Finance 369 Notes PDF

Finance 369 Notes: Chapter 1: -​ Personal Financial Planning: A systematic. process that considers important elements of an individual's financial (Whether you have a lot of money or not enough, you need personal financial planning affairs in order to fulfill financial goals.) S.M.A.R.T G...

Finance 369 Notes: Chapter 1: -​ Personal Financial Planning: A systematic. process that considers important elements of an individual's financial (Whether you have a lot of money or not enough, you need personal financial planning affairs in order to fulfill financial goals.) S.M.A.R.T Goals: -​ S: “Specific” - What do you want to do? -​ M: “Measurable” - How will you know when you have reached it? -​ A: “Achievable” - Is it in your power to accomplish it? -​ R: “Realistic/Relevant ” - Can you realistically achieve it? -​ T: “Timely” - When do you want to accomplish it? -​ Financial Goals: Results that an individual wants to attain, such as buying a home, building a college fund, or achieving financial independence. -​ Emergency Fund: When developing your financial plan, one critical part of the Short-Term Goal is an Emergency Fund. (Your emergency fund represents at least 6 months of your salary) The Personal Financial Planning Life Cycle Asset acquisition (Chapters 4 and 5) Liability and insurance (Chapters 6 and 7) Savings and investment (Chapters 2, 4, 11, 12 and 13) Employee benefit (Chapters 2, 3, 8, 9 and 10) Tax (Chapter 3) Retirement and Estate Planning (Chapter 14) Basic terms and definition: Investment - an asset (something of value) or item acquired with the goal of generating income or appreciation. Interest - cost of money (presented in the form of a percentage i.e., interest rate). Principal - the original sum invested or lent. Rate of Return - the money you earn from your investment. ADDED to the principal. Compound Interest - When the earned interest from your investment is Professional Financial Planner: -​ An individual or firm that helps clients establish financial goals and develop and implement financial plans to achieve those goals. Role is like that of a personal trainer at the gym Chapter 2: Assets: things that you own -​ Items that one owns -​ Liquid assets: Held in the form of cash -​ Investments: Acquired to earn a return -​ Real property: Immovable assets -​ Personal property: Movable and used in everyday life -​ Total assets = Total liabilities + net worth Liabilities: things that you owe -​ Debts like credit card charges, loans, and mortgages -​ Current or short-term: Due within 1 year of the date of the balance sheet -​ Open account credit obligations: Current liabilities that represent the balances outstanding against established credit lines -​ Long-term: Debt due 1 year or more from the date of the balance sheet Net worth: difference between assets and liabilities -​ What someone is worth (financial value) Individual's or family's actual wealth Equity: Actual ownership interest in a specific asset or group of assets  -​ If the net worth is less than zero, then the individual or family is insolvent Net worth = Total assets - total liabilities Financial Plans - are the roadmaps that show you the way. Financial Statements - lets you know where you stand financially (where you are). Budgets - detailed short-term financial forecast that compare estimated income with estimated expenses, allow you to monitor and control expenses and purchases in a manner that is consistent with your financial plans. Balance Sheet -​ Describes a person's financial position at a given time -​ Total assets = Total liabilities + net worth -​ Net worth = Total assets - total liabilities Income and expense statement: reports how you did financially over a period of time Income and Expense Statement: Cash surplus: -​ Excess amount of income over expenses Results in increased net worth Cash deficit: -​ Excess amount of expenses over income Results in insufficient funds and decreased net worth (Insolvent) Income = earnings received as wages, salaries, bonuses, commissions, interest and dividends, or proceeds from the sale of assets Expenses = Money spent on living expenses and to pay taxes, purchase assets, or repay debt Emergency Fund - what happens if you lose your job? You should have at least 6 months worth of income in an Emergency Fund Don't attempt to "keep up with the Jones." Living within you means (or even below) pays off in the long run and you really don't know how others manage their money. Know the difference between WANTS and NEEDS. Invest in a 401K on day one if it's available and don't touch it! Don't take on others' burdens. Learn quickly to say "NO." Chapter 3: So why do we pay taxes? -​ The US Constitution says so (it's the law) -​ Government provides Public Goods and Services -​ Government provides Protective Services (Armed Forces, Local Police, Fire, EMS etc.) -​ Pays for all Federal/State/Local Workers, Representatives, Consultants, etc. -​ "Dues paid for membership in a society" -​ (Cost of living in a country) What's the difference between GROSS and NET pay? -​ Gross Pay: Any and all income before various deductions. -​ Net Pay: Remaining income after various deductions. (Also called take-home pay) Federal Tax Laws -​ Administering and enforcing federal tax laws is the responsibility of the Internal Revenue Service (IRS), a part of the U.S. Department of Treasury. What determines the taxes to be withdrawn? -​ The classification you select on the W-4 and the other amounts you request: Tax Forms -​ Everyone can file Form 1040 -​ For 2018, form 1040 is about half page front and back but is supplemented by six schedules referred to as Schedule 1, 2, 3, 4, 5, and 6 to report additional income, credit, and taxes. -​ Using tax preparation software [Turbo Tax, Tax Act, others] reduces time and effort in filing. Significant time saving after learning curve Tax Rates -​ The federal income tax is referred to as a progressive tax rate, as income increases, the tax rate also increases. -​ However, since the higher income taxpayer spends less of their income on items subject to the sales tax, the sales tax paid as a percent of income actually decreases as the income increases. Thus, the sales tax is referred to as a regressive tax rate. -​ For planning purposes, tax rates are identified as -​ Average tax rate = Total tax / taxable income -​ Marginal tax rate = the tax on the last or next dollar of taxable income (the rate from the tax bracket that applies to the taxpayer) -​ The average tax rate is used for long range planning; the marginal tax rate, for short-term planning. Income Taxes - Progressive Tax Structure -​ Progressive tax structure: Larger the amount of taxable income higher the rate at which it is taxed. Gross income: any and all income subject to federal taxes that includes: -​ Wages and Salaries -​ Bonuses, commissions and tips -​ Interest and dividends received -​ Alimony received -​ Business and farm income -​ Gains from the sales of assets -​ Income from Pensions and Annuities -​ Income from rents and partnerships -​ Prizes, lottery and gambling winnings Estimated taxes: Payments required on income not subject to withholding that are paid in four instalments -​ Self employed, business owner, etc. -​ Additional income from cash payment jobs -​ Usual filing deadline is April 15th Tax Audit -​ IRS has responsibility to enforce tax laws -​ Returns are selected for audit both because of high probability of error and on a random basis to judge level of compliance If your return is selected for audit, -​ Keep Calm -​ Gather records -​ If you made an error, learn from it Tax Preparers -​ Commercial tax return preparers (H&R Block, Jackson Hewitt, Liberty Tax, etc.) -​ Certified Professional Accountants (CPAs) -​ Lawyers who specializes in tax - Tax Attorney -​ Enrolled Agents -​ Many "Software Programs" available -​ “All taxpayers can do their own tax return as well as change the oil in their cars. But many prefer to pay someone to do both." All professional preparers must register with IRS -​ Professional Preparers offer experience and knowledge Effective Tax Planning -​ Tax evasion: Illegal act of failing to accurately report income or deductions and failing to pay taxes -​ Tax avoidance: Act of reducing taxes in ways that are legal and compatible with the intent of Congress Objectives of tax planning -​ To reduce taxes -​ To shift taxes -​ To defer taxes Financial Institutions: -​ Banks (Commercial, Investment, etc.)  -​ Credit Unions -​ Savings and Loan (S&L) -​ Brokerage Company (Broker or dealer in securities) -​ Money services business -​ check cashing service -​ Where you exchange currency, buy money orders, transfer money, -​ Insurance Companies How do you make money from financial institutions? -​ Interest rate = Rate of Return Financial Facts or Fantasies? -​ FANTASY An asset is considered liquid only if it is held in the form of cash. -​ FACT Today's financial marketplace offers consumers a full range of financial products and services, many times all under one roof. -​ FACT Unlike money market mutual funds, money market deposit accounts are federally insured. -​ FACT At most banks and other depository institutions, you will be hit with a hefty service charge if your checking account balance falls even just $1 below the stipulated minimum amount for just one day out of the month. -​ FANTASY U.S. Series EE and I savings bonds are not a very good way to save Define Interest Rate: -​ The cost one pays to borrow money. Chapter 4: "The convenience of debit cards may be the biggest drawback; they make it EASIER to overspend." Interest -​ Discount securities: security is sold at a discounted price, i.e. less than redemption value. When redeemed, the difference is interest. Example is Treasury Bills or US Saving Bonds. -​ Direct Interest: Interest is added to account or paid directly.  -​ Compound interest: When interest earned in each subsequent period is determined by applying the nominal (stated) rate of interest to the sum of the initial deposit and the interest earned in each prior period. -​ Simple interest: Interest that is paid only on the initial amount of the deposit. Chapter 5: Financial Facts or Fantasies? -​ FACT For most people, an automobile will be their second largest purchase. -​ FANTASY The most popular form of single-family housing is the condominium -​ FANTASY The closing costs on a home are rather insignificant and seldom -​ amount to more than a few hundred dollars. -​ FACT The amount of money you earn has a lot to do with the amount of -​ money you can borrow. -​ FANTASY Mortgage insurance guarantees the lender that the loan will be paid off in the event of the borrower's death. -​ FACT In an adjustable-rate mortgage, payment will change periodically, along with prevailing interest rates. Fixed Cost vs. Variable Cost -​ Operation Expense are the out-of-pocket cost of operating an automobile includes not only car payments but also insurance, licenses (tags), fuel, oil, tires and other operation and maintenances outlays. Fixed Operation Expenses: -​ These expenses will virtually stay the same amount regardless how much or often you drive the vehicle. Example of FIXED Expenses: -​ Loan or Lease Payments -​ Insurance Premiums Variable Operation Expenses: -These expenses will change based on how often you drive the vehicle. Example of VARIABLE Expenses: -​ Fuel -​ Routine and not so routine maintenance Purchasing the Car -​ Drive the car and complete your evaluation of the car before you talk price -​ Sticker Price is the suggested retail price -​ Know the dealer's cost by searching Edmunds and Kelley Blue Book Decide your price -​ Mark-up 3-4 percent for car less than $20,000; -​ 6-7 percent for higher price cars Buying Services are available. They could do the following: -​ Have arrangement to sell cars at a predetermined price, -​ provide you with bids from several local dealers, or -​ place an order with the factory Housing: Rent or Buy? Types of Housing: -​ Single Family -​ Condominiums -​ Cooperative apartments -​ Rental Units Rent Ratio: The ratio of the average house price to the average annual rent, which provides insight into the relative attractiveness of buying a house versus renting in a given area of potential interest. -​ FACT: Based on data from 2015, buying was on average 23% cheaper than renting Cost of Homeownership (Seven types of cost to consider:) 1. Down Payment 2. Mortgage Points are fees charged by lenders at the time that they grant a mortgage loan. Can reduce interest. 3. Closing cost 4. Mortgage payments 5. Property taxes 6. Homeowner's Insurance 7. Maintenance and Operating Expenses Let's talk MONEY (payment impacting) -​ Loan-to-value ratio, if 80% then down payment 20% -​ May use funds from IRA for part of down payment on first home  -​ If the down payment is less than 20%, the buyer may be required to obtain private mortgage insurance (PMI) which protects the lender if borrower defaults on the loan. PMI ends when mortgage is paid down to 78 percent of the home's original value. Home-Buying Process -​ Research the market, may use agent to gather information -​ Conventional wisdom, using an agent does not add to the cost of purchasing a home. The seller bears that cost. -​ Agents using a Multiple Listing Service (MLS) have access to the entire market -​ Buyer could contract with an agent to represent their interest -​ Prequalifying for a mortgage speeds the process -​ All real estate transactions must have a written contract. Any negotiated agreement must be in the contract or it is not enforceable. -​ Title check will disclose any liens or deed covenants Fixed-Rate Mortgages: most common is 30-years, but 15-year loan becoming more popular. Normally there is no penalty for early payment of loan, thus you can pay off a 30-year mortgage in 15 years if you wish. Adjustable-Rate Mortgages: rate is fixed for a period (say six months or five years) after which the rate may be changed for another term. Rate will be adjusted based upon an index rate -​ Rates have a maximum stated as a margin between initial rate and maximum rate -​ Payment may also have a cap that limits how much the payment may be increased -​