1 (of 22) FIN 200: Personal Finance Topic 2–Introduction to Financial Planning Larry Schrenk, Instructor.

1 (of 22)

FIN 200: Personal Finance

Topic 2–Introduction to Financial Planning

Larry Schrenk, Instructor

2 (of 22)

Introduction

FIN 200 Personal Finance Larry Schrenk, Instructor

E-Mail: [email protected] Office: 260 McKinley Office Telephone: 202-885-2794

Course Page http://auapps.american.edu/~schrenk/FIN200/FIN200.htm

Syllabus

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Learning Objectives

1. Explain the concept of financial planning.

2. Outline the elements of a personal financial plan.

3. Describe the development of a personal financial plan.▪

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Poor Financial Planning

In a survey...a large majority of corporate owners and executives of middle-market companies do not meet their personal financial goals in spite of the success of their business enterprise. source

Multiple surveys “suggest that people's financial planning methods are fairly rudimentary, that their financial knowledge is generally poor, and that their self-described savings plans are often inconsistent with the predictions of standard saving models. source

Students and Financial Planning

Over 60% of you have credit cards. About 15% of you have balances over

$1,000; about 5% exceeding $3,000. Average Undergraduate Credit Card Debt:

$2,200 Sticking to minimum payments it would take

you more than 12 years and $1,115 in interest to pay off a $1,000 bill on a card with an 18 percent annual rate.

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Financial Thinking

Opportunity Costs Trade-Offs

Risk versus Return Costs versus Benefits

Incentives Short-Term versus Long-Term Wealth versus Income

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The Basic Definitions

Personal Finance:

Personal Financial Plan

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Elements of the Financial Plan

1. Budgeting (Topics 5-7)

2. Liquidity (Topics 8-9)

3. Financing (Topics 10-11)

4. Protecting (Topics 12-14)

5. Investing (Topics 15-21)

6. Retiring and Estate Planning (Topics 22-23)

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1. Budgeting

Evaluate your current position (market value) Assets: what you own Liabilities: what you owe Net Worth: Assets - Liabilities

Develop a plan for financial stability (more later) Identify personal needs, goals and desires Forecast the financial decisions required to meet these

‘Cash Flows’ e.g., Big Spender (little or no savings) Big Saver (relatively little spending) Negative Saver (withdrawing savings to support spending)

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2. Liquidity

Liquidity: The ability to meet your expected and unexpected short-term obligations.

Two facets: Money (‘cash-like’)–Expected obligations Credit (borrowing)–Unexpected obligations

Trade-off between liquidity and return E.g., cash, checking, savings account, versus Long-term investments

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3. Financing

Major Expenditures Car House Retirement

Key Decisions Is the purchase a sound financial decision? How do I best raise the required funds?

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4. Protecting

Insurance Auto Home Health and Disability Life

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5. Investing

Investment Opportunities Risk versus Return

Return: The increased value of an investment over time (expressed as a percentage)

Risk: The possibility that the return you expected is not what you actually receive.

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6. Retiring and Estate Planning

Retirement Planning Retirement Goals Required Savings Investment Plan

Estate Planning Planned Size of Estate Distribution of Estate

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Planning and Cash Flows

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Developing a Personal Financial Plan

1. Determine Lifetime Goals

2. Establish Financial Goals to Meet Lifetime Goals

3. Evaluate Current Financial Position

NOTE: This is the focus of the course project!

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Developing a Personal Financial Plan

4. Formulate Financial Plans Career Education Savings Spending Lifestyle

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Example: Career

Bureau of Labor Statistics (BLS) Data for 800 occupations.

Occupation Employment Mean Annual Income

Airline Pilots, Copilots, and Flight Engineers 78,250 $148,810

Anesthesiologists 31,030 $192,780

Bakers 141,560 $24,360

Carpet Installers 34,630 $39,960

Chemical Engineers 28,780 $84,240

Cooks, Fast Food 575,510 $16,860

Correctional Officers and Jailers 431,980 $39,970

Database Administrators 116,340 $70,260

Fitness Trainers and Aerobics Instructors 219,990 $32,990

Foresters 10,510 $54,030

Funeral Directors 24,020 $57,660

Historians 3,600 $54,630

Interior Designers 52,620 $50,190

Landscape Architects 21,890 $62,250

Lawyers 555,770 $118,280

Marriage and Family Therapists 23,340 $45,310

Motorcycle Mechanics 16,800 $32,210

Real Estate Brokers 49,270 $79,800

Sales Managers 322,170 $106,790

Special Education Teachers, Middle School 100,160 $51,610

BLS May 2007 National Occupational Employment and Wage Estimates

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Example: Education

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Developing a Personal Financial Plan

5. Select Optimal Plan

6. Evaluate Financial Plan

7. Revise Financial Plan

Project Notes

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Ethical Dilemma (Chap.1, 16.7)

Sandy and Phil decide to go to Sandy's cousin Larry, who is a stockbroker. Larry tells them the only fee he will charge is for transactions. Larry recommends stocks of several well-known companies which they purchase. Three months later, Larry tells them that they need to sell the stocks and buy several others. Three months later, the same thing happens. At the end of they had sold each of the stocks for more than they had paid, but the total dollar value of their portfolio had declined, since the transaction fees exceeded their capital gains. a. Do you think Larry behaved ethically? Explain. b. Would Larry have a personal reason for handling Sandy and

Phil's portfolio as he did? Explain.