Personal Finance Ch 1-4

Personal Finance
The process of planning your spending, financing and investing in order to optimize your financial situation.
Personal Finance Planning
The process of describing your financial goals and planning your spending, investing and financing in order to help you reach those goals.
Opportunity Cost
What you give up as a result of decision
How you benefit from knowing personal finance?
1. Make your own financial decisions (opportunity cost)
2. Judge the advice of financial advisors (informed decisions)
3. Become a financial advisor (career opportunities)
Components of a financial plan
1. Budgeting and tax planning
2. Managing liquidity
3. Financing for large purchases
4. Protecting your assets and income (insurance)
5. Investing your money
6. Retirement and estate planning
Budget Planning
Process of forecasting your future expenses and savings
-evaluate current financial position
-net worth
Access to funds to cover any short-term deficiencies.
i.e. do you have enough money to pay off current obligations this month and still eat, looking at NOW
Money Management
Decisions regarding how much money to keep in liquid form and how to allocate funds to short term financial instruments.
Ex: What you do with the $200 that you have left at end of month
Credit Management
Decisions regarding how much credit to obtain in order to support spending and which sources of credit to use
Questions to ask when managing loan (large expenditures=loans)
1. How much money can I afford to borrow?
2. What will the maturity of the loan be?
3. Getting loan at competitive interest rate
What protects your assets and income?
Insurance Planning
Determine the types and amount of insurance needed to protect your assets
Automobile and homeowners’ insurance protects
Health Insurance
Limits potential medical expenses
Disability and Life Insurance protects
Any funds beyond what you need to maintain liquidity should be invested
What is the primary objective of investing?
Earning a high return
Percentage breakdown of income
Live on 70%, 30% fun (10% investments, 10% savings, 10% fun)
Uncertainty surrounding the potential return on an investment
Ex: Dow Jones is down because more people wanting to sell than buy stock
To keep risk at a tolerable level you must…
Manage your Investments
What does building a financial plan do for you?
1. Grows wealth
2. Enhances net worth
3. Every competent on financial plan affects inflows and outflows and determines how much cash you have
How financial plan decisions affect your cash flows?
1. cash inflows (receive)
2. cash outflows (spend)
3. liquidity: deals with cash shortages/excesses
4. budgeting: balances income and spending
Financial Plan Decisions
1. Budgeting
2. Managing Liquidity
3. Personal Finance
4. Protecting your wealth
5. Personal Investing
6. Retirement and estate planning
Summary of Financial Plan components (Sources of Cash)
-work more hours
-sell investments
-cash in insurance policy
-take from retirement
-withdraw cash from savings
Summary of Financial Plan components (Uses of Cash)
-purchase of products and services
-deposit in checkings/savings
-pay interest payments
-make insurance payments
-make new investments
-contribute to retirement account
Integration of Financial Components
Budgeting decisions—> liquidity management–>financing decisions–>insurance decisions–> investment decisions–>retirement and estate–> budgeting
Psychology has an affect on what two aspects in human behavior?
Spending decisions and the ability to implement an effective financial plan
Two different types of spending behavior
1. Focus on Peer Pressure and Immediate Satisfaction
2. Focus on future
Questions to ask yourself when assessing your own spending behavior:
1. Do you live with a roommate or alone?
2. Do you have large monthly car payments?
3. Do you have credit card bills that you only make the minimum payment on each month?
4. Do you spend all your income that is not needed on home and car payments in the first two days?
5. Do you always find a reason each month to spend all of your income?
Developing a Financial Plan:
1. Establish Financial Goals
2. Consider current financial position
3. Identify and evaluate alternative plans to help you reach goals
4. Select and implement best plan to help you achieve goals
5. Evaluate Financial Plan
6. Revise Financial Plan
Establishing your financial goals
1. What type of goal (car, home, college, wealth, charity)
2. Realistic goals (more likely to achieve)
3. Timing of Goals
Intermediate Goal
1-5 years
Short Term Goal
Within 1 year
Long Term Goal
Beyond 5 years
Considering Current Financial Position
1. How your future financial position is tied to your education
2. How your future financial position tied to career choice (enjoyable and suit skills)
3. How your future financial position is tied to the economy (economic conditions affect, salaries, jobs available, prices of services, value of assets. Ex. 2008)
When identifying and evaluating alternative plans to help reach your goals, you have to choose a plan that is more aggressive. T or F?
False, you can choose a plan that is conservative or aggressive.
What is a good source to use when selecting and implementing the best plan for achieving your goals?
The Internet
Why use the internet when selecting and implementing a good source to use to help you reach your goal?
1. it has updated info on all parts of your financial plan.
