AAEC 2104, Intro + Chap 1-2 notes
AAEC 2104, Intro + Chap 1-2 notes AAEC 2104
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This 9 page Bundle was uploaded by Mara DePena on Saturday February 6, 2016. The Bundle belongs to AAEC 2104 at Virginia Polytechnic Institute and State University taught by Dr. White in Spring 2016. Since its upload, it has received 116 views. For similar materials see Personal Financial Planning in Agricultural & Resource Econ at Virginia Polytechnic Institute and State University.
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Date Created: 02/06/16
AAEC 2104 INTRODUCTION WHAT IS FINANCIAL PLANNING? Budgets- The keystone of financial planning. Health expenses are the biggest causes of debt. You are booted off of your parents’ insurance when you are 26. Individual Retirement Account (IRA) should probably be set up before the end of the semester. Savings account should have 3-6 months of living expensives. Financial planning is an organized method of achieving your life goals. Identifying and managing risks and unexpected events. o Financial, property, health, disaster, etc. Improving the security of a household. Reducing your stress level. Improving your life style helps you do what you want to do. MAIN ASPECTS OF PERSONAL FINANCE Setting goals Budgeting and cash management Debt management o Credit cards, auto loans, mortgages, etc. Insurance planning o Life, health, auto, home, disability, long term care Investing o Stocks, bonds, mutual funds, asset allocation Income tax management Retirement planning o IRA, 401(k), SIMPLE, SEP, etc. Education planning o 529 plans, Hope/Lifetime credits Estate planning o POA, AMD, will, trusts, gifting o Controlling assets while alive and after we die A BIG PUZZLE All aspects are interrelated o Changes in one area filter through other areas Constantly changing o Laws and regulations o Life events o Changing goals Requires patience AAEC 2104 CHAPTER 1 WHY PERSONAL FINANCIAL PLANNING? Money doesn’t come with instructions It’s easier to spend than save People are ignorant If you don’t control your finances, they will control you To achieve your goals To reduce your stress WHAT YOU CAN ACCOMPLISH Manage the unplanned “Find money” Make big-ticket purchases Accumulate wealth for special expenses and goals Invest for retirement Cover assets Invest intelligently Maximize after-tax income THE FINANCIAL PLANNING PROCESS Financial planning is an ongoing process o As your life goals and situation Five basic steps to personal financial planning: o Evaluate your current financial position What do you own? (assets) What do you owe? (liabilities, debts) What do you earn? (income) What do you spend? (expenses) What are you spending it on? Requires careful record keepings Assets, liabilities, income, expenses o Define your financial goal Short term (less than 1 year) Intermediate (1-10 years) Long term (over 10 years) Over time, goals change, so revise them SMART goals Specific Measurable Attainable/achievable Rewarding Timeframe o Develop a plan of action Babe Ruth Rule- Have three different plans. Written, organized plan with deadlines Flexible Plan for life changes/the unexpected Liquidity (cash on hand) Accessing cash quickly and easily Protection Prepare for the unexpected with insurance Managing taxes Keep more of what you earn o Implement your plan Put the plan into action Keep goals in mind and work towards them o Review your progress, re-evaluate your situation/goals, and revise your plan Review regularly THE LIFE CYCLE OF FINANCIAL PLANNING The early years o Expenses > income The earning years o Starting in the work force The golden years o Prime earning years The retirement years o Expenses are probably > income KEY PRINCIPLES OF PERSONAL FINANCE These principles form the foundation of personal finance 1. The best protection is knowledge o Keep up-to-date on financial matters o Ask, read, observe, etc. o Lots of sources of information o Avoid “mistakes of ignorance” 2. Nothing happens without a plan o Think before you act o Saving must be planned Pay yourself first (take 10% of paycheck in savings) o Time is your best friend 3. The time value of money o Money has a time value (RIO) Risk- you may not get paid in the future Inflation- money won’t buy you as much in the future Opportunity cost o $1 today is worth more than $1 in the future o Compound interest 4. Taxes affect personal finance decisions o They influence your actual earnings o Goal- maximize your after-tax return o Compare investment alternatives on an after-tax basis o Don’t make decisions strictly based on taxes 5. Stuff happens- the importance of liquidity o Have funds available for the unexpected 3-6 months of living expenses o Without liquid funds Long-term investments must be liquidated Results in lower price, tax, consequences, or misses opportunities o With nothing to sell: Pay higher interest to borrow money quickly 6. Waste not, want not- smart spending matters o Fastest way to improve your financial situation- reduce your spending o Wants v. needs o Be a smart consumer o Comparison shop o Take care of your stuff 7. Protect yourself against major catastrophes o Have the right insurance before a tragedy occurs o Know your policy coverage Know what’s not covered o Insurance focus should be on major catastrophes which can be financially devastating 8. Risk-Return Trade-Off o Low risk <-> Low return o High risk <-> High return o Investors demand higher return for taking added risk o What is your risk tolerance? 