3. Money Market
5. Money Market Mutual Funds
6. US Treasury Bills
7. US Series EE Bonds
8. US Series I Bonds
Annual Percentage Yield
(1+ [APR/Periods])Periods -1
After Tax Returns
Before Tax Returns * (1-Marginal Tax Rate)
Equivalent Taxable yield
After tax return / (1-Marginal Rate)
[(1+nominal rate) / (1+ inflation)] – 1
Main goal of cash management
To give you sufficient liquidity to help you achieve your financial goals
Considerations when choosing a financial institution
Cost, Convenience, and Consideration
Comparing Cash Management Alternatives
1. Interest Rates
2. After-tax Returns
5. Maturity and interest rate adjustment periods
The process potential creditors use to determine whether or not an individual deserves to be given credit
The result of that credit valuation
Credit Score Determination
35 % payment record, 30% amount owed as a percentage of available credit, 15 % length of credit history, 10 % application history, and 10 % on credit mix
Credit Card Benefits
Emergencies, Reservations, Convenience, Cash flow and Timing, and free services
Using Credit cards effectively
1. Know your personal and family goals
2. Spend money on things planned for in your budget
3. Don’t go into debt
4. Use Wisdom in deciding what to buy
Credit card factors
1. Interest Rate
2. Compound Period
3. Balance Calculation Method
4. Cash Advances
5. Grace Period
6. Credit Card Philosophy (Credit users, convenience users, or combined users)
Managing Credit Cards
1. Reduce your balance
2. Protect yourself against Fraud
3. Be aware of signs of trouble in credit card spending
4. Control your spending
5. Opt Out
Single Payment Loans
Also known as balloon loans. Normally used for ST lending of one year or less. Sometimes called bridge or interim loans.
Repaid in one lump sum and uses simple interest method.
Annual Percentage Rate
[(Interest Payments + fees) / # of years] / Average Amount Borrowed
Repaid in regular installments that include both principal and interest. It amortizes over the entire length of the loan and is based on simple interest
Uses one of your assets as collateral to guarantee that the lending institution will get the amount of the loan back, even if you fail to make payments
Unsecured Loans and Signature Loans
No Collateral and are generally offered only to borrowers with excellent credit histories.
Typically higher interest rates
These loans maintain the same interest rate for the duration of the loan. Generally interest rates are higher
These loans have an interest rate that is adjusted at different intervals over the life of the loan
Loans where the interest rate structure can change
Special types of Consumer Loans
1. Home Equity Loans (2nd Mortgage)
2. Home Equity Lines of Credit
3. Student Loans
4. Automobile Loans
5. Payday Loans
Types of Loans
1. Conventional Loans – not insured or guaranteed
2. Jumbo Loans – Loans in excess of the maximum eligible for purchase by the two federal agencies
3. Piggyback Loans – two separate loans
4. Fixed Rate Mortgages
5. Variable or adjustable rate mortgages
6. Fixed or variable Interest only loans
7. Option Adjustable Rate Mortgages
8. Negative amortization mortgages
9. Balloon Mortgages
10. Reverse Mortgages
11. Special Loans
After-tax Lost return
Nominal Interest Rate * (1-tax rate)
Reasons people accumulate debt
Ignorance, Carelessness, Compulsiveness, Pride and Necessity
Debt Reduction Strategies
1. Recognize and accept that you have a debt problem
2. Stop incurring debt
3. Make a list of all your bills
4. Look for many different ways to reduce debt, not just one.
5. Organize a debt repayment strategy and follow it
Types of Debt Strategies
Two types of debt that’s ok to incur
Educational debt and Mortgage Debt
A current commitment of money or other resources with the expectation of reaping future benefits
The only tool that everyone has an equal amount of each day
A dollar in hand is worth more than a dollar received in the future
Loan paid off in equal installments (both Principal and interest)
A series of equal payments made at the end of a specific time period for a specified number of time periods
An investment that involves depositing the same amount of money at the end of each year for a certain number of years
The # of periods during the year where interest is calculated
Effective interest rate
The actual rate that is received after the effects of compounding are taken into account
The value of an investment at some point in the future
= PV * (1+I)^N
Interest or Discount Rate
The stated rate you will receive for investing at a specified compounding period for a specified period of time
The return on your investment before the impact of inflation and taxes is taken into account
The current value of a future sum of money
= FV / (1+I)^N
The money you have available to invest or save, or the stated amount on a bond or deposit instrument
The rate of return on an investment after the impact of inflation is accounted for.
