DECA PERSONAL FINANCE
Personal financial planning -Personal financial planning is the process of managing your money to
achieve personal economic satisfaction. This planning process allows you
to control your financial situation. Every person, family, or household has
a unique situation; therefore, financial decisions must be planned to meet
specific needs and goals
A financial plan is an organized report that summarizes your current financial situation, analyzes your financial needs, and recommends future financial activities. You can create this document on your own (by using the Your Personal Financial Plan sheets at the end of each chapter), or you can seek assistance from a financial planner or use a money management app
The adult life cycle—the stages in the family situation and financial needs of an adult—is an important influence on your financial activities and decisions. The stages are affected by marital status, number and age of household members, and employment situation. Your life situation is also affected by events such as graduation, dependent children leaving home, changes in health, engagement and marriage, divorce, birth or adoption of a child, retirement, a career change or a move to a new area, or the death of a spouse, family member, or other dependent.
In addition to being defined by your family situation, you are defined by your values—the ideas and principles that you consider correct, desirable, and important. Values have a direct influence on such decisions as spending now versus saving for the future or continuing school versus getting a job.
Daily economic transactions facilitate financial planning activities. Exhibit 1–2 shows the monetary flows among providers and users of funds that occur in a financial system. These financial activities affect personal finance decisions. Investing in a bond, which is a debt security,involves borrowing by a company or government. In contrast, investing
in stock, called an equity security, represents ownership in a corporation.
Other financial market activities include buying and selling mutual funds,
certificates of deposit (CDs), and commodity futures.
In most societies, the forces of supply and demand set prices for
securities, goods, and services. Economics is the study of how wealth is
created and distributed. The economic environment includes business,
labor, and government working together to satisfy needs and wants. As
shown in Exhibit 1–2, government agencies regulate financial activities.
The Federal Reserve System, the central bank of the United States, has
significant economic responsibility. The Fed, as it is often called, attempts
to maintain an adequate money supply to encourage consumer spending,
business growth, and job creation. Global Influences The global economy influences financial activities. The U.S. economy is affected by both foreign investors and competition from foreign companies. American businesses compete against foreign companies for the spending dollars of American consumers. When the level of exports of U.S.-made goods is lower than the level of imported goods, more U.S. dollars leave the country than the dollar value of foreign currency coming into the United States. This reduces the funds available for domestic spending and investment. Also, if foreign companies decide not to invest in the United States, the domestic money supply is reduced. This reduced money supply can cause higher interest rates. Exhibit 1–2 The Financial System Inflation Most people are concerned with the buying power of their money. Inflation is a rise in the general level of prices. In times of inflation, the buying power of the dollar decreases. For example, if prices increased 5 percent during the last year, items that previously cost $100 would now Financial Regulators: Federal Reserve System, Federal Deposit Insurance Corporation, National Credit Union Administration, Oce of the Comptroller of the Currency, Consumer Financial Protection Bureau, Securities and Exchange Commission, state banking agencies, state insurance agencies. Funds Funds Funds Funds FUNDS Users (borrowers, spenders) of funds Providers (savers, investors) of Funds Financial Intermediaries banks, credit unions insurance companies investment companies other financial institutions Financial Markets stock markets bond markets money markets commodity markets individuals businesses governments foreign entities individuals businesses governments foreign entities inflation A rise in the general level of prices. economics The study of how wealth is created and distributed. 4 Chapter 1 Personal Financial Literacy: An Introduction For Copyright © McGraw Hill Review PuInflation Most people are concerned with the buying power of their money.
Inflation is a rise in the general level of prices. In times of inflation, the
buying power of the dollar decreases. For example, if prices increased
5 percent during the last year, items that previously cost $100 would now
Financial Regulators: Federal Reserve System, Federal Deposit Insurance Corporation, National Credit Union Administration,
Oce of the Comptroller of the Currency, Consumer Financial Protection Bureau, Securities and Exchange Commission,
state banking agencies, state insurance agencies.
Funds
Funds
Funds
Funds
FUNDS
Users
(borrowers, spenders)
of funds
Providers
(savers, investors)
of Funds
Financial
Intermediaries
banks, credit unions
insurance companies
investment companies
other financial institutions
Financial Markets
stock markets
bond markets
money markets
commodity markets
individuals
businesses
governments
foreign entities
individuals
businesses
governments
foreign entities
inflation A rise in
the general level of
prices.
economics The
study of how wealth
is created and
distributed.
4 Chapter 1 Personal Financial Literacy: An Introduction
For
Copyright © McGraw Hill
Review Purposes Only
cost $105. This means more money is needed to buy the same amount of
goods and services.
Inflation is most harmful to people with fixed incomes. Due to inflation,
retired people and others whose incomes do not change can only afford
fewer goods and services. Inflation can also have a negative effect on
lenders of money. Unless an appropriate interest rate is charged, amounts
repaid by borrowers in times of inflation have less buying power than the
money they borrowed.
