Personal Finance Chapter 1 PDF

Chapter 1: Personal Financial Planning: An Introduction Ted Stephenson, MBA, CFA, CFP Professor @ George Brown College  2024 McGraw Hill Limited Chapter 1: Learning Outcomes Learning Objectives: LO1 Analyze the process for making personal financial decisions. LO2 Develop personal financi...

Chapter 1: Personal Financial Planning: An Introduction Ted Stephenson, MBA, CFA, CFP Professor @ George Brown College  2024 McGraw Hill Limited Chapter 1: Learning Outcomes Learning Objectives: LO1 Analyze the process for making personal financial decisions. LO2 Develop personal financial goals. LO3 Assess economic factors that influence personal financial planning. LO4 Determine personal and financial opportunity costs associated with personal financial decisions. LO5 Identify strategies for achieving personal 2 financial goals for different life situations.  2024 McGraw Hill Limited The Financial Planning Process (1)  Personal financial planning is the process of managing your money to achieve personal economic satisfaction.  Advantages of personal financial planning:  Increased effectiveness in obtaining, using, and protecting your financial resources  Increased control of your financial affairs  Improved personal relationships  A sense of freedom from financial worries 3  2024 McGraw Hill Limited The Financial Planning Process (3)  Personal finance activities involve three main decision areas:  Spending is a major challenge in financial planning 4  2024 McGraw Hill Limited The Financial Planning Process: Summary (5) 5  2024 McGraw Hill Limited The Financial Planning Process (6)  Evaluate your Economic or Product Risks:  Interest Rate Risk  Inflation Risk  Liquidity Risk  Product Risk 6  2024 McGraw Hill Limited The Financial Planning Process (7)  Evaluate your Personal Risks:  Risk of Death  Risk of Income Loss  Health Risk  Asset and Liability Risk 7  2024 McGraw Hill Limited Developing Personal Financial Goals (1)  Financial goals are influenced by:  Personal values and attitudes towards money  Time frame  Short-term, intermediate, and long-term goal  Type of financial need that drives your goals  Your life situation  Goals for different financial needs  Consumable products goals  Durable product goals 8  2024 McGraw Hill Limited Developing Personal Financial Goals (4) 9  2024 McGraw Hill Limited Developing Personal Financial Goals (5)  Average person goes through four basic stages in personal financial management  Life cycle approach to financial planning 1. Early years (until the mid-30s) 2. Middle years (mid-30s to mid-50s) 3. Middle Years (50s+) 4. Retirement Years 10  2024 McGraw Hill Limited Developing Personal Financial Goals (6) Life Situation and Specialized Financial Activities 1. Young, single (18–35)  Establish financial independence  Obtain disability insurance to replace income during prolonged illness  Consider home purchase 11  2024 McGraw Hill Limited Developing Personal Financial Goals (7) Life Situation and Specialized Financial Activities 2. Young couple with children under 18  Carefully manage the increased need for the use of credit  Obtain an appropriate amount of life insurance for the care of dependants  Use a will to name a guardian for children 12  2024 McGraw Hill Limited Developing Personal Financial Goals (8) Life Situation and Specialized Financial Activities 3. Single parent with children under 18  Obtain adequate amounts of health, life, and disability insurances  Contribute to savings and investment funds for children’s higher education  Name a guardian for children and make other estate plans 13  2024 McGraw Hill Limited Developing Personal Financial Goals (9) Life Situation and Specialized Financial Activities 4. Young dual-income couple, no children  Coordinate insurance coverage and other benefits  Develop savings and investment programs for changes in life situation (larger house, children)  Consider tax-deferred contributions to retirement fund 14  2024 McGraw Hill Limited Developing Personal Financial Goals (10) Life Situation and Specialized Financial Activities 5. Older couple (+50), no dependent children at home  Consolidate financial assets and review estate plans  Obtain health insurance for post-retirement period  Plan retirement housing, living expenses, recreational activities, and part-time work 15  2024 McGraw Hill Limited Developing Personal Financial Goals (11) Life Situation and Specialized Financial Activities 6. Mixed-generation household (elderly individuals and children under 18)  Obtain long-term health care insurance and life/disability income for care of younger dependants Use dependant care service, if needed  Provide arrangements for handling finances of elderly if they become ill  Consider splitting investment cost, with elderly getting income while alive and principal going to surviving relatives 16  2024 McGraw Hill Limited Developing Personal Financial Goals (12) Life Situation and Specialized Financial Activities 7. Older (+50), single  Make arrangements for long-term health- care coverage  Review will and estate plan  Plan retirement living facilities, living expenses, and activities 17  2024 McGraw Hill Limited Developing Personal Financial Goals (13) Goal-Setting Guidelines SMART Goals  Specific  Measurable  Action Oriented  Realistic  Timely 18  2024 McGraw Hill Limited Developing Personal Financial Goals (14) Financial Planning Activity & Professional Practice Inquiry 1. What are examples of long-term goals? 