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81 Cards in this Set
- Front
- Back
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The Financial Planning Process
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1. Determine your current financial situation
2. Develop financial goals 3. Identify alternative courses of action 4. Evaluate alternatives/risks 5. Create and implement a financial action plan 6. Reevaluate and revise your plan |
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Types of Financial Risks
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1.Inflation risk-
Rising prices cause lost buying power 2. Interest-rate risk- Effects cost of borrowing and rate of return 3. Income risk- The loss of a job 4. Personal risk- Health, safety, or costs 5. Liquidity risk- Higher return may mean less liquidity |
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Influences on Personal Financial Planning
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See Exhibit 1-6 pg. 13
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Simple Interest
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Principal X Rate X Time
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Rule of 72
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72/Annual rate of return= the num. of years it takes to double your $
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Opportunity Cost
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What you give up by making a choice
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Time Value of Money
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Study HW
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Components of Personal Financial Planning
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1. Obtaining
2. Planning 3. Saving 4. Borrowing 5. Spending 6. Managing Risk 7. Investing 8. Retirement and estate planning |
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Money Principle #1
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When dealing with the financial services industry and third party financial advice, be highly skeptical and aware of potential conflicts of interest.
If it's too good to be true, the it probably is. |
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Mistakes in Financial Planning
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1. Delaying decisions
2. Spending more than you earn/not saving enough 3. Not paying off high interest credit cards 4. Looking for the big kill, chasing latest trend 5. Letting emotions interfere 6. Trying to time the market 7. Failing to diversify 8. Not taking enough risk |
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CFP's see these Financial Planning Mistakes
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1. Don’t set measurable goals
2. Make decisions without understanding the effect on other financial issues 3. Confuse financial planning with investing or tax planning 4. Neglect to reevaluate financial “plant” 5. Think planning is for the wealthy, or older people, or only for retirement 6. Wait for a crisis before planning 7. Having unrealistic investment expectations |
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Financial Aspects of Career Selection
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1. Trade-offs of career decisions
-Overtime vs. family time? -Company moves (spouse transfer)? -Two income household? 2. Career training and development -Get trained by the best if possible -Continue to upgrade your skills |
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Economic Conditions Influence Jobs
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1. Competition in other geographic regions
2. Automated Production |
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Resume Parts
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1. The personal data section
2. The career objective section 3. The education section 4. The experience sections 5. The related information section 6. The references section Provided on request Prep your references! 6. Cover letter/email |
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Types of Resumes
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1. Chronological
Focuses on experience in reverse order 2. Functional Focuses on your skills 3. Targeted Modified for a specific position 4. E-resumes for applying for a job online |
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Pre-Tax and After
Tax Benefits |
1. Pre-Tax benefits X (1-tax rate) = After Tax Value
2. After Tax benefit divided by (1-tax rate) = Pre-Tax benefit value |
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401-K Plan
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1. Allows employees to save for retirement and get a tax break
2. Allows employers to match employee contributions with no immediate tax due 3. All savings grow tax deferred 4. Amounts saved are taxed when withdrawn at retirement 5. Early withdrawal will trigger tax due 6. Early withdrawal results in 10% penalty (except 457 Plans) |
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Cost of Living and Salary Formula
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Index Num. X Salery/ Index Num. = $ buying power
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Money Principle #2
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A dollar today is worth more than a dollar received in the future.
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Tax Deferred Liabilities
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Better because you are worth more now and are borrowing on a 0% interest rate.
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Money Principle #3
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If you don’t measure it, you can’t manage it.
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Basic Financial Statements
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Balance sheet, income statement, and cash flow.
Review Excel Files |
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Balance Sheet
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Assets= liabilities + net worth
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Income Statement
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Revenues or income minus expenses = net income or loss, which either increases or decreases net worth
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Cash Flow Statement
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Reflects cash flow generated, less casg used for (or from) investments, and cash used for (or from) financing. It reconciles beginning and ending cash balances
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(Types of) Assets
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Cash or other property with monetary value.
1. liquid- things that can easily be turned into cash including checking and savings acct., money market accts., investments (stocks and bonds), cash value of life insurance. 2. Illiquid- real estate, personal possessions, cars, investments assets (retirement). |
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(Types of) Liabilities
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Ammounts owed not including items not due yet.
