Unit 2: Money Management

1. Unit 2: Money Management 1. Explain how limited personal financial resources affect the choices people make. 2. Interpret the opportunity costs of financial decisions. 3. Evaluate the consequences of personal financial decisions. 4. Apply a decision-making process to personal financial choices. 5. Summarize how inflation affects spending and saving decisions. 6. Evaluate how insurance (e.g., auto, home, life, medical and long-term health) and other risk-management strategies protect against financial loss. 7. Design a financial plan (budget) for earning, spending, saving, and investing. 8. Demonstrate how to use the services available from financial institutions. 9. Analyze the role of the Federal Reserve in controlling the money supply.

2. Personal Financial Planning

3. Financial Decisions & Goals • Personal Financial Planning: arranging to spend, save, and invest money to live comfortably, have financial security, and achieve goals

4. Benefits to Financial Planning • More money and financial security • Knowing how to use money to achieve goals • Less chance of going into debt you cannot handle

5. Steps in Financial Planning • Step 1: Determine your current financial situation • Savings • Monthly income • Monthly expenses • Debts

6. Steps in Financial Planning • Step 2: Develop your financial goals • What is your attitude toward money? • What are your personal values? • Values: the beliefs and principles you consider important, correct, and desirable • Needs vs. Wants • Need: something you must have to survive, such as food, shelter, and clothing • Want: something you desire or would like to have or do

7. Steps in Financial Planning • Step 3: Identify your options • Expand the current situation • Change the current situation • Start something new • Continue the same course of action

8. Steps in Financial Planning • Step 4: Evaluate your alternatives • Find different sources of financial information • Figure out the consequences of your choices • Opportunity Cost: trade-off, what you give up when making one choice instead of another • Understand your risks

9. Financial Risks • Inflation Risk-uncertainty over the real future value of your money • Interest Rate Risk- risk an investments value will change due to a change in interest rate • Income Risk- risk of change in income (cash inflow) • Personal Risk- loss of income, increase in expenses, or elimination of assets due primarily to death, poor health, old age or unemployment • Liquidity Risk • Liquidity: the ability to easily convert financial assets into cash without loss in value

10. Steps in Financial Planning • Step 5: Create and use your financial plan of action • Utilize the options you have for reaching your financial goals

11. Steps in Financial Planning • Step 6: Review and revise your plan • Your needs and finances will change as time goes on, so your financial plan will need to change as well

12. Types of Financial Goals • Time Frame of Goals • Short-term goals: take one year or less to achieve • Intermediate goals: takes one to five years to achieve • Long-term goals: take more than five years to achieve

13. Types of Financial Goals • Goals for Different Needs • Good: physical item that is produced and can be weighed or measured • Consumable good- used up or depleted, replaced often • Durable good- long lasting, replaced infrequently • Intangible items- can’t be touched, but can be measured • Service: task that a person or machine performs for you

14. Guidelines for Setting Goals • Goals should be SMART • Specific • Measurable • Attainable • Results-based • Time-bound

15. Setting SMART Financial Goals • What is missing? • Goal: Save money this summer to pay for all college fees. • Goal: Get a job to afford to buy a motorcycle. • Goal: Use money received as birthday gifts to pay own monthly phone fees. • Goal: Go on white water rafting trip.

16. Influences on Financial Planning • Life situations • Going to college, getting married, starting a new career, having children, moving to a new city

17. Influences on Financial Planning • Economic Factors: • Play a role in the day-to-day financial planning and decision making for most people • Economics: the study of the decisions that go into making, distributing, and using goods and services • Economy: consists of the ways in which people make, distribute, and use their goods and services

18. Influences on Financial Planning • Economic Factors: Market Forces • Supply: the amount of goods and services available for sale • Demand: the amount of goods and services people are willing to buy • High demand or low supply will cause the price of products to rise • Low demand or high supply will cause the price of products to drop

19. Influences on Financial Planning • Economic Factors: Financial Institutions • Provide services that increase financial activity in the economy • Banks • Credit unions • Insurance companies • Investment companies • Federal Reserve System: Fed, central banking organization of the US that regulates the money supply

20. Influences on Financial Planning • Economic Factors: Global Influences • We are part of a global market • Economy of every nation is affected by competition with other nations

21. Influences on Financial Planning • Economic Factors: Economic Conditions • Consumer prices • Inflation: the rise in the level of prices for goods and services, mainly caused by an increase in demand without an increase in supply • Consumer spending • Consumer: person who purchases and uses goods or services • Interest rates • Interest: the price that is paid for the use of another’s money

22. Opportunity Costs & Strategies • Personal opportunity costs • Must make choices about how to manage your personal resources • Health, knowledge, skills, and time • Financial opportunity costs • Must make choices about how you spend money • Time value of money: the increase of an amount of money due to earned interest or dividends

23. Time Value of Money: Terminology • Future value: the amount your original deposit will be worth in the future based on earning a specific interest rate over a specific period of time • Annuity: series of equal regular deposits; like depositing $50 each month into your savings

24. Time Value of Money: Terminology • Present Value: amount of money you would need to deposit NOW in order to have a desired amount of money in the future • Annual Interest Rate: Interest rate you are earning on your deposited funds

25. Calculating Simple Interest • Need to know: • Principal: original amount of money on deposit • Annual Interest Rate • Length of Time • Principal x Rate x Time = Interest Earned

26. Strategies for Achieving Your Financial Goals • Obtain financial resources • Plan • Spend wisely • Save • Borrow wisely • Invest • Manage risk • Plan for retirement

27. Money Management Strategy

28. Organizing Financial Records Opportunity Costs and Money Management Money Management: planning how to get the most from your money In order to manage your money well, you may have to consider financial trade-offs (or opportunity costs) Consider the factors that influence your decisions before you chose an option

