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Chapter 1 Personal Finance Basics and the Time Value of Money 09/01/09

Chapter 1 Personal Finance Basics and the Time Value of Money 09/01/09. Why Important. Nobody can avoid dealing with personal finance People do claim bankruptcy. Chapter 1 Learning Objectives. Analyze the process for making personal financial decisions Develop personal financial goals

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Chapter 1 Personal Finance Basics and the Time Value of Money 09/01/09

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  1. Chapter 1 Personal Finance Basics and the Time Value of Money 09/01/09

  2. Why Important • Nobody can avoid dealing with personal finance • People do claim bankruptcy

  3. Chapter 1 Learning Objectives • Analyze the process for making personal financial decisions • Develop personal financial goals • Assess personal and economic factors that influence personal financial planning • Determine the personal and financial opportunity costs associated with personal financial decisions • Identify strategies for achieving personal financial goals for different life situations

  4. The Financial Planning Process Objective 1: Analyze the process for making personal financial decisions Personal Financial Planning is the process of managing your money to achieve personal economic satisfaction Advantages of Personal Financial Planning are: • Increased effectiveness in obtaining, using and protecting financial resources • Increase control of one’s financial affairs • Sense of freedom from financial worries

  5. The Financial Planning Process (continued) Six-step procedure for Financial Planning • Determine your current financial situation. • Develop your financial goals. • Identify alternative courses of action. • Evaluate your alternatives. • Create and implement your financial action plan. • Review and revise your plan.

  6. The Financial Planning Process (continued) Step 1: DETERMINE YOUR CURRENT FINANCIAL SITUATION • Determine current financial situation regarding income, savings, living expenses, and debts • Prepare a list of current asset and debt balances and amount spent for various items • Match financial goals to current income and potential earning power

  7. The Financial Planning Process (continued) Step 2: DEVELOP YOUR FINANCIAL GOALS • Identify feelings about money and the reasons for those feelings • Determine the source of your feelings about money • Determine the effects of economy on your goals and priorities • Make sure that your goals are your own and are specific to your situation

  8. The Financial Planning Process (continued) Step 3: IDENTIFY ALTERNATIVE COURSES OF ACTION • Possible courses of action can be: • Continue the same course of action • Expand the current situation • Change the current situation • Take a new course of action • Creativity in decision making is vital to effective choices

  9. The Financial Planning Process (continued) Step 4: EVALUATE YOUR ALTERNATIVES • CONSEQUENCES OF CHOICES • Opportunity cost - What you give up when you make a choice • The cost or trade-offof a decision cannot always be measured in dollars. Sometimes the cost is your time • EVALUATING RISK • Uncertainty is a part of every decision. • Best way to analyze and minimize risk is to gather information from financial planning sources. (Exhibit 1-3)

  10. The Financial Planning Process (continued) Step 5:CREATE AND IMPLEMENT YOUR FINANCIAL ACTION PLAN • Develop an action plan that identifies ways to achieve financial goals • Possible action plans can be increasing savings, reducing spending, or making provisions for taxes • To implement action plans you may need assistance from others

  11. The Financial Planning Process (continued) Step 6:REVIEW AND REVISE YOUR PLAN • Financial planning decisions need to be assessed regularly • Complete review should be done at least once a year • Regular reviews of decision-making process can help in making priority adjustments to achieve financial goals

  12. Developing Personal Financial Goals Objective 2: Develop personal financial goals • TYPES OF FINANCIAL GOALS can be: • Influenced by the time frame in which you want to achieve your goals • Influenced by the financial need that drives your goals • TIMING OF GOALS • Short-term, intermediate and long-term goals • Long term goals should be planned in coordination with short-term and intermediate goals • GOALS FOR DIFFERENT FINANCIAL NEEDS • Consumer product goals • Durable-produce goals • Intangible-purchase goals

  13. Developing Personal Financial Goals (continued) GOAL-SETTING GUIDELINES • Goals should be realistic • Goals should be stated in specific terms • Goals should have a time frame • Goals should indicate the action to be taken • Discuss some of your goals

  14. Developing Personal Financial Goals (continued)

  15. Influences on Personal Financial Planning Objective 3: Assess personal and economic factors that influence personal financial planning LIFE SITUATION AND PERSONAL VALUES • Adult life cycle stage • Marital status, household size, and employment • Major events • Graduation, marriage, career change, children, retirement, etc • Values • What values are important to you?