2. online calculators
What kind of update information does the internet provide for you when creating your financial plan?
Has updated information on all parts of your financial plan
1. current tax rates and regulations
2. investment performances
3. new retirement plan rules
What can an online calculator from the internet help you do when financial planning?
1. calculate taxes
2. determine how your savings will grow over time
3. determining whether buying or leasing a car is more appropriate
What should you focus on when selecting and implementing the best financial plan to help you attain your goals?
Focus on Ethics: Personal Finance Advice
-Get best advice appropriate to your needs
-Be wary of unethical behavior
-Be wary of incompetent advice (be alert, ask questions, carefully consider)
After creating a financial plan what should you do with it?
keep in accessible place and monitor progress
How often should you monitor your financial plan?
Every year
Put in proper order of how much you should focus when investing. 1. Savings Account, 2. Treasury Bonds, 3. Independent Stock Bonds, 4. Mutual Funds
1, 2, 4, 3
Example of integration of the financial plan components
Walmart Door guy–> low interest rates
Revise financial plan when…
financial condition and financial goals change
Personal Cash Flow Statement
financial statement that measures a persons’ inflows and outflows
Cash inflows include
salaries, dividends, tips, interest
Cash outflows include
all expenses large and small
Which is not considered an inflow
A. salaries
b. insurance premium
c. interest
d. dividend
B. insurance premium
Create a Cash Flow Statement by recording your _____ and ____ over a period of time.
revenues and expenses
Net Cash Flows=
Cash Inflows – Cash Outflows
Factors affecting cash inflows include:
1. Stage in career
2. Type of job (based on skill level and demand for those skills)
3. # of income earners in your household
Factors affecting cash outflows
1. Size of family
2. age
3. Personal consumption behavior (saver or spender?)
a cash flow stmt that is based on forecasted cash flows for a future time period
What are budgets useful for?
anticipating cash surpluses or cash deficiencies
Creating a budget
-Anticipating cash shortages
-Assessing accuracy of budget
-forecast net cash flows over several months
-create an annual budget by extending your budget out for longer periods
-improving the budget
-focus on ethics
Anticipating cash shortages
– small shortages can be made up from checking account
– budget provides warning of shortages so you can prepare for them
Forecast net cash flows over several months
-use the info for a typical month and adjust it for unusual expenses i.e. christmas shopping
-allow for some unexpected expenses like medical care, car and home maintenance
Assessing the accurate of the budget
-compare predicted cash flows to accurate cash flows
-adjust if necessary
Improving the budget
-Periodically review budget to see if you are progressively moving towards goals
-Look for areas that can be changed to improve the budget over time
Focusing on Ethics with budget
-don’t become overly dependent on others
-create a budget and stay within it
Personal Balance Sheet
a summary of your assets, your liabilities, and your net worth
A balance sheet reflects your financial position at a ______ point in time
Liquid Assets
financial assets that can be easily sold without a loss in value
Ex. money market account, cash, checking, savings, etc.
Household Assets
items normally owned by a household (home, car, boat, furniture, etc.)
-establish market value, the value would be at what you receive if sold today (call appraiser)
*have a value
Investment Assets
Could lose money when liquidate if mkt goes down
Investments on Balance Sheet
Stocks, bonds, mutual funds, real estate
certificates representing partial ownership of firm
certificates issued by borrower, usually government agencies and firms, to raise money
Mutual Funds:
investment companies that sell shares and invest the proceeds in investment instruments; bunch of different kinds of stocks
Real Estate:
holdings in real estate property and land, need value not amount paying rent on
Rental property:
housing or commercial property that is rented out to others
Assets on Personal B.S.
Liquid and Household, investment assets
Current Liabilities
debts that will be paid within year, credit cards
Long-term liabilities
debts that will be paid in greater than one year; payoffs, car and mortgage payments
Creating a personal balance sheet…
1. helps determine your net worth
2. update periodically to monitor changes in your net worth over time
Changes in personal balance sheet will affect both your personal balance sheet and your net worth. T or F?
False, some will change both and some will only change your personal balance sheet
Impact of economy on personal balance sheet
1. ^ job opp and income
2. v job opp and income
3. net worth can decline to the point of becoming negative
How cash flows affect the balance sheet
1. wealth is built by using net cash flows to invest in assets without increasing liabilities
2. net cash flows can be used to decrease liabilities which in turn increases net worth
3. Net worth can change even if net cash flows is 0, i.e. if value of investment or assets goes up or down
Analysis of the personal balance sheet
-allows monitoring of liquidity, debt, and ability to save
-liquidity measured by liquidity ratio
Liquidity Ratio=
Liquid Assets / Current Liabilities
Higher result of liquidity ratio=
greater liquidity
Debt-to-asset ratio is used to measure
debt level
Debt-to-asset ratio =
total liabilities / total assets
Higher Debt-to-asset ratio means
Higher debt relative to assets
What does the savings rate measure?
