PERSONAL FINANCIAL PLANNING

By Group 4 Section AMohammad Arshad Islam 41Saba Rais 59Mitesh Parmar 75Danish Haidar 95Sakshi Khurana 145

Definition Personal financial planning is the process of

managing your money to achieve personal economic satisfaction.

It is the process of systematically planning your finances towards achieving your short-term and long-term life goals.

Financial planning is the process of developing a personal roadmap for your financial well being.

The inputs to the financial planning process are:

your finances, i.e., your income, assets, and liabilities,

your goals, i.e., your current and future financial needs and

your appetite for risk.

The financial planning process

Step 1: Identify your current financial situation

Step 2: Identify your goals Step 3: Identify financial gaps Step 4: Prepare your personal financial

plan Step 5: Implement your financial plan Step 6: Periodically review your plan

Benefits of financial planning Helps monitor cash flows and reduces

unnecessary expenditure. Enables maintenance of an optimum

balance between income and expenses. Helps boost savings and create wealth. Helps reduce tax liability. Maximizes returns from investments.

Contd… Creates wealth and ensures better

wealth management to achieve life goals.

Financially secures retirement life. Reviews insurance needs and therefore

also ensures that dependents are financially secure in the unfortunate event of death or disability.

Lastly, it also ensures that a will is made.

Helps achieve peace of mind

Age

Income

10 20 30 40 50 60 70 80

Income Stream

Personal Financial Planning Lifecycle

Retirement/Estate

TaxSavings/Investment

Asset Acquisition

Liability/Insurance

Benefits

Case Study

Building your financial plan Dave and Sharon Thompson are 30 years old They have 2 children who are 5 & 6 years old Dave’s salary is currently $48000 per year They have not been able to save any money

as Dave’s income is just enough to cover their expenses

Sharon has just taken up a part time position at a local department store at a salary of $12000 per year

Assess their current financial position

CURRENT FINANCIAL POSITION

Major Assets Amount

Savings (High, Medium, or Low) nil

Money Owed $100000

Salary   $60000

 Financial Goals  

Goal 1. Purchase new car for Sharon this year

Goal 2. Pay for children's college education in 12-17 years from now

Goal 3. Set aside money for retirement

How to Achieve the Goal

save $500 each month

save $300 each month

consult a financial advisor

Cash Inflows This Month  Salary after taxes per month $4,000                Total Cash Inflows $4,000 Cash OutflowsRent/Mortgage $900 Cable TV   60Electricity and water 80Telephone 70Groceries   500Health care insurance and expenses 160Clothing   180Car expenses (insurance, maintenance, and gas) 300Recreation 1,000Credit card minimum payments 20Other   100Total Cash Outflows 3,370Net Cash Flows $630

Personal Cash Flow Statement

AssetsLiquid AssetsCash $300 Checking account 1,700Savings account  Total liquid assets $2,000

Household AssetsHome $1,00,000 Car 9,000Furniture 3,000Total household assets $1,12,000

Investment AssetsStocks  Bonds  Mutual Funds  Total investment assets  

Total Assets $1,14,000

Balance Sheet

Liabilities and Net WorthCurrent LiabilitiesLoans  

Credit card balance 2,000Total current liabilities $2,000

Long-Term LiabilitiesMortgage  Car loan 100,000Total long-term liabilities $100,000

Total Liabilities $102,000

Net Worth $12,000

Savings for child education Their oldest child is 6 years old and will

begin college in 12 years They are investing $300 per month in

the savings account earning 5% p.a. interest

They wonder how much will they accumulate at an interest rate of 7% p.a.

They also want to know the accumulated savings if they invest $400 per month

Savings Accumulated Over the Next 12 Years (Based on Plan to Save $3,600 per Year)Amount Saved Per Year $3600 $3600

Interest Rate 5% 7%

Years   12.00 12.00

Future Value of Savings   $57,302 $64,398

Savings Accumulated Over the Next 12 Years (Based on Plan to Save $4,800 per Year)

Amount Saved Per Year   $4800 $4800 Interest Rate 5% 7%Years   12.00 12.00

Future Value of Savings   $76,402 $85,865

If the Sampsons set a goal to save $70,000 for their children's college education in 12 years, how much would they have to save by the end of each year to achieve this goal, assuming a 5 percent annual interest rate?

