The Financial Planning Process Chapter 1. © 2013 Pearson Education, Inc. All rights reserved.1-2 Learning Objectives 1.Explain why personal financial

The Financial Planning Process

Chapter 1

© 2013 Pearson Education, Inc. All rights reserved. 1-2

Learning Objectives

1. Explain why personal financial planning is so important.

2. Describe the five basic steps of personal financial planning.

3. Set your financial goals.


Learning Objectives

4. Explain the personal finance lessons learned in the recent economic downturn.

5. Explain how career management and education can determine your income level.

6. List ten principles of personal finance.

7. Understand that achieving financial security is more difficult for women.


Introduction

• It’s easier to spend than to save.

• Personal financial planning is an ongoing process—it changes as your financial situation and position in life change.

• Manage and control your finances with a personal financial plan.

• It helps you achieve financial and lifestyle goals.


Importance of Personal Financial Planning

• Accumulate wealth for special expenses

• Save for retirement

• “Cover your assets”

• Invest intelligently

• Minimize payments to Uncle Sam


Five basic steps to personal financial planning

1. Evaluate your financial health

2. Define your financial goals

3. Develop a plan of action

4. Implement your plan

5. Review your progress, reevaluate, and revise your plan


Step 1: Evaluate Your Financial Health

• Examine your current financial situation.

– How much money do you make?

– How much are you spending and on what?

• Use careful record keeping to track finances and spending.


Step 2: Define Your Financial Goals

• Write or formalize your goals. An unwritten goal is simply a Dream!

• Attach a financial cost to each one.

• When will you need the money to achieve the goal?

• Analyze and revise your goals.


Step 3: Develop a Plan of Action

• Flexibility: – Plan for life changes and the unexpected

happens.

• Liquidity– Immediate use of cash by quickly and easily

(costlessly) converting an asset.

• Protection– Prepare for the unexpected with insurance.

• Minimize Taxes– Keep more of what you earn.


Step 4: Implement Your Plan

• Stick to it.

• Use your financial plan as a road map to achieve goals.

• Keep goals in mind and work towards them.


Step 5: Review, Reevaluate, and Revise

• Review progress.

• Reevaluate and revise for changes in your life.

• Be prepared to formulate a different plan to meet your goals.


ESTABLISHING YOUR FINANCIAL GOALS

Short-term—within 1 yearIntermediate-term—1 to 10 yearsLong-term—more than 10 years


Short–Term Goals

• Accumulate Emergency Funds Equaling at least 3 Months’ Living Expenses

• Pay Off Bills and Credit Cards• Purchase Insurance• Purchase a smallish Major Item• Finance a Vacation


Intermediate-Term Goals

• Save for Older Child’s College • Save for a Down Payment• Pay Off Major Debt• Finance Large Items (Weddings)• Purchase a Vacation Home


Long-Term Goals

• Save for Younger Child’s College• Purchase Retirement Home• Create a Retirement Fund to Maintain

Current Standard of Living• Take Care of Elderly Family Members • Start a Business


Figure 1.3A Typical Individual’s Financial Life Cycle


Stage 1 The Early Years—A Time of Wealth Accumulation

• Prior to age 54

• Develop a regular savings pattern:

– How much can be saved?

– Is that enough?

– Where should the savings be invested?

• Cost of raising children


Stage 2 Approaching Retirement—The Golden Years

• Transition years between ages 55-64.

• Depends on preparation for retirement.

• Reassess financial goals and decisions—retirement, insurance protection and estate planning.


Stage 3 The Retirement Years

• After age 65, live off savings

– Retirement age depends on savings.

• Less risky investment strategy

• Consider extended nursing home protection.

• Estate planning decisions and documents are critical.

The foundation of personal finance.


Principle 1: The Best Protection Is Knowledge

• Understand the basics of personal finance.

• Take responsibility for your lifetime financial plan.

• Seek professional advice wisely.


Principle 2: Nothing Happens Without a Plan

• Easier to think about spending than about saving.

• Saving must be planned.

• Putting off a financial plan means goals are harder to achieve.


Principle 3: The TimeValue of Money

• Money received today is worth more than money received in the future.

• Understand how savings and investments grow over time

• Understand compound interest.

• Understand spending now and paying later


Principle 4: Taxes Affect Personal Finance Decisions

• Know the effect of taxes on the rate of return of investments.

• Compare investment alternatives on an after-tax basis.

• Understand tax laws.


Principle 5: Stuff Happens, or the Importance of Liquidity

• Plan for unexpected events

• Have money or liquid funds available

• Liquid funds should cover 3 to 6 months of living expenses


Principle 6: Waste Not, Want Not - Smart Spending Matters

• Differentiate want from need

• Do homework before the purchase

• Make the purchase at the best price

• Maintain your purchase


Principle 7: Protect Yourself Against Major Catastrophes

• Have the right kind of insurance before a tragedy occurs.

• Know your insurance policy coverage.

• Focus insurance on major catastrophes which can be financially devastating.


Principle 8: Risk and Return Go Hand in Hand

• Saving and investing grows money.

• Investors demand a minimum return above anticipated inflation.

• Investors demand higher return for added risk.

• Diversification by spreading money in several investments reduces risk.


Figure 1.7 The Risk-Return Trade-Off


Principle 9: Mind Games, Your Financial Personality, and Your Money

• Behavioral biases lead to big financial mistakes.

– Mental accounting impacts financial decisions.

– “Sunk cost effect” pours good money after bad money because of bias.


Principle 10: Just Do It!

• Taking the first step towards your goals is difficult.

• The following steps become easier.

• First step is to pay yourself first—save then spend.

• Saving early can make a big difference.


Women and Personal Finance

• Tougher to achieve financial security.

• Generally earn less.

• Less likely to have pensions.

• Qualify for less Social Security.

• Live longer than men.

• Planning for financial independent more difficult for them than it is for men.


Women and Personal Finance

• Need to take charge of their money and financial future.

• Acquire knowledge.

• Make things happen—need a plan.

• See a financial planner about specific concerns.


Summary

• Personal financial planning allows you to manage your finances and achieve lifecycle financial goals.

• There are five basic steps to personal financial planning.

• Set your financial goals in order to achieve them with a financial plan.


Summary

• An emergency fund can help protect yourself in the event of an economic downturn.

• The more educated your are, the more you will earn.

• There are ten basic principles on which personal financial planning is built.

• Planning is especially important for the financial future of women.


Figure 1.6 How Long Households Go Without Income Before Hardship Sets In

Documents

The Financial Planning Process Chapter 1. © 2013 Pearson Education, Inc. All rights reserved.1-2 Learning Objectives 1.Explain why personal financial