1. Current or short term-medical bills, tax payments, insurance premiums, cash loans, and charge accts. 2. Long Term- Mortgage, home improvement loan, and a student loan. |
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Net Worth
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assets - liabilities
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Insolvency
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liabilities exceed assets/can't pay debts when they are due
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Fixed vs. Variable Expenses
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Fixed- don't vary from month to month
Variable- change every month |
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Financial Ratios
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1. Net worth = Total assets – total liabilities
2. Debt ratio = Liabilities/net worth 3. Liquidity ratio = Liquid assets/monthly expenses 4. Debt payments ratio = Monthly credit pmts/take home pay 5. Savings ratio = Monthly savings/gross monthly pay |
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Money Principle #4
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Understanding taxes is critical to wealth accumulation.
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Tax Forms
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Study form 1040 and Schedule A
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Taxable Income
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net amount of income, after allowable deductions. on which income tax is computed.
gross income -adjustments= AGI -standard or itemized deduction -exemptions= taxable income |
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Tax Exempt Income
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Income that can't be taxed
example: 1. Employer paid accident and health insurance premiums 2. Employer paid company parking 3. Athletic facilities provided by employer on site 4. Damage awards: personal physical injuries or sickness 5. Gifts and inheritances received 6. Scholarships and fellowships: degree programs 7. Payments under workers compensation acts |
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Tax Deferred Income
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not included in gross income.
Example: Income that will be taxed at a later date, such as earnings from an traditional individual retirement account (IRA) or interest on a U.S. Savings Bond |
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Adjusted Gross Income
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is gross income after certain reductions have been made. These reductions are called adjustments to income, and include the following
1. Contributions to a traditional IRA or Keogh 2. Alimony payments 3. Student loan interest up to $2,500 4. Moving expenses |
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Deductions from AGI to get Taxable Income
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Itemize deductions on Schedule A
1. Medical and dental expenses >7.5% of AGI 2. Taxes, contributions and theft loses 3. Mortgage interest, investment interest 4. Charitable contributions 5. Moving and job-related expenses |
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Marginal vs. Average Tax Rates
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Marginal is used to make all financial descisions.
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Tax Credit
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an amount subtracted directly from the amount of taxes owed
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Capital Gains and Losses
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Investments are called capital assets.
Gross Income includes net capital gaines. Long-term capital gains are taxed at more favorable rates. |
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Tax Free Investments
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1. Interest on municipal bonds
2. Interest on Roth IRAs 3. Interest from Sec. 529 college savings plan |
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Dividends
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Dividends are paid by corporations to shareholders from after tax profits (most pay 35% tax)
Individuals also pay taxes on these dividends, thus they are taxed twice |
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Types of Taxes
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1. Taxes on purchases
Sales tax & excise tax (regressive) 2. Taxes on property Real estate tax Personal property tax 3. Taxes on wealth Federal estate and gift taxes $13,000 per person per year exclusion (2010) for gifts State inheritance tax 4. Taxes on earnings Income tax (progressive) Employment taxes 5. Use taxes Toll roads Airport landing fees |
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Money Market Accounts and funds
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Money market accounts ARE covered by the FDIC, but money market mutual funds previously were not
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Money Market Mutual Fund
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Money market mutual funds are offered by your broker or even your bank
Mutual funds pool money and invest in U.S. treasuries (very safe) Consider buying Treasury bills directly from the government Short term commercial paper (CP) issued by major corporations (widely diversified investments) with low risk of default Some covered by temporary government insurance |
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Money Market Account
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savings acct. that requires a min. balance and has earning based on market interest rates
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Foreign Currency
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Fee at market rate or no fee at a higher rate.
