Chapter 1 Understanding Personal Finance PDF

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Chapter 1 Understanding Personal Finance Financial literacy is your knowledge of facts, concepts, principles, and technological tools that are fundamental to being smart about money. Personal Finance Study of personal and family resources for achieving financial success and involves spending, saving, protecting and investing resources. Financial responsibility: YOU are accountable for your future financial well-being. Strive to make wise personal financial decisions. Fundamental Steps in the Financial Planning Process 1) Evaluate your financial condition relative to your education and career choice 2) Define your financial goals 3) Develop a plan of action to achieve your goals 4) Periodically develop and implement spending plans to monitor and control progress towards goals. 5) Review your financial progress and make changes as appropriate Achieving Financial Success Financial success is the achievement of financial aspirations that are desired, planned or attempted. Financial happiness is when you are satisfied with your money matters as a result of practicing good financial behaviors. Financial security is the comfortable feeling that your resources will be sufficient to meet your needs, and most wants. None are based on having high income Things you will accomplish studying personal finance - Recognize how to manage the unexpected and unplanned financial events - Pay as little as possible in income taxes to the IRS - Understand comparison shopping - Protect what you own - Invest wisely - Accumulate and protect wealth The study of personal finance involves how people spend, save, and invest their financial resources. Important Notes By saving and investing, you are much more likely to have funds available for the future. You cannot build financial security or wealth unless you spend LESS than you earn. Financial objectives are rarely met without restraining current consumption.

The Economy and Financial Success - Economy: system of managing the productive and employment resources of a country, state, or community. - The US economy is capitalism – controlled by private owners who see profit - Economic Growth: increasing production and consumption in the economy. The overarching goal of every economy is to grow and, thereby, enhance the prosperity of its members.

What is the Future Direction of the Economy? - Economic Indicator o Statistic that suggest how well the economy is doing now and in the future. - The Gross Domestic Product o Nation’s broadest measure of economic health. o Measures the value of all goods and services produced in the united states. o Procyclical indicator- moves in the same direction as the economy. You can track the economy by paying attention to the gross domestic product. It is the sum total of all economic activity in the economy. When it is growing the economy is expanding. The unemployment rate acts in the opposite direction and when unemployment is growing the economy is contracting.

The Unemployment Rate is a countercyclical indicator- moves in the opposite direction from the economy. Ex. Unemployment gets larger as the economy gets worse. Leading indicators- changes that occur before the economy changes. Ex. Stock market a good indicatordeclines shortly before recession. o Index of Leading Economic Indicators- a composite index that suggests the future of the economy; looks at 10 components of growth such as building permits, factory orders, etc. o Consumer Confidence Index- gauges how consumers feel about the economy and their personal finances; consumers willingness to spend. You can track the economy by paying attention to the gross domestic product. It is the sum total of all economic activity in the economy. When it is growing the economy is expanding. The unemployment rate acts in the opposite direction and when unemployment is growing the economy is contracting.

The Economy and Financial Success - Where are we in the business cycle as the economy grows and contracts over time? o Expansion- preferred phase; makes it easy for consumers to buy homes, cars, and other goods; retail sales are high o Peak- interest rates and inflation rise o Contraction o Downturn o Trough- a good time to invest o Recovery The economy does not grow at an even rate but goes through economic cycles. The economy grows during a period of economic expansion but eventually reaches a peak. At the peak the economy will begin to contract and there will be negative economic growth. At some point the economy will bottom out and begin to expand again.