  16. Influences on Personal Financial Planning(continued) ECONOMIC FACTORS • Forces of Supply and Demand and prices • Federal Reserve Bank and it’s role in the economy

  17. Influences on Personal Financial Planning(continued) GLOBAL INFLUENCES • Global marketplace influences financial activities • Balance of exports and imports • Foreign investments and their role in the US Money Supply

  18. Influences on Personal Financial Planning(continued) ECONOMIC CONDITIONS ConsumerThe value of the dollarpriceschanges in inflation ConsumerThe demand for goods and spendingservices by individuals and households Interest ratesThe cost of money; cost of credit when you borrow; return on your money when you save or invest

  19. Opportunity Costs and the Time Value of Money • Object 4: Every financial decision involves giving up something to obtain something else PERSONAL OPPORTUNITY COSTS • Time • Other personal opportunity costs can be related to health, leisure etc. • Personal resources like financial resources require careful management

  20. Opportunity Costs and the Time Value of Money (continued) FINANCIAL OPPORTUNITY COSTS Time Value of Money • Increases in an amount of money as a result of interest earned. • Saving today means more money tomorrow. Spending means lost interest. • Saving and spending decisions involve considering the trade-offs. Current needs can make spending worthwhile.

  21. Opportunity Costs and the Time Value of Money (continued) INTEREST CALCULATIONS • Three amounts are required to calculate the time value of money • Principal • Interest rates • Time

  22. Opportunity Costs and the Time Value of Money (continued) COMPUTING SIMPLE INTEREST (Amount in savings) x (annual interest rate) x (time period) = (interest) For Example: $100 x 5% x 1 (1 year) 100 x .05 x 1 = $5.00In one year you have $100 in principle plus $5.00 in interest for a total of $105 at the end of the year

  23. Opportunity Costs and the Time Value of Money (continued) FUTURE VALUE OF A SINGLE AMOUNT • Future value is the amount to which current savings will increase based on a certain interest rate and a certain time period • Future value is also call compounding - earning interest on previously earned interest FUTURE VALUE OF A SERIES OF DEPOSITS • Future value can be computed for a single amount or for a series of deposits called annuities

  24. Opportunity Costs and the Time Value of Money (continued)

  25. Opportunity Costs and the Time Value of Money (continued) PRESENT VALUE OF A SINGLE AMOUNT • Present Value is 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 • The present value of the amount you want in the future will always be less than the future value (See Exhibit 1-8C) PRESENT VALUE OF A SERIES OF DEPOSITS • Present value can be computed for a single amount or for a series of deposits (See Exhibit 1-8D)

  26. Achieving Financial Goals Objective 5: Identify strategies for achieving personal financial goals different life situations COMPONENTS OF PERSONAL FINANCIAL PLANNING • Obtaining (chapter 2) • Planning (chapters 3, 4) • Saving (chapter 5) • Borrowing (chapters 6, 7) • Spending (chapters 8, 9) • Managing risk (chapters 10-12) • Investing (chapters 13-17) • Retirement and estate planning (chapters 18, 19)

  27. Achieving Financial Goals (continued) DEVELOPING A FLEXIBLE FINANCIAL PLAN • A financial plan is a formalized report that... • Summarizes your current financial situation • Analyzes your financial needs • Recommends future financial activities • Your financial plan can be created by you, with assistance from a financial planner, or made using a money management software package

  28. Achieving Financial Goals (continued) IMPLEMENTING YOUR FINANCIAL PLAN • Develop good financial habits • Use a well conceived spending plan to help you stay within your income, while allowing you to save and invest for the future • Have appropriate insurance protection to prevent financial disasters • Become informed about tax and investment alternatives

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