2. What are the four main characteristics of useful financial goals? 19 3. How does your life situation affect your financial  2024 McGraw Hill Limited  The Influence of Economic Factors on Personal Financial Planning (1)  Economics is the study of how wealth is created and distributed.  Market Forces  Supply and demand  Financial institutions  Influence of the Bank of Canada  Global Influences  Level of exports, foreign investors, competition.  Economic conditions.... 20  2024 McGraw Hill Limited The Influence of Economic Factors on Personal Financial Planning (2)  Consumer Prices  Measures changes in inflation (a rise in the general level of prices)  Bank of Canada Key Inflation Indicators  Consumer Spending  Measures the demand for goods and services by individuals and households influences employment opportunities 21  2024 McGraw Hill Limited The Influence of Economic Factors on Personal Financial Planning (3)  Interest Rates  Measures and represents the cost of money  The cost of credit when you borrow  The return on your money when you save or invest  Bank of Canada Policy Interest Rate 22  2024 McGraw Hill Limited The Influence of Economic Factors on Personal Financial Planning (4)  Money Supply  Measures the dollars available for spending in our economy  Unemployment Rate  Measures the number of people without employment who are willing and able to work  Housing Starts  Measures the number of new homes being built  Gross Domestic Product (GDP)  Measures the value of goods and services produced within a country’s borders including items produced with foreign resources 23  2024 McGraw Hill Limited The Influence of Economic Factors on Personal Financial Planning (5)  Trade Balance  Measures the difference between a country’s exports and its imports  S&P/TSX composite index and other stock market indexes  Measures the relative value of stocks represented by the index 24  2024 McGraw Hill Limited The Influence of Economic Factors on Personal Financial Planning (6) Did you know? To find out how fast prices double, use the rule of 72. Just divide 72 by the annual inflation rate (or interest rate). For example, an annual inflation rate of 8  percent means prices will double in nine years:  72 / 8 = 9  P/Y = 1, I/Y = 8, PV = -100, PMT = 0, FV = 200, CPT N = 9.00647 Years  P/Y = 1, I/Y = 2, PV = -100, PMT = 0, FV = 200, CPT N = 35.00279 Years 25  2024 McGraw Hill Limited  The Influence of Economic Factors on Personal Financial Planning (7) Professional Practice Inquiry 1. How might the uncertainty of inflation make personal financial planning difficult? 2. What factors influence the level of interest rates? 26  2024 McGraw Hill Limited Opportunity Costs and the Time Value of Money (1) Key Terms: Opportunity Cost: What a person gives up by making a choice. Personal Opportunity Costs   Time, when used for one activity cannot be used for another  Health, poor eating habits, lack of sleep, exercise can result in time away from work or school, increased health costs, and reduced financial security 27  2024 McGraw Hill Limited Opportunity Costs and the Time Value of Money (2)  Financial Opportunity Costs  Consider the time value of money; the increases in an amount of money because of interest earned  When you spend, save, invest or borrow you should consider the time value of that money as an opportunity cost 28  2024 McGraw Hill Limited Opportunity Costs and the Time Value of Money (3) 29  2024 McGraw Hill Limited Opportunity Costs and the Time Value of Money (4)  Financial Opportunity Costs  Setting aside funds in a savings plan with little or no risk has the opportunity cost of potentially higher returns from an investment with greater risk 30  2024 McGraw Hill Limited Opportunity Costs and the Time Value of Money (5) Interest Calculations Three amounts are used to calculate the time value of money for savings in the form of interest earned: 1.The amount of the savings (P). 2.The annual interest rate (R). 3.The length of time the money is on deposit (T) 31  2024 McGraw Hill Limited Opportunity Costs and the Time Value of Money (6) Interest Calculations There are two methods of calculating interest: 1.Simple interest and 2.Compound interest. Simple interest is calculated as follows: I=PxRxT 32  2024 McGraw Hill Limited Opportunity Costs and the Time Value of Money (7)  Simple Interest: interest compounded on the principal, excluding previously earned interest (P) (r) (T) (I) Amount × Annual × Time = Intere in Savings Interest Rate Period  For example, $500 on deposit at a 2 percent annual  $500 × 2% × 2 (2 years) $500 ×.02 × 2 = $20.00 In two years, you have $520. 33  2024 McGraw Hill Limited Opportunity Costs and the Time Value of Money (8)  Compound Interest: Interest that is earned on previously earned interest  Each time interest is added to the principal, the next interest is computed 1ston the$500 year: new× balance 2% × 1(year) = $510.00 2nd year: ($500 + $10) × 2% × 1(year) = $520.20 3rd year: ($500 + $20.20) × 2% × 1(year) =$530.60 34  2024 McGraw Hill Limited Opportunity Costs and the Time Value of Money (9) Future Value of a Single Amount Deposited money earns interest that increases over time. Key Terms: Future value is the amount to which current savings will increase based on a certain interest rate and a certain time period. Future value computations typically involve compounding. Compounding allows the future value of a deposit to  grow faster 35  2024 McGraw Hill Limited Opportunity Costs and the Time Value of Money (10) Future Value of a Series of Deposits Key Terms:  Annuity – An annuity is a series of equal amounts (deposits or withdrawals) made at regular time intervals. 