Personal Finance Literacy

Personal Financial Plan

specifies your financial goals & describes the spending, financing, & investing plans that are intended to achieve these goals.

Opportunity Cost

what you give up as a result of a decision

Budgeting

set goals by estimating income & expenses on a monthly basis to determine how much to save & spend.

Assets

what you own

Liabilities

what you owe (debt)

Net Worth

value of what you own (assets) minus the value of what you owe (liabilities)

Insurance Planning

determining the types & amount of insurance needed to protect your assets

Estate Planning

determining how your wealth will be distributed before/upon your death

Good Goals

define an amount & a time period

Long Term Goal

5+ years

Short-Term Goal

within the next year

Financial Plans should be...

monitored and updated annually

Personal Cash Flow Statement

measures a person's cash inflows & cash outflows

Net Cash Flow

cash inflows minus cash outflows

Cash Inflow

Income

Cash Outflows

Expenses

Budgeting Tips

Don't over or under estimate cash flows

Compare actual w/ budgeted cash flows for accuracy

Liquidity

Access to funds to cover any short term cash deficiencies

Liquid Assets

Cash

Checking & Saving Accts

Home

Car

Furniture

Bonds

Stocks

Mutual Funds

Real Estate

Mutual Funds

Min. Investment: $500-$3000

Value can be found in periodicals (Wall St. Journal)

Managed by portfolio managers

Short-Term Loan

paid off within the near future (within one year)

Long-Term Loan

paid off over a period beyond one year

Best representation of Financial Position

net worth which is shown on a balance sheet

Changes in Cash Flow & Net Worth

Spend less & Save more

Higher Interest Rates mean:

Higher accumulation of money

Lower Interest Rates mean:

lower accumulation of money

Compounding

Accumulation of interest over time

Time value of money

based on earning interest

Dollar received today...

...is worth more than a dollar received tomorrow

All financial decisions involve

opportunity costs

Marginal Tax Rate

tax rate imposed on any additional income earned

Progressive Tax

any tax in which the rate increases as the amount subject to taxation increases

Gross Income

All reportable income from any source

Adjustable Gross Income

calculated by adjusting your gross income for contributions to IRAs, alimony payments, interest paid on loans, & other circumstances

Taxable income

equal to AGI minus deductions & exemptions

Itemized Deductions

specific expenses that can be deducted to reduce taxable incomes

Standard Deductions

a fixed amount that can be deducted from the AGI to determine taxable income

Contribution to IRA

for qualified individuals, this is an adjustment to gross income.

Long-Term Gain

a gain on assets that were held for 12 months or more

Short-Term Gain

a gain on assets that were held for less than 12 months.

Interest Income

interest earned from investments in various types of: savings accounts, debt securities, or providing loans to others.

FICA (employed)

7.65% of income & employer pays 7.65%

FICA (self-employed)

15.3% (both parts)

Planning an Investment Strategy

best to use many different investments w/ many different maturities & risk characteristics to diversify your risk

Interest Rates affect:

cash inflows & outflows

Impact of Rising Interest Rates

increases amount of interest paid on deposits but also increase the amount of interest charged on loans

Why Interest Rates Change

-shift in monetary policy

-shift in govt. demands for funds

-shift in business demands for funds

Yield Curves

typically upward sloping, meaning that annualized interest is higher for debt securities w/ longer terms to maturity

Relationship of Risk & Return

higher the risk, higher the return

lower the risk, lower the return

Risk Free Rate

a return on an investment that is guaranteed for a specific period

Risk Premium

an additional return beyond the risk free rate that can be earned from a deposit guaranteed by the govt.

Factors for choosing a Financial Institution

-convenience

-deposit rates

-deposit insurance

-fees

Credit Card

Purchases made on credit; billed at the end of a cycle & charged interest

Debit Card

used to make purchases charged against a checking acct

Depository Institution

financial institutions that accept deposits from individuals & provide loans

Examples of Depository Institution

-commercial banks

-savings institutions

-credit unions

Non-depository Institutions

do not offer federally insured deposit accts but provide various other financial services

Examples of Non-depository Institutions

-finance companies

-securities firms

-insurance companies

-investment companies

Insurance at Commercial Banks

deposits are insured up to $100,000 per depositor by the FDIC

Credit Risk

risk that the borrower will not repay on a timely basis

Interest Rate Risk

risk that the value of an investment could decline as a result of a change in interest rates

Liquidity Risk

the potential loss that could occur as a result of converting an investment into cash

Checking Acct

deposit funds into the account to write checks or use a debit card to pay for the various purchases

Savings Acct

Pay a higher interest rate than NOW accts

NOW Acct

type of deposit that provides checking services & pays interest

Asset Management Acct

combines deposit acct w/ a brokerage acct that is used to buy & sell stocks

Money Market Funds

investments for short term funds

Investments used in Money Market Funds

-Checking accts

-NOW accts

-Savings deposits

-Certificate of deposits

-Money Market deposit account

-Treasury bills

-money market funds

-asset management acct

Characteristics of CD's

specifies a min amount to be deposited, a maturity date, & an annualized interest rate.

Evaluation of Checking Accts

-overdraft protection