(1 + Nominal Return(rn)) = (1 + real return(rr)) * (1+ inflation)
Tax Adjusted Return
The return on your investment after the impact of federal and state taxes have been taken into account
Effective Interest Rate
[(1+(Nominal Rate or APR/periods))]^periods – 1
A legal contract between you and an insurance firm.
The uncertainty concerning the occurrence of a specified loss
4. Transfer (insurance)
1. Frequency of potential loss
2. Severity of potential loss
Principles of Insurance Planning
1. Know yourself and your goals
2. Know your budget and what you can afford
3. Understand in detail the costs and benefits of each insurance product
4. Insurance against High-cost, High-severity losses only
5. Work only with highly qualified individuals and firms
6. Review your insurance needs annually
5 Questions regarding life insurance
1. Why should you have life insurance
2. How does life insurance work
3. Who needs life insurance
4. How much life insurance do you need
5. What type of life insurance
Approaches to determining life insurance needs
1. Earnings Multiple Approach
2. Needs Approach
Earnings Multiple Approach
The goal is income replacement. It replaces the annual salary of the breadwinner for a specified number of years. Normally 5-15x the gross salary.
1. Adjust the pre-incident salary down to compensate for the reduction in household expenses.
2. Choose the appropriate interest rate to match the assumed after-tax and after inflation earnings on a policy settlement.
3. Determine the income stream replacement and annuity.
The goal is to meet the total financial needs of the household after the death of the breadwinner.
1. Add up all funding needs (immediate needs, debt reduction, and transitional needs)
2. Subtract current insurance coverage and other available assets
3. Determine the income stream that would be needed to meet the family needs and then calculate the amount of money required to provide the needed annuity.
Term Life Insurance
Life insurance is provided for a specified period of time. Premiums are generally lower. It’s only valid if the insured dies within the specified period of time.
Annual Term Insurance
The face or death benefit amount is constant throughout the selected term of coverage. Premiums increase with each renewal
Renewable Term Insurance
Can be renewed for a specified # of years. Premiums increase at each renewal
Convertible Term Insurance
A policy that can be exchanged for a permanent policy within a specific # of years after issuance, without evidence of insurability
Reasons why term is cheaper
1. Only pay for a specified period of time – most policies lapse
2. Policies are generally for shorter time periods
3. The policies are less complex
Permanent Life Insurance
A contract in which the premiums are divided between life and death protection and savings. Carrier Cannot be canceled.
Sources of cash to increase the value of permanent life insurance
– Regular premium payments
– The investment yield from the cash value portion
– Receiving tax-free dividends from the insurance company as a legal return of premium
Investment Criteria for permanent life insurance
– Mortality Risk – risk that insured dies within contract period and is covered by insurance
– Investment Risk – Refers to who takes responsibility for the investment outcome
– Policy Costs – Compares the costs of the policy to other life insurance products
– Investment Choice – refers to the types of vehicles or assets the insured chooses to use to build his or her tax-deferred savings
– Investment Flexibility – The degree of risk of flexibility the insured has regarding insurance products
Whole Life Insurance
Lifelong coverage with a fixed premium based on your age at the time of purchase. Also called Straight Life or Ordinary Life.
Ideal for those who want and can afford permanent life insurance protection with a savings element. Good for those who have low self-discipline or low tolerance for risk in saving and investing.
Fixed Death Benefit, growing cash value, and potential growth from tax-deferred dividends.
Universal Life Insurance
A mix between term insurance and savings. Mortality risk is eliminated and investment risk is low. There is a guaranteed minimum interest rate that is set for life of the insured.
Monthly fee for insurance coverage. Premium and face amounts are flexible
Variable Life Insurance
Allows you to direct the investment portion of your premium into one or more separate investment accounts. The investment risk is substantial.
Appropriate for those who want to take risks, manage their own investments, manage their own investments, and have the opportunity for tax-deferred growth. You can lose money with this type of insurance.