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Liquidity vs. Safety
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Higher Return = lower liquidity
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Interest Rates and Variables on investments
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Actions if Interest Rates Are Increasing
Investors: Keep short term horizon e.g. short term CD Borrowers: Lock in long term rates e.g. mortgage Actions if Interest Rates Are Decreasing Investors: Lock in long term rates e.g. long CD or bonds Borrowers: Borrow short term, wait for fall to lock in |
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After Tax Rate of Return on SAvings
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Yield on savings times (1 minus tax rate)
6% times (1 - .25) .06 times .75 = .045 or 4.5% So even if you are earning 6%, after you pay taxes on the interest you earn you are actually earning only 4.5% after you pay taxes on the interest |
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Treasury Yield Curve
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The treasury yield curve is normally “positive”…short term rates
are lower than long term rates. When long term rates are lower than short term rates, the curve is “negative” or inverted, often forecasting a recession |
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Base Points
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represent 1/100th of a percent
100 basis points = 1% (.01) 50 basis points = ½% (.005) 25 basis points = ¼% (.0025) Example: 30 year fixed rate mortgages are currently 245 basis points above the 10 year treasury note |
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APR vs. APY
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APR = Periodic interest rate times number of periods
Annual interest rate of 10% paid annually = 10% APR (.10 x 1) Annual interest rate of 10% paid monthly; the periodic rate is .10/12 or .00833/month. The APR is .00833 x 12 or 10% Which scenario is best for investors???? 1,000 invested for one year at 10% APR with: Annual compounding = $100.00 of interest Monthly compounding = $104.71 of interest Daily compounding = $105.16 of interest APY indicates effective rate APY = (1 + periodic rate) - 1 Daily APY = (1 + (.10/365)) -1 or 10.516% You should know how to compute PV and FV using your HP (the I key represents APR interest) The more frequent of the compounding, the higher the APY or effective interest rate will be (good for the investor, bad for the borrower) APY is the appropriate measure of effective interest earnings or cost |
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Bank Reconciliations
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To reconcile the bank statement:
Balance per bank statement + Deposits in transit not clearing - Outstanding checks not clearing = Correct balance in your checkbook |
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Check Endorsements
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Checks are negotiable instruments
Checks can be signed over to another person Restrictive endorsements provide protection For deposit only Be careful of special endorsements for promotional items, for example Cell phone promotional check obligates you to 2 year commitment Insurance settlement checks |
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Appropriate Debt
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Home mortgages – equity loans for improvements
Loans for capital or long term durable goods (e.g. autos) Student loans if needed, within a limited time period Medical emergencies |
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Inappropriate Debt
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Credit card
High cost finance companies Paycheck advances Pawn shops Borrowing to pay current expenses Home equity loans to pay off credit cards Saves interest, but are you risking your house? |
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401-K Borrowing vs. Home Equity Loan
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Home equity loan is better: interest is deductable
payback longer no double tax Credit capacity is a function of the home’s value less the mortgage outstanding; most lenders target 75% - 85% of fair market value (FMV) |
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FICO Score Impacts
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Types of credit accounts
Mortgage, car loan, and limited cc best Length of credit history The longer the better Number of recently opened accounts More than 1 or 2 = trouble How much you owe Timeliness of payments |
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FICO Score Improvements
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Stop paying bills late!!!
Reduce credit card/account applications (reduces your FICO score by 3 to 12 pts.) Pay down credit cards evenly * Don’t use a new credit card to lower other balances * * These actions may not be in your best economic interest if you can save money with a lower rate |
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Debit Cards vs. Credit Cards
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Debit:
Advantages Convenient Don’t have to carry cash or checks Can prevent credit card debt and bad checks Disadvantages Consumer protections weaker if lost No stop payment ability Fees Loss of float Rewards/points not as good as credit cards Debit cards are not considered “best practice” but may be appropriate for spenders Credit Cards: Used by 8 out of 10 Americans One-third are convenience users The other two-thirds are borrowers Co-branding - linking a credit card with a business offering rebates on products and services $50 exposure for lost card |
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Money Principle #5
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You will never get ahead financially if you are paying interest on credit card debt…and paying off credit card debt is a great investment.
