Chapter 1 Personal Financial Planning: An Introduction

Chapter 1

Personal Financial

Planning: An Introduction

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Kapoor Dlabay Hughes Ahmad

Prepared by Cyndi Hornby, Fanshawe College 2009 McGraw-Hill Ryerson Ltd.

Learning Objectives – Chapter 1

1. Analyze the process for making personal financial decisions.

2. Develop personal financial goals.3. Assess economic factors that influence

personal financial planning.4. Calculate the time value of money.5. Identify strategies for achieving personal

financial goals for different life situations

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Learning Objective # 1

Analyze the process for making personal financial decisions.

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Financial Planning and Its Benefits

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.

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The Financial Planning Process

Step 1: Determine your current financial situation. Prepare a list of current asset and debt balances

and amounts spent for various items Step 2: Develop financial goals.

Analyze your financial values and attitudes towards money.

What is your financial decision making process? Step 3: Identify alternative courses of action.

Continue as you are, expand or change the current situation, or take a new course of action.

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Step 4: Evaluate alternatives. Take into consideration your life situation,

personal values and current economic situation.

Opportunity cost is what you give up by making a choice.

The cost, referred to as the trade-off of a decision, can be measured in money or time

Consider lost opportunities that will result from your decisions.

Evaluate the risks faced

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Evaluate your Economic or Product Risks Interest Rate Risk

Changing interest rates affect your costs when you borrow and your benefits when you invest

Inflation Risk Rising prices cause lost buying power

Liquidity risk Some investments may be more difficult to

convert to cash or sell without significant loss in value

Product Risk Products or services flawed or not meet

your expectations Retailers may not honour their obligations

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Evaluate your Personal Risks

Risk of Death Premature death can cause financial hardship

to family members left behind Risk of Income Lost

Your income could stop as a result of job loss or because you fall ill or are hurt in an accident

Health Risk Poor health may increase your medical costs,

may reduce your working capacity or life expectancy

Asset and Liability Risk Assets may be stolen or damaged Others may sue you for negligence or for

damages caused by your accidents

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Step 5: Create and implement a financial action plan. Choose ways to achieve your goals May require assistance from others

Step 6: Reevaluate and revise your plan. Your plan should be reviewed regularly based

on your life circumstances

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Financial Planning Information Sources

Printed materials. Financial institutions. School courses and educational seminars. Computer software, World Wide Web, and on-line information sources. Financial specialists.

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Develop personal financial goals.

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Developing Personal Financial Goals

Financial goals are influenced by; Personal values and attitudes

towards money Time frame in which you want to

achieve your goals. Type of financial need that drives

your goals. Your life situation

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Factors that influence your financial goals:

Timing of goals. Short-term, intermediate and long-term

goals. Goals for different financial needs.

Consumable products goals Food, clothing

Durable product goals Appliances, cars, sporting equipment

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Developing Personal Financial Goals – Your Life Situation Life Situation takes into consideration

personal factors Age, income, marital status, household size,

personal beliefs and employment situation Influences your spending and savings

patterns Social Changes

Married at later age More households with two incomes Single parents Living longer

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Developing Personal Financial Goals – Your Life Situation Average person goes through four basic

stages in personal financial management Referred to as the life cycle approach to

financial planning1. Early years (until the mid-30’s)

Focus on creating an emergency fund, saving for down payment on house or condo, purchasing life insurance, start thinking about retirement

2. Middle years (mid-30’s to mid-50’s) Focus on building wealth by paying down

mortgage and increasing savings and investments

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Developing Personal Financial Goals – Your Life Situation3. Middle Years (50’s+)

Focus is on providing an adequate retirement fund

4. Retirement Years Focus is on the efficient management of

previously acquired wealth

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Developing Personal Financial Goals – Your Life Situation Other events that influence your life

situation include; Graduation Engagement and marriage Birth or adoption of a child Career change or move to a new area Dependant children leaving home Changes in health Divorce Retirement Death of spouse or other family member

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Developing Personal Financial Goals – Your Life Situation Common financial goals and activities include;

Obtain appropriate career training Create an effective financial record keeping system Develop a regular savings and investment program Accumulate an appropriate emergency fund Purchase appropriate types and amounts of insurance

coverage Create and implement a flexible budget Evaluate and select appropriate investments Establish and implement a plan for retirement goals Make a will and develop an estate plan

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Financial goals should... Be realistic Be stated in specific, measurable terms

Have a time frame Indicate the type of action to be taken.

