chapter 1: understanding personal finance garman/forgue personal finance tenth edition ppt slide...

Chapter 1:Understanding Personal Finance

Garman/Forgue

Personal FinanceTenth Edition

PPT slide program prepared by Amy Forgue and Ray Forgue.

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Introduction

Financial literacy is knowledge of:FactsConceptsPrinciplesTechnological tools

…that are fundamental to being smart about money.

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Introduction

Personal finance is the study resources important for achieving financial success and involvesspendingsavingprotecting and investing resources.

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Introduction

Financial responsibility means

You are accountable for your future financial well-being.

You strive to make wise personal financial decisions.

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Your Next Five Years

In the next five years :

1. Stay up-to-date with current economic conditions.

2. Use marginal and opportunity costs and time value of money calculations when making financial decisions.

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Your Next Five Years

3. Harness the power of compounding by saving a consistent amount each month for long-term goals.

4. Take responsibility for managing your own financial success.

5. Take advantage of tax sheltering through your employer’s benefits program.

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Learning Objective #1

Use the building blocks to achieving financial success.

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Achieving Financial Success

Spend less to save and invest!

Savings

Investments

Standard of Living versus Level of Living

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Achieving Financial Success

Financial Success: achievement of financial aspirations.

Financial Happiness: Satisfaction about money matters.

Use the Building Blocks of financial success

Figure 1.1: Building Blocks to Achieving Financial Success

Concept Check 1.1

Describe financial success.

What is financial happiness?

What are the building blocks to achieving financial success?

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Learning Objective #2

Understand how the economy affects your personal financial success.

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The Economy and Financial Success

Economy: System of managing the resources of a country, state, or community.

Economic Growth: Increasing production and consumption in the economy.

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Where Are We in the Business Cycle?

The economy grows and contracts over time: Expansion

Peak

Contraction

Trough

Figure 1.2: Business Cycles Phases

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What is the Future Direction of the Economy?

The Gross Domestic Product is a procylical indicator.

The Unemployment Rate is a countercyclical indicator.

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What is the Future Direction of the Economy?

The Index of Leading Economic Indicators and the Consumer Confidence Index are leading indicators.

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What Is the Future Direction of Inflation

Inflation: Steady rise in the general level of prices.

How does inflation affect income and consumption?

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Inflation

How inflation is measured:

Consumer Price Index (or CPI)

Personal Inflation Rate

Inflation reduces real incomes.

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What Is the Future Direction of Interest Rates?

Federal Funds Rate:

Rates banks charge each other

Set by the FED

Concept Check 1.2

Summarize the phases of the business cycle.

Describe two statistics that help predict the future direction of the economy.

Give an example of how inflation affects income and consumption.

Explain how the federal government measures inflation.

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Learning Objective #3

Apply economic principles when making financial decisions.

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Think Like an Economist

Opportunity Cost: Cost of decision measured by the value of the next best alternative.

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Think Like an Economist

Marginal Utility/Cost: Usefulness or cost of the next increment of something.

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Think Like an Economist

Marginal Tax Rate: Tax rate at which your next dollar earned is taxed.

The very best kind of income is tax-exempt income.

The second best kind of income is tax-sheltered income.

Figure 1.3: Tax-Sheltered Returns

Concept Check 1.3

Define opportunity cost and give an example of how opportunity costs might affect your financial decision making.

Explain and give an example of how marginal analysis makes some financial decisions easier.

Describe and give an example of how income taxes can affect financial decision making.

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Learning Objective #4

Perform time value of money calculations in personal financial decision making.

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Time Value of Money

What will an investment (or a series of investments) be worth after a period of time?

This question asks for a future value.

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Time Value of Money

How much has to be put away today (or as a series of investments) to provide some dollar amount in the future?

This question asks for a present value.

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Compounding

Compounding: When interest on an investment itself earns interest.

Compounding is the roadmap to wealth.

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Calculating Future Values

Future Value (FV) of a Lump-Sum: Valuation of an asset projected to the end of a particular time period in the future.