Variable Universal Life Insurance
This type of insurance combines the flexible features of universal life with the investment options and risks of variable life insurance. Can choose where to invest your premium and assume the risk. There is no guarantee on your cash value.
May be the best option if you need a tax shelter and if you are comfortable with high-risk/high-reward investing.
Equity Indexed Universal Life Insurance
Combines the flexible features of universal life insurance with the investment options and risks of a equity index mutual fund which offers a capped exposure to the major equity markets for the cash value portion of the policy.
Considerations when buying permanent life insurance
-Can you commit to the premiums over the long term?
-Do you need the tax benefits now?
-Are the rates of return on these insurance products guaranteed?
-Do I have a history of medical problems that would preclude my ability to get life insurance?
Sales Charges/Front-end Load
Deductions for salesman distribution expenses (0-10%)
State Premium Taxes
Vary by state (0-5%)
Deferred Acquisition Taxes
A corporate federal income tax that is imposed on insurance company
First year admins fees which include the cost of setting up the policy
Monthly Administrative Fees
Enable the insurance company to provide services company such as mailing confirmation notices
Mortality and expense charges
Compensate the insurance company for certain mortality and expense risks and can range from .4 – 1.3% annually
Investment Management Fees
Fees paid for the professional fees
Used to pay financial advisors and brokerage firms
Types of Health Insurance
1. Basic Health Insurance – most policies that cover, hospital, surgical, and physician expenses
2. Major Medical Expense – Covers medical cost that are in excess of those covered by basic health insurance
3. Dental & Eye Insurance
4. Dread Disease and Accident Insurance – covers specific diseases and accidents
Fee for Service Plans
Private health care plans where doctors bills the patient directly and the insurance company reimburses a specific percentage
Managed Healthcare Providers
Prepaid healthcare plans for employers and individuals.
-Health Maintenance Organizations – use of specified doctors, hospitals, and clinics – has flat fee
-Preferred Provider Organization – cross between traditional fee for service plans and HMO plans.
-Point of Service Plans – Many attributes of HMOs, PPOs, and Fee for Service plans
-Exclusive Provider Organizations – Similar to HMOs , but they operate through an insurance company. Only covered by contracted providers , unless there is an emergent situation.
Government Sponsored Plans
1. Worker’s Compensation
Provides payments to the insured individuals in the even that regular income is interrupted by illness or an accident.
Types of Disability Insurance
1. Individual Disability Income
2. Group Disability Income
3. Social Security Disability Income
4. Worker’s Compensation
5. Disability Overhead Expense
6. Key Person Disability
Parts of Auto Insurance
– Medical Payment Coverage
– Uninsured/underinsured motorists
– Comprehensive Physical Damage Coverage
Types of Homeowner’s Insurance
1. HO-2 – general insurance and least expensive. Covers only named perils
2. HO-3 – includes open perils that cause direct physical damage to house. there is a list of exclusions
3. HO-4 – Renter’s insurance covering only the personal property
4. HO-5 -includes open perils with an additional rider that covers personal property
5. HO-6 – Condo Owner’s insurance. It covers any improvements made to the dwelling
6. HO-8 – Modified coverage for older homes
Homeowner’s Insurance Parts
-Loss of Use
Homeowner’s insurance cost factors
-Location of structures
-Type of structure
-Level of Coverage
Homeowner’s insurance considerations
1. Don’t Underinsure – s/b insured within 80% of the replacement cost.
2. Select a financially sound insurance company
3. Get a CLUE report
4. Reduce the insurance company’s risk
5. Know your coverage restrictions
6. Make your coverage work
7. Keep your credit score high
4 Options for Deciding on a home
1. Are your priorities in order and are you square with the lord?
2. Do you have adequate life and health insurance?
3. Are you out of high-interest credit card and consumer debt.
4. Have you written down your personal goals?
1. Know yourself
2. Understand Risk
3. Stay Diversified
4. Make Low cost and tax efficient investments
5. Investments for the Long run
6. Use Caution if you are investing in individual assets
7. Monitor portfolio performance against benchmarks
8. Do not waste too much time and energy trying to beat the market
9. Invest only with high quality, licensed, reputable people
10. Develop a good investment plan and follow it closely
Holding Period Return
(Ending Price – Beginning Price + Dividends + Distributions) / Beginning price