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Credit Card Interest Calculation Methods
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Average daily balance excluding new purchases
Best Average daily balance including new purchases Better (typical) Two cycle daily balance excluding new purchases Bad (now illegal) Two cycle daily balance including new purchases Worst (now illegal) |
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Advantages of Credit
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You get to buy now
Even when funds are low Use for financial emergencies Convenient when shopping Safer than cash Can take advantage of float time May get cash rebates, airline miles, etc. Demonstrates financial stability |
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Disadvantages of Credit
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Purchases are more expensive
Temptation to overspend Ties up future income Possible financial difficulties Marital issues Potential loss of merchandise due to late or non-payment |
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Closed Ended Credit
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Repaid at maturity
Mortgage loan Automobile loans Installment and some home equity loans |
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Open-Ended Loans
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Use as needed until reaching line of credit
You pay interest and finance charges if you do not pay the bill in full when due Revolving check credit - prearranged loan Open end home equity loan |
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Cosigning Loans
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Before cosigning a loan consider...
If the person doesn’t pay, you will have to Can you afford to pay if the person does not? It can affect your credit report Request that a copy of overdue payment notices be sent to you Cosigning loans is a very BAD idea! |
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Five C's of Credit
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Character - Do you pay bills on time?
Capacity - Can you repay the loan? Capital - What are your assets and net worth? Collateral - What do you have of value that the lender can take if you don’t repay? Conditions - What economic conditions could affect your repayment of the loan? |
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Fair Credit Billing Act
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Notify creditor of error in writing within 60 days
They must respond within 30 days Credit card company has 90 days to resolve the problem or tell you why they think the bill is correct Won’t affect your credit rating while in dispute You can withhold payment on shoddy goods if you have paid for them with a credit card |
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The Truth in Lending Act
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The Truth In Lending Act requires creditors to provide you with accurate and complete credit costs and terms (APR)
Creditors must disclose credit terms and information... In a clear and conspicuous manner In a form you can keep |
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Fair Credit Reporting Act
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Is your credit report accurate?
If you are denied credit based on your report, you can get a copy free within 60 days Inaccurate information must be corrected within 30 days Only authorized persons have access to your report Adverse data can be reported for seven years and bankruptcy for ten years |
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Other Acts/Laws
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Consumer Leasing Act
Equal Credit Opportunity Act Fair Credit Billing Act Fair Credit Reporting Act Consumer Credit Reporting Reform Act Fair and Accurate Reporting Act |
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Sources of Consumer Credit
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Inexpensive loans
Parents and family members Loans based on assets, such as a CD Medium-priced loans Commercial banks, savings and loans Credit unions Expensive loans Finance companies Retailers such as car or appliance dealers Bank credit cards and cash advances |
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Trade-Offs of Getting a Loan
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Lowers Interest Rate
Loan term Short term Interest rate Variable rate Down payment High down pmt. Collateral Good collateral Raises Interest Rate Long term Fixed rate Low down pmt. No collateral |
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Debt Capacity
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Debt Payments-to-Income Ratio
Should Be < 20% monthly payments*/monthly after tax income *Not including housing |
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Debt to Equity Ratio
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total liabilities/net worth*=
should be less than 1 *Excluding home value |
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APR
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periodic rate x number of periods
Borrow $100 and pay 10% due in one year APR = 10% x 1 or 10% APY = (1 + .10) - 1 or 10% Borrow $100 and pay 10% ($10) interest, in 12 equal installments. $110/12 = $9.17/mo Solve for APR (i) using HP End Mode PV = -100 Pmt/yr = 12 n = 12 Pmt = 9.17 FV = 0 Solve for I = 17.97% APR Periodic rate = .1797/12 = .014976/mo APY = (1 + .014976) -1 = .1952 |
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How to Fix a Credit Problem
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Notify creditors if you can’t make a payment
Debt collection practices require If a debt collector calls you, within five days they must send you a written notice of amount owed You can dispute the debt The debt collector has 30 days to verify the debt Consolidate loans if it makes sense Consumer Credit Counseling Service If you can’t pay your bills, postpone further credit purchases, talk with your creditors, or seek help from a non-profit credit counseling service Non-profit (CCCS recommended) Make an appointment Businesses pay for its operation Provides education about credit Provides help with spending plan Provides debt counseling services for those with serious financial problems |
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Bankruptcy Types
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Chapter 13
Plan to pay a portion of your debt Trustee distributes money to your creditors Can keep most of your property Must have a regular income Chapter 7 Submit a petition and pay a fee Lawyers charge +-$500, including court costs Can keep some property Idea is a fresh start Congress just made Chapter 7 more difficult if you have some source of income to partially repay debts |