Savings over the period in relation to disposable income over the period
Savings Rate =
Savings during period / disposable income during the period
The key budgeting decisions for building your financial plan are:
1. How can I improve my net cash flows in the future?
2. How can I improve my net cash flows in the distant future?
If you don’t budget for unexpected expenses, you will likely experience
a cash shortage
How often should you do a personal balance sheet?
Once a year (current, where you are today)
What influences the value of money?
The time it is received
The value of a given amount of money is generally ______ the earlier it is received.
The earlier you start saving, the more quickly your money can _________________
earn interest and grow
A single dollar amount of money is also called a
Lump Sum
A series of equal cash flow payments that are received or paid at equal intervals in time. i.e. a monthly deposit of $50 into your savings account
Compounding (FV of single dollar amount)
The process of earning interest on interest
To determine the FV of a single amount of money you deposit today, you must know:
1. amount deposited today
2. interest rate to be earned on deposit
3. # of years money will be invested
Future Value Interest Factor (FV of 1)
a factor multiplied by today’s savings to determine how the savings will accumulate over time
As numbers of years increase, FVIF ______
increases (aka greater savings)
The higher the interest rate, the more your money will ________.
Compounding effects debt as well as savings. T or F?
Don’t hold payment past due date because company can raise______
Compounding can only expand your savings, not your debt. T or F?
False. Compounding can expand your debt. Not only do you pay interest on your debt, but you will pay interest on interest of your debt.
Is it a good idea to postpone debt payment as long as possible?
No, debt will accumulate
the process of obtaining present values
Present Values tell you the amount ________ and is based off of ______
you need to invest today to accumulate a certain amount as some future time and is based off of an interest rate you could earn over that period.
To determine present values you need to know:
1. How much will be received in the future
2. the interest rate to be earned on the deposit
3. # of years the money will be invested
Present Value Interest Factor (PVIF)
Factor multiplied the future value to determine the present value of that amount
Present Value Interest Factor gets ______ as # of years increases and as the ____ _____ increases.
lower, interest rate
To solve for PV you need all except:
1) How much you will need in future
2) how long
3) expected rate on return
4) currency
Annuity Due
A series of equal payments that occur at beginning of each period
Diagrams that show payments received or paid over time
Future Value Interest Factor for an Annuity (FVIFA)
a factor multiplied the periodic savings levels (annuity) to determine how the savings will accumulate over time
Present Value of an Annuity is determined by
discounting the individual cash flows of the annuity and adding them up
Present Value Interest Factor for an Annuity (PVIFA)
a factor multiplied by a periodic savings level (annuity) to determine the present value of the annuity
What provides motivation for regular saving?
Estimating the FV From savings
Estimating annual savings that will achieve a future amount will help…
specific goals when saving for a large purchase
How can time value motivate saving?
1. money can grow substantially over time when you invest periodically and earn interest
2. May be more motivated to save because you can see the reward of your effort
Key saving decisions for building your financial plan:
1) How much should I attempt to accumulate in savings for a future point in time?
2) How much should I attempt to save every month for a year?
Taxes are paid on
earned income, consumer purchases, wealth transfers and capital assets
Special taxes are levied on things like
alcohol, cigarettes, gasoline
Corporations pay ______ tax on profits
Homeowners pay ________ tax
Taxes are used to pay for
government services and programs
Most individuals pay taxes at ______, ______, and _____ levels
federal, state, and local
Who is the Federal Tax System administered by?
The Internal Revenue Service (IRS)
Taxes are paid in several ways:
1) at the time of a transaction
2) through payroll withholding
3) by making estimated quarterly payments
Tax year for federal income tax ends on ________ with taxes filed on _____
December 31; April 15
Economic Growth and Tax Relief Reconciliation Act of 2011:
tax cut package designed to provide short-term economic stimulus through tax relief for taxpayers (2001-2011); post 9-11 to help people become normal again
Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010:
Legislation that extend many of the previous tax law provisions through year 2012
-unless made permanent, will expire at beg. of 2013
-Revert to old, higher tax rates with the highest being 39.6%
Jobs and Growth Tax Relief Act of 2003:
an act that accelerated much of the tax relief resulting from the 2001 Tax Relief Act
-Individual rates lowered 2-3%
-Child tax credit increased to $1,000
-Standard deduction increased for married taxpayers
-Will also need an extension to go beyond 2013
Earned Income represents
salary, wages, tips, bonuses and commissions
FICA (Federal Insurance Contribution Act):
SS and Medicare taxes
A government health insurance program that covers people over age 65 and provides payments to health care providers in the case of illness
Tax Relief Acts of 2001 and 2003
Bush Tax Cuts
A corporation’s profit is taxed how many times?