9. Diversification reduces risks o Don’t put all your eggs in one basket o Place money in several types of investments o Reduce your risk exposure Smooths out your returns However, may reduce your potential returns 10. Just do it o Making the commitment to start is difficult Rest is easier o Time is one of your main investment allies Procrastination = enemy o Take action now AAEC 2104 CHAPTER 2: MEASURING YOUR FINANCIAL HEALTH WHERE ARE YOU TODAY? Balance sheet o List of all the stuff you own/owe On a given date o What you own and how you have paid for it o Terms: Assets- What you own Listed at fair market value Monetary- Cash, checking, savings, CDs, MMAs, emergency funds Investments (non retirement)- Stocks, bonds, mutual funds, real estate. Cash value of life insurance, annuities Retirement assets- Values of IRAs, 401(k), pensions Housing- Value of owned residences. Automobiles- Value of all autos Personal property- Collections, clothing, furnishings, etc. Liabilities- Your debts, what you owe TODAY Current liabilities- Due within 1 year. o Payables- Bills you owe but haven’t paid yet, credit card balances (principal only) Long-term or non-current liabilities- Principal remaining on each loan Net worth/equity- Your financial value Assets-liabilities Want it to be positive and to grow over time Income statement o Grant Hill Principle- Doesn’t matter how much you earn, but how much you spend o “Budget”- cash in and cash out o Income and expense statement o Tracks your money over a period of time o Cash accounting Record when the cash changes hands o Easier to do on a monthly basis, then do it annually o Helps identify ways to reduce spending, project a budget for the future, determine how much you can save/invest per month o Swamp issues- Issues you can’t change, and move on Budgeting o Crucial for your financial future o Projections of your income and expenses o Relatively simple o Review your goals o Review your income statement o Estimate your income for the upcoming month Gross or net of income taxes Don’t double count income/payroll taces o Build savings and investments into your budget Before you look at your expenses Pay yourself first o Estimate expenditures for the month Based on experience and income statement Incorporate goals o Incorporate a “fudge factor” of 10-20% You will forget or underestimate something Multiple expenses by .1 and then add that in as other expenses (worst case scenario) o Find leaks in wallet o Compare actual expenses to budget o Revise budget and/or lifestyle o For on campus- room & board, divide by four o What if it comes out negative? Is your math correct? Can you reduce any expenditures? Look at top 5 Shop smart Do you need to change your lifestyle? Do you have savings to fall back on? o What if it comes out positive? Increase savings Invest for retirement Pay down debts Donate to church/charity Increase living expenses a little o Help? Spreadsheet Quicken, quickbooks Mint.com FINANCIAL HEALTH Need to look at everything o Balance sheet o Income statement o Financial ratios Track changes over time Identify potential problems Impact of change in goals Financial ratios o Liquidity Months living expenses Monetary assets/monthly living expenses Doesn’t include savings/taxes Benchmark: Standard: 3-5 months o Debt payment Debt payment/income ratio Total debt payments/gross income Benchmark: Less than 38-40% Use total debt payments plus HO insurance and property taxes PITI- Principles and interest, taxes and insurance Try and keep consumer debt payments (auto, student, credit card) under 10% of your gross income o Savings ratio Not looking at total amount in savings, looking at how much added Savings+investment/gross income Record keeping- why? o Prepare taxes o Track finance over time and control spending o CYA (cover your ass)- in case of lawsuit, etc o Emergencies and the 5 D’s Disease, disability, divorce, disasters, death Drugs, dependence, dumbness, debt, etc o How? File cabinet, envelopes Computer- quicken, etc Accounting service o What to keep Tax records Investment records Insurance records The list goes on o Where? Home- final cabinet Fire-proof safe Safe deposit box o How long? Tax records- 3-7 years Debt records- for life of debt, plus 3 years Investment records- for life of investment + 3 Real estate records- for life Estate planning records- for life, until revised FINANCIAL PLANNING PROFESSIONALS How the charge o Fee only Per hour or per project o Fee and commission o Fee offset Fees reduced by commissions o Commission only Bottom lines: o Work with someone you trust, someone who understands your goals, someone you understand
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