36  2024 McGraw Hill Limited Opportunity Costs and the Time Value of Money (11) Present Value of a Single Amount Key features of present value of a single amount and a series of deposits include the following:  The current value of a future amount based on a certain interest rate and a certain time period.  Present value calculations are also called discounting.  Allows you to determine how much to deposit now to obtain desired future amount.  Can be computed for a single amount or a series of deposits (Annuities). 37  2024 McGraw Hill Limited  Opportunity Costs and the Time Value of Money (12) EXAMPLE 1 Miguel has two children who will start post-secondary education in 10 years. He plans to set aside $1,500 a year for his children’s education during that period and estimates he will earn an annual interest rate of 5 percent on his savings. What amount can Miguel expect to have available for his children’s post-secondary education when they are ready to enroll? 38  2024 McGraw Hill Limited Opportunity Costs and the Time Value of Money (13) EXAMPLE 1 Miguel has two children who will start post-secondary education in 10 years. He plans to set aside $1,500 a year for his children’s education during that period and estimates he will earn an annual interest rate of 5 percent on his savings. What amount can Miguel expect to have available for his children’s post-secondary education when they are ready to enroll? 39  2024 McGraw Hill Limited Achieving Financial Goals (2) 40  2024 McGraw Hill Limited Achieving Financial Goals (3)  A financial plan is formalized report that:  Summarizes your current financial situation.  Analyzes your financial needs.  Recommends future financial activities.  Your financial plan can be created by you, done with assistance from a financial planner, or made using a money management software package. 41  2024 McGraw Hill Limited Achieving Financial Goals (4)  Develop good financial habits.  Use a spending plan.  Have appropriate insurance  Become informed about tax and investment alternatives.  Achieving your financial objectives requires:  A willingness to learn.  Appropriate information sources. 42  2024 McGraw Hill Limited Achieving Financial Goals (5) 43  2024 McGraw Hill Limited Achieving Financial Goals (6)  IMPLEMENTING YOUR FINANCIAL PLAN The most important strategy for success is the development of financial habits that contribute to both short-term satisfaction and long-term financial security: 1. Using a well-conceived spending plan 2. Having appropriate insurance 3. Becoming informed about tax and investment alternatives 44  2024 McGraw Hill Limited Summary (1)  LO1: Analyze the process for making personal financial decisions  Determine current financial situation  Develop financial goals  Identify alternative courses of action  Evaluate alternatives  Create and implement a financial plan  Re-evaluate and revise the financial plan 45  2024 McGraw Hill Limited Summary (2)  LO2: Develop personal financial goals  Goals should be SMART  Affected by person’s values, attitudes towards money and life situation 46  2024 McGraw Hill Limited Summary (3)  LO3: Assess economic factors that influence personal financial planning  Consumer prices  Interest rates  Employment opportunities 47  2024 McGraw Hill Limited Summary (4)  LO4: Determine personal and financial opportunity costs associated with personal financial decisions.  Every decision involves a trade off  Personal opportunity costs include time, effort and health  Financial opportunity costs based on time value of money  Future and present value calculations enable you to measure increased value (or lost interest) from saving, investing, borrowing or purchasing decisions 48  2024 McGraw Hill Limited Summary (5)  LO5: Identify strategies for achieving personal financial goals for different life situations  Requires specific goals combined with spending, saving, investing and borrowing strategies  Based on your personal life situation and various social and economic factors 49  2024 McGraw Hill Limited  Appendix 1A Financial Planners and Other Financial Planning Information Sources Financial Planners and Other Financial Planning Information Sources  Current Periodicals  Financial Institutions  Courses & Seminars  Personal Finance Software  Spreadsheets  Money Management & Financial Planning Programs  Tax Software  Investment Analysis Programs  The Internet 50  2024 McGraw Hill Limited Appendix 1B The Time Value of Money: Future Value and Present Value Computations  Financial Calculators  Future Value of a Single Amount  Future Value of a Series of Equal Amounts (an Annuity)  Present Value of a Single Amount  Present Value of a Series of Equal Amounts (an Annuity)  Using Present Value to Determine Loan Payments  Calculating the Effective Annual Rate (EAR) Using a Financial Calculator (Texas Instruments BA II Plus) 51  2024 McGraw Hill Limited