What is the future of Direction of inflation? - Inflation is a steady rise in the general level of prices- process by which the cost of goods and services tends to rise over time. - Inflation is measured by the Consumer Price Index o The consumer price index (CPI) is a broad measure of changes in the prices of all goods and services purchased for consumption by households. How Inflation affects Consumption - Decreases purchasing power- when prices rise, income must rise at the same rate to maintain purchasing power. - During times of high inflation, interest rates rise on new loans for cars, homes, and credit cards. Opportunity Cost - Cost of decision measured by the value of the next best alternative that must be foregone. - Ex. Spending money on current living expenses reduces amount of money that can be invested Trade-off - Giving up one thing for another Marginal Utility/Cost - Extra satisfaction derived from having one more incremental unit of a product or service. It is the usefulness or cost of the next increment of something - Ex. Purchase a TV. 42 in screen/$600; 47 in/$750 is the larger screen worth the additional price? Financial decisions often impact income taxes. Marginal Tax Rate is the tax rate at which your last dollar earned is taxed - Tax-exempt income- free or exempt from taxation. PREFERRED - Tax-sheltered income- currently sheltered but may be subject to taxation later. Ex. IRA - Tax deferred income- paying taxes is postponed Ex. Roth IRA. Time Value of Money (TMV) - Single most important concept in personal finance - Interest- cost of money that is borrowed or lent; price of money - Adjusts for the fact that dollars to be received or paid out in the future are not equivalent to those received or paid out today. - Future Value- what will an investment (or a series of investments) be worth after a period of time. - Present Value- how much has to be put away today (or as a series of investment) to provide some dollar amount in the future. Compound Interest - Occurs when interest on an investment is left on deposit so you can earn interest on interest as well as on the original investment. - Produces larger investment values than simple interest - Key to building wealth Future Values variation of an asset projected to the end of a period of time.

Rule of 72 reveals number of years it rakes fir the principle to double. How many years would it take $1,000 to double to $2,000 without ever having to invest another $1? - 2% (72/2) – 36 years - 4% (72/4) - 18 years - 6% (72/6) - 12 years - 8% (72/8) - 9 years - 10% (72/10) - 7.2 years - 12% (72/12) - 6 years - 14% (72/14) - 5.14 years Smart Money Decisions at Work: Employee Benefits Retirement Plans, Paid Holidays, and Health Insurance Good decisions are critical in the workplace when it comes to money Many options may be available. - Cafeteria plans/ Flexible Benefit Plan offer a menu of benefits from which you may select; give you a choice of selecting either cash or one or more qualifying nontaxable benefits. - Cafeteria plans may offer tax-free or tax-sheltered benefits. Flexible Spending Accounts - Money that the employees set up at the start of each year that can be used to pay for child care and medical expenses with pre-tax dollars. - Allows employee-paid expenses for medical or dependent care to be paid with employee’s pretax dollars rather than after-tax income. Pretax Dollars: Money income that has not been taxed by the government. Making Decisions About Health Care Plans - Health Care Plans may be fully or partially paid by an employer - High Deductible Health Care Plans may cost less o A deductible is the first out of pocket expense - Health Savings Accounts (or HSAs) provide tax-sheltered savings for health expenses – special savings account intended for people who have a high deductible health care plan. Making Decisions About Employer Insurance Plans - Participating in employer o Life insurance, o Disability insurance, and o Long-term care insurance plans. The premiums paid by a worker are often LESS expensive when purchased through one’s employer. Making Decisions About Retirement Plans - First Advantage: tax- deductible contributions - Second Advantage: employer’s matching contributions; a match is an employer contribution according to the mount the employee contributes - Third advantage: employer’s contributions are not current income taxable - Fourth advantage: tax-deferred growth of contributions and earnings - Fifth advantage: you can borrow tax free - Sixth advantage: starting early really pays off big

Starting Earlier Versus Later

START YOUNG and DON’T TOUCH IT Ex. Do not touch retirement $ to pay for an unexpected expense Professional Financial Planning Advice - A true financial planner should be able to analyze a family’s total needs in such areas as: o Investments o Taxes o Insurance o Education goals o Retirement Appropriate professional designates and credentials for advisors include: - Certified Financial Planner (CFP) o All financial planners do not have to be a CPF - Chartered Financial Consultant (CFP) - Certified Public Accountant (CPA) - Accredited Financial Counselor (AFC) A financial planner who adheres to a fiduciary standard must always act in the best interest of the client regardless of how it might affect the advisor. How financial planners are compensated: - Commissions-only financial planners/brokers o No up-front fee; based on earnings - Fee-based financial planner/brokers o Charges upfront fee - Fee- offset financial planners/brokers o Charges annually or hourly fee but reduced by any commissions earned - Fee-only financial planner o Earn no commission and work solely on fee-for-service basis Always ask an advisor - If an advisor adheres to a fiduciary standard meaning that they will always act in your best interest - For an investment policy statement detailing your investment philosophy and situation, the risks you are willing to take and what the advisor will do for you

Conclusion Engaging in financial planning and implementing those plans, rather than simply earning a high income, is necessary for financial success. NEVER EVER - Spend more than you earn - Only think about money matters when you have a financial problem - Believe and act on financial advice from amateurs rather than trust professional sources....