_______ tax is matched by your employer
Social Security (6.2%) and Medicare (1.45%)
Social Security taxes equal _____% of your salary with a maximum level of $________ as of 2012.
6.2%; 110,100
Medicare taxes are _____% of your earned income, with no limit.
Self employed people must pay______________.
both parts of these taxes- 15.3%
Employees SS and Medicare taxes are paid before or after income tax is withheld?
What percentage was ss tax reduced to in 2011 and 2012?
Personal income taxes:
taxes imposed on income earned
If you earn income you must file a _______, _______ or ________ to determine your tax liability.
1040, 1040A, 1040EZ
Filing deadline is _________ of each year.
April 15
Different ______ are associated with each filing status
Different types of filing statuses
single, married filing jointly, married filing separately, HOH, qualifying widow(er), with dependent child
Gross Income
All reportable income from any source, including salary, interest income, dividend income, and capital gains received during the tax year
Gross income- Salaries and Wages
included bonuses, but excludes contributions to an employee sponsored retirement account
Gross Income- Interest Income
Interest earned from investments or loans to other individuals
Gross Income- Dividend Income
Income received in the form of dividends paid on stocks or mutual funds
Gross Income-Capital gains
income earned when an asset is sold at higher price than it as paid for
Short-Term Capital Gain
a gain on assets that were held less than 12 months
Long-Term Capital gain
a gain on assets that were held for 12 months or longer
It is a better idea to hold a capital gain for a longer or shorter period of time?
Capital Gains Tax
the tax that is paid on a gain earned as a result of selling an asset for more than purchase price
Schedule B
Interest and Ordinary Dividends
Schedule D
Capital Gains and Losses
Determining Gross Income
Salary + Net Business Income Interest Income + Dividend Income + Capital Gains
adjusts GI for contributions to IRA, alimony payments, interest paid on student loans, and other special circumstances, money into retirement program
Standar Deduction
a fixed amount that can be deducted from AGI to determine taxable income
-not affected by income
-affected by filing status and age
-adjusted by the IRS each year to keep pace with inflation
The standard deduction for married filing jointly
Itemized deductions
specific expenses that can be deducted to reduce taxable income
-interest expense
-State income tax
-local income tax
-real estate tax
-charitable gifts
-medical expenses in excess of 7.5% of AGI
-other expenses (theft losses, job expenses if substantial)
Interest expense:
interest paid on borrowed money- primarily interest on mortgages
State income tax:
an income tax imposed by some states on people who receive income from employers in that state
Real Estate Tax
a tax imposed on a home or other real estate in the county where the property is located
Charitable Gifts
-gifts to qualified organizations (cash or property)
-keep receipts and records of gifts
Theft Losses–>
if insurance policy doesn’t cover all then can deduct excess leftover
Summary of deductible expenses
total deductible expenses to decide whether to itemize or use the standard deduction
Schedule A
Itemized Deduction
Personal Exemption
an amount that can be deducted for each person who is supported by the income reported on a tax return
-deducted from gross income to determine taxable income
Taxable Income
AGI – deductions and exemptions
Taxes are dependent upon
taxable income and filing status
Progressive tax
a tax system where a positive relationship exists between an individual’s income level and tax rate
Tax Liability =
-determine filing status
Tax on Base + [% on excess over the base * (Taxable income – base)]
1. Gross income, 2. Deductions/Exemptions 3. Taxable Income 4. Calculate Tax 5. AGI 6. Tax Credits
1, 5, 2, , 3, 4, 6
Tax Credits
specific amounts used to directly reduce tax liability
Child tax credit
a tax credit allowed for each child in household
-was increased to $1,000 in 2003, may revert to 500 in 2013
-available as refund to low income workers who owe no income tax
College expense credit
tax credit allowed to those who contribute towards their dependents’ college expenses
-coverdell savings accounts
-section 529 college savings plans
Coverdell Savings Accounts
tax- free accounts that can be used for a variety of school expenses
Section 529 College Savings Plan
-allows tax benefits for parents who set aside money for their children’s future college expenses
-available to all parents, regardless of income
Earned Income Credit
a credit used to reduce tax liability for low-income taxpayers
-other credits also available ( i.e. child care and adoptions)
The key tax planning decisions for your financial plan are:
1. what tax savings are currently available to you?
2. how can you increase your tax savings in the future?
3. should you increase/decrease the amount of your withholding?
4. What records should you keep?