Calculator: Savings Needed Each Year

Future Value   $70,000

Interest Rate   5%

Years   12

Savings Needed Each Year   $4,397.78

Tax Planning Dave’s earnings are $48000 Sharon’s earnings are $12000 Child tax credits are currently $1000 per child The Sampsons will pay $6300 in home mortgage They will pay $1200 in real estate taxes They will make charitable contributions of $600

per year They file for tax jointly and income tax rate is

15% Assess their income tax liability

Gross Income $60,000

Retirement Plan Contribution  

Adjusted Gross Income $60,000

DeductionsInterest Expense $6,300

Real Estate Taxes 1,200

Contributions 600 $8,100

Exemptions ($3,200 each)  

Taxable Income $51,900

Tax Rate 15%

Tax Liability Before Tax Credits $7,785

Child Tax Credit(s) 2,000

Tax Liability $5,785

Calculating Tax Liability

Managing credit The Sampsons have by now saved

$2000 They are currently earning an interest of

5% on their savings. They have been carrying a balance of

$2000 on their credit card The credit card is charging them 18% They want to evaluate the return they

are receiving from their savings versus the interest expenses they are accruing on their credit card

Savings    

Interest rate earned on savings   5%Savings balance   $2,000

Annual interest earned on savings   $100.00

Paying Off Credit Balance    

Interest rate paid on credit   18%Credit balance   $2,000

Annual interest paid on credit   $360.00

Suggestion The interest owed on credit card exceeds

the interest earned on deposits by $260 He should use the available balance to

pay off his credit bill immediately He would lose the opportunity to earn

$100 but will also be able to avoid the liability of $360

Thus his wealth would be higher by $260

Personal Loan The Sampsons have saved $500 a month for

10 months to be used as down payment for the purchase of their new car

The car is priced at $25000 plus 10% sales tax They shall receive $1000 trade-in credit on

their existing car They would like to allocate maximum $500

per month towards loan payment of the new car

The annual interest rate is currently 7%

 Three-Year (36-month) Periods

Four-Year (48-month) Periods

Five-Year (60-month) Periods

Interest rate 7% 7% 7%

Total finance payments $20,250 $20,250 $20,250

Total payments including the down payment and the trade-in $25,250 $25,250 $25,250

Monthly payment $625 $485 $400

Purchasing and financing a home The Sampsons have bought a home for

$90000 at a 30 years mortgage The interest rate is 9% After 1 year the interest rates have fallen

to 8%. The cost of refinance is $1400 They are in the 25% tax bracket Should they refinance the loan?

Mortgage loan $90,000

Interest rate 8%

Years   30

Loan payment   $660.39

Mortgage loan $90,000

Interest rate 9%

Years 30

Loan payment $724.16

Current Mortgage Payments

Mortgage Payments after Refinancing

Current mortgage payment $724.16

New mortgage payment $660.39

Monthly savings $63.77

Annual savings $765.26

Marginal tax rate 25%

Decrease in taxes $191.32

Annual savings after-tax $956.58

Years in house after refinancing 29

Total savings $27740.28

Savings on refinancing

Investment Decision The Sampsons save $300 per month for

their children’s education They are currently investing this amount

in bank CDs earning an interest of 5% Investment in a particular stock shall

yield 2% in weak market conditions and 9% in strong market conditions

What should they do?

Savings Accumulated Over the Next 12 Years

   CD: Annual

Return Weak Stock Strong Stock

    = 5%Market

ConditionsMarket

ConditionsAmount invested per year $3,600 $3,600 $3,600

Annual return 5% 2% 9%

FVIFA (n=12 years) 15.9171 13.4121 20.1407

Value of investments in 12 years $57,301.66 $48,283.52 $72,506.59

Investment in bondsType of Bond Bond Yield offered Risk premium

within bond yield

Treasury bonds 7% 0.0%

AAA rated corporate bonds

7.5% 0.5%

A rated corporate bonds

7.8% 0.8%

BB rated corporate bonds

8.8% 1.8%

CCC rated corporate bonds

9.5% 2.5%

Suggestion Out of all the bonds only the Treasury

bonds are risk free The other bonds have a risk premium

which is subject to change over time The Sampsons should prefer either

Treasury bonds or AAA rated bonds They should be risk averse and the risk

premium is not enough compensation for the risk

Retirement Planning Dave Sampson shall contribute $7000 of

his salary per year The employer shall contribute $3000 The retirement funds will be invested in

mutual funds The expected return is 7% and he hopes

to retire after 30 years

Future Value of Annuity

Contribution   $10,000

Years   30

Annual rate of return 7.00%

Future value   $9,44,607.86

Monthly cash flows

Future Value $9,44,607.86

Rate of interest 7.00%

Cash Flows per month $5510

References www.moneycontrol.com Tata McGraw Hill Case Study- Personal Finance by Jeff

Madura, Pearson Publication