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Assess economic factors that influence personal financial planning.

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Influences on Personal Financial Planning

Market Forces. Supply and demand. Production costs and competition.

Financial institutions. Influence of the Bank of Canada

Global Influences. Level of exports, foreign investors,

competition. Economic conditions....

Economics: The study of how wealth is created and distributed

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Changing Economic Conditions

Consumer PricesThe value of the dollarChanges in inflation (a rise in the general level of prices)Mainly caused by increase in demand without increase in supplyHarmful to people on fixed incomesCan adversely affect people who lend money

Consumer SpendingThe demand for goods and services by individuals and households influences employment opportunitiesReduced spending causes unemployment

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Interest RatesRepresents the cost of moneyThe cost of credit when you borrow

Borrowing increases demand and interest rates rise

The return on your money when you save or invest

Saving and investing increase the supply of money and interest rates decrease

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Money SupplyDollars available for spending in our economy

Unemployment RateThe number of people without employment who are willing and able to work

Housing StartsThe number of new homes being built

Gross Domestic Product (GDP)The value of goods and services produced within a country’s borders including items produced with foreign resources

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Trade BalanceThe difference between a country’s exports and its imports

S&P / TSX composite index and other stock market indexes

The relative value of stocks represented by the index

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Calculate the time value of money.

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Financial Opportunity Costs

(discounting)Present

AmountNow

FutureValue(compounding)

ValueAmount

Later

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Time Value of Money• Is the increases in an amount of money as a result of interest earned•Every time you spend, save, invest or borrow money you should consider the time value of money as an opportunity cost

How Simple Interest is Computed

Simple Interest: interest compounded on the principal, excluding previously earned interest

$100 x 6% x 1 (1 year) 100 x .06 x 1 = $6.00

In one year you have $106.

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(P) (r) (T) (I)

Amount x Annual x Time = Interest

in Savings Interest Rate Period

How Compound Interest is Computed

Compound Interest: Interest that is earned on previously earned interest Each time interest is added to the

principal, the next interest is computed on the new balance

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1st year: $100 x 6% x 1(year) = $106.00

2nd year: ($100 + $6) x 6% x 1(year) = $112.36

3rd year: ($106 + $6.36) x 6% x 1(year) =$119.10

Future Value of Money

Is the amount to which current savings will increase based on certain interest rate and certain time period

Calculations involve compounding since interest is earned on previously earned interest

Can be computed for a single amount or a series of deposits Annuity - series of equal deposits or

payments Start investing now to take advantage of

the future value of money.

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Present Value of Money

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

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Identify strategies for achieving personal financial goals for different life situations.

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Components of Financial Planning

Obtaining (chapter 1) Planning (chapters 2,3) Saving (chapter 4) Borrowing (chapters 5,6) Spending (chapter 7) Managing Risk (chapters

8,9) Investing (chapters 10-13) Retirement and Estate

Planning (chapters 14,15)

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Developing a Flexible Financial Plan

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.

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Implementing Your Financial Plan

Develop good financial habits. Use a spending plan to stay within your

income, allowing you to save and invest for the future.

Have appropriate insurance protection to prevent financial disasters.

Become informed about tax and investment alternatives.

Achieving your financial objectives requires.. A willingness to learn. Appropriate information sources.

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Summary of Learning Objectives

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

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Develop personal financial goals Goals should be realistic Be stated in specific, measurable terms Have a time frame Indicate the type of action to be taken Affected by person’s values, attitudes

towards money and life situation

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Assess economic factors that influence personal financial planning

Consumer prices Interest rates Employment opportunities

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Calculate the time value of money.

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

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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

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Chapter 1A - Appendix

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

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Financial Planning Specialists Accountants Bankers Credit counselors Certified Financial Planners Insurance agents/brokers Investment Brokers Lawyers Real Estate Agents Tax Preparers

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Financial planners are categorized based on the method of compensation

1. Fee-only planners2. Fee-and-commission planners3. Commission-only planners

Do you need a financial planner? Your income Your willingness to make independent

decisions

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Chapter 1 Personal Financial Planning: An Introduction

Economy & Finance

Transcript of Chapter 1 Personal Financial Planning: An Introduction