Table 1.1: Future Value of $1 After a Given Number of Periods

Periods 4% 7% 8% 10%

1 1.0400 1.0700 1.0800 1.1000

2 1.0816 1.1449 1.1664 1.2100

3 1.1249 1.2250 1.2597 1.3310

4 1.1699 1.3108 1.3605 1.4641

5 1.2167 1.4026 1.4693 1.6105

10 1.4802 1.9672 2.1589 2.5937

Figure 1.4: The Importance of Higher Yields and More Time

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The Rule of 72

Rule of 72: Reveals number of years for principle to double

$1000 invested at 8% would double to $2000 in 9 years (72/9)

$2000 to $4000 in 9 more years $4000 to $8000 in 9 years

without ever having to invest another $1

Figure 1.5: Rule of 72 Illustrated

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Calculating Future Values

Future Value (FV) of an Annuity: Valuation of a series of deposits projected to the end of a particular time period in the future.

Figure 1.6: Future Value of $2000 Annual Investments

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Calculating Present Values

Present value of a lump sum; what is the equivalent value today of a dollar amount to be received in the future?

Present value of an annuity; what is the equivalent value today of a series of payments to be received in the future?

Concept Check 1.4

Explain the difference between simple interest and compound interest, and describe why that difference is critical.

What are the two components used when figuring the time value of money?

Use Table 1.1 to calculate the future value of (a) $2000 at 5 percent for four years, (b) $4500 at 9 percent for eight years, and (c) $10,000 at 6 percent for ten years.

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Learning Objective #5

Make smart decisions about your employee benefits.

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Smart Money Decisions at Work

Flexible benefit plans offer tax-free money

Flexible benefit plans offer a menu of benefits from which you may select

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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

Health Savings Accounts (or HSAs) provide tax-sheltered savings for health expenses

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Making Decisions About Flexible Spending Accounts

Pretax Dollars: Money income that has not been taxed by the government.

Flexible-spending accounts can pay for child care and medical expenses with pre-tax dollars

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Making Decisions About Employer Insurance Plans

Participating in employer life insurance,

disability insurance, and

long-term care insurance plans

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Making Decisions About Retirement Plans

First advantage: tax-deductible contributions

Second advantage: employer’s matching contributions

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Employer Retirement Plans

Third advantage: tax-deferred growth

Fourth advantage: starting early really pays off

Table 1.3: Starting to Save Early Versus Starting Late

Earlier Later

Age $ Value Age $ Value

23 $ 3000 23 $ 0

31 6000 31 3000

39 12,000 39 6000

47 24,000 47 12,000

55 48,000 55 24,000

63 $96,000 63 $48,000

Concept Check 1.5

Summarize the benefits of participating in a high-deductible health care plan at work.

Show a math example of why many employees participate in a tax-sheltered employee benefit plan, such as an HAS or 401(k) plan.

List two ways you can maximize the benefits from a tax-sheltered retirement program.

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Learning Objective #6

Identify the professional qualifications of providers of financial advice.

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Professional Financial Planning Advice

A true financial planner should be able to analyze a family’s total needs in such areas as: investments taxes insurance education goals retirement

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Professional Financial Planning Advice

Appropriate professional designations and credentials for planners: Certified Financial Planner (CFP) Chartered Financial Consultant (CFC) Certified Public Accountant (CPA) Accredited Financial Counselor (AFC) Mutual Fund Chartered Counselor

(MFCC) Registered Investment Advisor (RIA)

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Professional Financial Planning Advice

How financial planners are compensated: Commission-only financial

planners/brokers

Fee-based financial planner/brokers

Fee-offset financial planners/brokers

Fee-only financial planners

Concept Check 1.6

What are the four ways financial planners may be compensated?

Describe two professional certification programs for financial planners.

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Top 3 Financial Missteps in Personal Finance

People slip up in personal finance when they do the following:

1. Think about money matters only when faced with a financial problem.

2. Spend more than they earn.

3. Get financial advice from amateurs.

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Do It NOW!

Understanding the economy can help you manage your personal finances appropriately. Start today by:

1. Searching the Internet to identify the current stage of the business cycle.

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Do It NOW!

2. Visiting www.bls.gov to determine the current inflation rate.

3. Going to www.conference-board.org to assess expectations for economic growth for the next 12 months.