Inflation rates vary. During the late 1950s and early 1960s, the annual
inflation rate was in the 1 to 3 percent range. At other times, the cost of
living increased 10 to 12 percent annually. At a 12 percent annual inflation
rate, prices double (and the value of the dollar is cut in half) in about six
years. To find out how fast prices (or your savings) will double, use the
Rule of 72: Just divide 72 by the annual inflation (or interest) rate.The consumer price index (CPI), computed and published by the Bureau of Labor Statistics, is a measure of the average change in the prices urban consumers pay for a fixed “basket” of goods and services. Inflation rates can be deceptive since the price index is based on certain items. Many people face hidden inflation since the cost of necessities (food, gas, health care) on which they spend the greatest proportion of their money may rise at a higher rate than that of nonessential items, which could be dropping in price. This results in a reported inflation rate much lower than the actual cost-of-living increase being experienced by consumers. Deflation, a decline in prices, can also have damaging economic effects. As prices drop, consumers expect they will go even lower. As a result, consumers cut their spending, which causes damaging economic conditions. While widespread deflation is unlikely, certain items may be affected and their prices will drop. Interest Rates In simple terms, interest rates represent the cost of money. Like everything else, money has a price. The forces of supply and demand usually influence interest rates. When consumers expand their saving and investing, the supply of money available for lending increases and interest rates tend to decrease. However, as borrowing by consumers, businesses, and government increases, interest rates are likely to rise due to an increased demand for money. EXAMPLE: Rule of 72 An annual inflation rate of 4 percent, for example, means prices will double in 18 years (72 ÷ 4 = 18). Regarding savings, if you earn 6 percent, your money will double in 12 years (72 ÷ 6 = 12). BE AWARE ! People who encounter money troubles start their bad habits when they are young. To avoid a life of financial difficulties, take these actions: • spend less than you take in • track your spending • set specific savings goals • create and follow a budget • pay your bills on timeInterest Rates In simple terms, interest rates represent the cost of money. Like everything else, money has a price. The forces of supply and demand usually influence interest rates. When consumers expand their saving and investing, the supply of money available for lending increases and interest rates tend to decrease. However, as borrowing by consumers, businesses, and government increases, interest rates are likely to rise due to an increased demand for moneyInterest rates affect your financial planning activities. The earnings you receive as a saver or an investor reflect current interest rates as well as a risk premium based on such factors as the length of time your funds will be used by others, expected inflation, and the extent of uncertainty about getting your money back. Risk is also a factor in the interest rate you pay as a borrower. People with poor credit ratings pay a higher interest rate than people with good credit ratings. Interest rates influence many financial decisions.To achieve a secure financial position, you must coordinate several components through an organized plan and wise decision making, as shown in Exhibit 1–3. Earning (Chapters 1–2) You obtain financial resources from employment, investments, or ownership of a business. Earning income is the foundation of financial planning. Planning (Chapters 3–4) Planned spending with a budget is key to achieving goals and future financial security. A spending plan starts with tracking your spending (see Daily Spending Diary at the end of the chapter). Efforts to anticipate expenses and financial decisions can reduce taxes. Wise tax planning is a vital element for increasing your financial resources. Saving (Chapter 5) Long-term financial security starts with a regular savings plan for emergencies, unexpected bills, replacement of major items, and the purchase of expensive goods and services, such as a college education, a boat, or a vacation home. Once you have established a basic savings plan, use additional money for investments that offer greater financial growth. Managing Credit (Chapter 6) Wise use of credit can contribute to your financial goals. In contrast, the overuse and misuse of credit will likely result in a person’s debts exceeding the resources available to pay those debts. Spending (Chapters 7, 8) Financial planning is not designed to prevent enjoyment of life but to help you obtain what you want. Too often purchases are made without considering the financial consequences. Some people shop compulsively, creating financial difficulties. What would you like to do tomorrow? Believe it or not, that question involves
goal setting, which may be viewed in three time frames (see Exhibit 1–4):
• Short-term goals will be achieved in two years or less, such as saving
for a vacation or paying off small debts.
• Intermediate goals have a time frame of two to five years.
• Long-term goals involve financial plans that are more than five years
off, such as retirement, money forWhat would you like to do tomorrow? Believe it or not, that question involves goal setting, which may be viewed in three time frames (see Exhibit 1–4): • Short-term goals will be achieved in two years or less, such as saving for a vacation or paying off small debts. • Intermediate goals have a time frame of two to five years. • Long-term goals involve financial plans that are more than five years off, such as retirement, money for children’s college education, or the purchase of a vacation home. children’s college education, or the
purchase of a vacation home.Goal setting is central to financial decision making. Your financial goals are the basis for planning, implementing, and measuring the progress of your spending, saving, and investing activities. Exhibit 1–1 offers short-term and long-term financial actions that can be the basis for your financial goals. Your financial goals should take a SMART approach, in that they are: • S—specific, so you know exactly what your goals are and can create a plan designed to achieve those objectives. • M—measurable, by a specific amount. For example, “Accumulate $5,000 in an investment fund within three years” is more measurable than “Put money into an investment fund.” • A—action-oriented, providing the basis for the personal financial activities you will undertake. For example, “Reduce credit card debt” will usually mean actions to pay off amounts owed. • R—realistic, involving goals based on your income and life situation. For example, it is probably not realistic to expect to buy a new car each year if you are a student. • T—time-based, indicating a time frame for achieving the goal, such as three years. This allows you to measure your progress toward your financial goals. Once you identify a S-M-A-R-T goal, planning is needed to achieve the goal. Actions, along with a timeline, can be the basis for achieving financial goals. The Financial Literacy NOW! feature “Creating Goals and Assessing Financial Health” can guide your goal-setting activities