29. Organizing Financial Records Personal Financial Documents: a variety of materials, such as bank statements and paycheck stubs May also include receipts, ownership titles, birth certificates, and tax forms Tell you how much money you have and/or spend

30. Organizing Financial Documents • First step in effective money management is organizing your information • Bank statements, paycheck stubs, receipts, car title, tax forms • Benefits of organizing financial documents: • Quickly find needed documents • Plan and measure financial progress • Handle routine money matters (ex. paying bills on time)

31. Storing Financial Documents • Home File • Simple, takes limited space • Bank account statements, receipts, employment information, tax records, insurance records, investment records • Safe-Deposit Boxes • Small, secure storage box rented at a bank • Car title, birth certificates, stock certificates, valuable documents not easily replaced • Home Computer • Budgets, check summary, personal financial statements

32. Personal Financial Statements Personal Financial Statements: document that provides information about an individual’s current financial position and presents a summary of income and spending Helps determine what you own and owe Measures your progress towards goals Track financial activities Organize financial information

33. Personal Financial Statements Personal Balance Sheet: (net worth statement) a financial statement that lists items of value owned, debts owed, and a person’s net worth Net Worth: the difference between the amount you own and the debts you owe; measure of your current financial position

34. Personal Financial Statements To create a BALANCE SHEET: Step 1: Determine Your Assets Assets: any items of value that an individual or company owns, including cash, property, personal possessions, and investments Wealth: the abundance of valuable material possessions or resources Asset Categories: liquid assets, real estate, personal possessions, and investments

35. Personal Financial Statements Asset Categories: Liquid Assets: cash and items that can be quickly converted to cash Real Estate: land and any structures that are on it, such as a house or any other building that a person or family owns Valued at the Market Value: the price at which it would sell Personal Possessions: cars and any other valuable belongings that are not real estate Should be listed at current market value Investment Assets: include retirement accounts and securities such as stocks and bonds

36. Personal Financial Statements To create a BALANCE SHEET: Step 2: Determine Your Liabilities Liabilities: debts that you owe Current Liabilities: short-term debts that have to be paid within one year (medical bills, cash loans, taxes) Long-Term Liabilities: debts that do not have to be fully repaid for at least one year (car loans, student loans, and mortgage loans)

37. Personal Financial Statements To create a BALANCE SHEET: Step 3: Calculate Your Net Worth Subtract your Liabilities from your Assets NET WORTH = ASSETS – LIABILITIES Insolvency: a financial state that occurs if liabilities are greater than assets; unable to pay all of your debts

38. Personal Financial Statements To create a BALANCE SHEET: Step 4: Evaluate Your Financial Statements Is your net worth increasing? Is it decreasing? Are you holding steady? Maybe you need to re-evaluate and update your budget!

39. Personal Financial Statements Cash Flow Statement: Income vs. Expenses; summary of your cash flow during a particular period (usually a month or a year) Cash Flow: money that actually goes into and out of your wallet Cash Inflow: money you receive (INCOME) Cash Outflow: money you spend (EXPENSES)

40. Personal Financial Statements To create a CASH FLOW STATEMENT: Step 1: Record your income (cash inflow) List all sources of income during the month at the exact amount Gross pay- total amount of money you have earned prior to anything being taken out Take-home pay- (net pay) the amount of income left after taxes and other deductions are taken out of your gross pay Discretionary income- the money left over after paying for the essentials

41. Personal Financial Statements To create a CASH FLOW STATEMENT: Step 2: Record your expenses (cash outflow) Fixed expenses- more or less the same each month Variable expenses- may change from month to month

42. Personal Financial Statements • To create a CASH FLOW STATEMENT • Step 3: Determine your net cash flow • Net Cash Flow = Income – Expenses • Surplus- extra money that can be spent or saved • Deficit- more money is spent than received • Every time your cash flow changes, so does your net worth (balance sheet)

43. Personal Financial Statements • Evaluating your financial progress • Debt Ratio = Liabilities / Net Worth • Compares how much you owe to your total financial position; should be low • Liquidity Ratio = Liquid Assets / Monthly Exp. • Number of months you would be able to pay your living expenses in case of emergency

44. Personal Financial Statements • Evaluating your financial progress • Debt-Payment Ratio = Monthly Credit Payment / Take-home Pay • How much you make that goes to pay debts; should be less than 20% each month • Savings Ratio = Amount Saved / Gross Income • Should be no less than 10% each month • Home Payment Ratio = House Payment/Gross Income • Should be less than 28%-30%

45. Budgeting for Financial Goals Budget- a plan for using money to meet wants and needs Using a budget, you learn to live within your income and avoid costly debt

46. Budgeting for Financial Goals • Budgeting Step 1: Set your financial goals • What do you want to accomplish with your money?

47. Budgeting for Financial Goals • Budgeting Step 2: Estimate your income • Include all income you know you may receive for the next month • If you are unsure about a source of income or the amount, do not include it

48. Budgeting for Financial Goals • Budgeting Step 3: Budget for Fixed Expenses • List all monthly expenses that do not change from month to month • Mortgage, automobile payments, student loan payments, insurance premiums • PAY YOURSELF FIRST! (i.e. emergency fund or retirement)

49. Budgeting for Financial Goals • Budgeting Step 4: Budget for Variable Expenses • List all monthly expenses that change from month to month • Utilities based on usage, food, clothing • Make your best guess as to the cost for the month • Look at previous month or ask friends and family • Consumer Price Index- measure of changes for commonly purchased goods and services • If guessing, guess high!

50. Budgeting for Financial Goals • Budgeting Step 5: Budget for Unexpected Expenses • Put aside a little money each month to pay for unexpected items • Set up an “Emergency Fund” • 3 to 6 months of living expenses • This should be a fixed expense!!!