Personal Finance Chapters 1-4

Personal Finance Key Concepts

• Inflation: Considered the enemy of compound interest, it complicates achieving financial goals by reducing purchasing power.

• Tax Filing: Individual circumstances like income, dependents, and types of deductions impact eligibility for tax credits and deductions.

• Portfolio Income: Includes income from non-tax-deferred investments such as dividends and interest that must be reported on tax returns and may be taxed differently than wages.

• Interest Rate Calculation: A loan payment structure can determine interest rates; e.g., a loan of $39,927.10 repaid in five annual payments of $10,000 equals an 8% interest rate.

• Investment Growth: Investing at an annual interest rate accumulates over time; e.g., $15,750 at 8% grows to $29,152.15 in 8 years.

• Compounding Effect: Long-term saving strategies emphasize self-discipline, such as leaving an $1,000 investment untouched to double in approximately 9 years.

• Deductions and Standard Deductions: Factors influencing decision-making between itemized deductions and standard deductions include home ownership, deductible expenses, and record-keeping requirements.

• Parenting Financial Adjustments: Single parents may qualify for various deductions, such as student loan interest adjustment and child-related credits.

• Itemized Deductions: Deductions calculated from Schedule A that lower taxable income can significantly affect tax obligations.

• Savings for Down Payments: Calculating future savings to meet down payment requirements, e.g., $30,000 needed in 5 years at 9% return requires annual savings of about $5,013.

Understanding Financial Statements

• Wage Reporting: Wages are reported on W-2 forms, while interest and dividends are reported on 1099 forms.

• Personal Balance Sheet: This financial position statement includes assets, liabilities, and calculates net worth (assets minus liabilities).

• Income Statement: Reflects money flow, detailing income sources and expenditures over time to manage budgeting effectively.

• Fixed vs. Variable Expenditures: Understand control over expenses; fixed expenditures are obligatory, while variable expenditures can fluctuate.

Financial Ratios and Indicators

• Current Ratio: Measures liquidity, defined as monetary assets divided by current liabilities.

• Debt Ratio: Indicates financial health, calculated as total liabilities divided by total assets.

• Long-Term Debt Coverage Ratio: Assesses ability to meet long-term debt obligations by comparing income available for living against long-term payments.

• Month's Living Expenses Covered Ratio: A liquidity indicator that measures monetary assets against annual expenditures divided by 12.

Principles of Personal Finance

• Rule of 72: A time-saving method to estimate how long it will take for an investment to double; divide the annual growth rate into 72.

• Time Value of Money: Emphasizes that a dollar today is worth more than a future dollar, affecting savings and investment comparisons.

• Diversification: Mitigates investment risk by spreading investments across various assets.

• Liquidity: Refers to the ease of converting assets to cash, crucial for meeting financial obligations.

• Personal Financial Planning Steps: Include evaluating financial health, defining goals, developing a plan, implementing it, and regularly reviewing progress.

Final Notes

• Tax Planning: Understanding expenses, exemptions, and the progressive tax system is crucial for minimizing tax liabilities.

• Emergency Fund: Essential for financial stability, it ensures availability of cash reserves during unforeseen circumstances.

• Estate Planning: Involves preparing for wealth transfer and ensuring that assets are managed according to one’s wishes after death.

• Investment Terms: Key concepts like principal, future value, present value, and annuity are foundational in understanding financial returns and investments.### Deductions and Income Terms

• Allowable deductions are calculated and subtracted from adjusted gross income to determine taxable income.

• Itemized deductions refer to specific expenses that taxpayers can list to reduce taxable income, rather than opting for the standard deduction.

• Standard deduction is a fixed dollar amount determined by the IRS, available regardless of actual expenses incurred by the taxpayer.

Income Definitions

• Taxable income encompasses all income that is subject to taxation.
• Adjusted gross income (AGI) includes all sources of income minus certain adjustments such as IRA contributions, student loan interest, and alimony paid prior to standard or itemized deductions.

Tax Rates and Categories

• Marginal tax rate or marginal tax bracket denotes the tax rate applied to the last dollar earned by the taxpayer.
• Bracket creep occurs when taxpayers move into higher tax brackets due to inflation-driven wage increases, leading to higher effective tax rates.

Capital Gains and Assets

• Tax-deferred income refers to earnings on which taxes are postponed until a later date, allowing for potential growth over time.
• Capital assets include personal property such as stocks, bonds, and real estate, excluding certain business assets.
• Capital gain is defined as the profit realized from the sale of a capital asset when the selling price exceeds its purchase price.
• Capital gains tax is the tax imposed on the realized profit from the sale of capital gains.

Social Programs

• Social Security is a federal program providing benefits for disability and retirement based on an individual's work history and contributions.
• Medicare is the federal insurance program offering medical benefits to individuals aged 65 and over.