Study guide AAEC 2104
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This 9 page Study Guide was uploaded by Savah Notetaker on Friday September 16, 2016. The Study Guide belongs to AAEC 2104 at Virginia Polytechnic Institute and State University taught by Dr. White in Fall 2016. Since its upload, it has received 9 views. For similar materials see Personal Financial Planning in AAEC at Virginia Polytechnic Institute and State University.
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Date Created: 09/16/16
Personal Finance: Study Guide Financial planning process 5 steps 1. Evaluate current financial situation 2. Define financial goals 3. Develop a plan of action 4. Implement your plan 5. Review your decisions 1. What do you own? (assets) What do you owe? (liabilities or debts) What do you earn? (income) What do you spend? (expenses) These require careful record keeping 2. Goals Short term (less than ~1 year) Intermediate (~110 years) Long term (~over 10 years) Over time goals change so revise them! o Life events, aging, accomplishing other goals, etc. SMART goals Specific o Make them real! Measurable Achievable Rewarding Time frames 3. Written, organized plan with deadlines Use Babe Ruth Rule: 3 reasons to do or not do something, make 3 plans, look at 3 car companies/ insurances options, etc. Flexible plan for life changes and unexpected circumstances Liquidity is accessing cash quickly and easily Protection to prepare for the unexpected with insurance Manage taxes to keep more of what you earn 4. Put plan into action then stick to it 5. Review and revise as needed The last step often returns to the first, no plan is fixed in stone. No goals=No sense Life cycle of financial planning Early years (college students or earlier) o Expenses > income Earning years o Starting the work force Golden years o Prime earning years Retirement years o Expenses are probably > income Key principles form the foundation of personal finance 1. Knowledge a. Keep up to date on financial matters b. Ask, read, observe, ask, read, and so on c. Lots of sources of information i. Rely on trustworthy sources!! d. Avoid mistakes of ignorance 2. Have a plan a. People spend money without thinking, but can’t save without thinking about it b. Saving must be planned i. Start off with a modest, uncomplicated plan ii. Modify later and expand plan 1. “pay yourself first” (put money into your savings account first) c. Remember time is your friend!! i. Earlier you start, the more tools you have 3. Time value of money a. Money has a time value (“RIO”) i. Risk ii. Inflation cost level is increasing iii. Opportunity cost b. $1 today is worth more than $1 to be received in the future c. Compound interest rocks! i. Interest paid on interest 4. Taxes affect Personal Finance Decisions a. Taxes influence your actual earnings b. Goal maximize your after taxreturn c. Compare investment alternatives on an aftertax return d. “Don’t let the tax tail wag the dog” i. Don’t make decisions strictly based on taxes 5. Stuff Happens, or the Importance of Liquidity a. Have funds available for the unexpected b. Without liquid funds: i. Longterm investments must be liquidated ii. Results in lower price, tax consequences, or missed opportunities c. With nothing to sell i. Pay higher interest to borrow money quickly 6. Waste not, want not a. Fastest way to improve your financial situation is to reduce your spending! b. What you want vs what you need c. Be a smart consumer d. Comparison shop (Brand name vs Generic) e. “Take care of your stuff” 7. Protect yourself against major catastrophes a. Have the right insurance before a tragedy occurs b. Know your policy coverage i. Know what’s NOT covered! c. Insurance focus should be on major catastrophes which can be financially devastating 8. RiskReturn TradeOff a. Lowrisk low return b. High risk High return c. Investors demand higher return for taking added risk 9. Diversification Reduces Risk a. “Don’t put all your eggs in one basket” b. Place money in several types of investments c. Reduce your risk exposure i. “smooths out” 10. Just do it!! a. Making a commitment to start is difficult Balance sheet o Budget o Income and expense statements What you own and how you paid for it What you own and owe on a given date Terms o Assets what you own Listed at fair market value o Liabilities debts, what you owe o Net worth financial value Net worth=AssetsLiabilities Balance sheet Assets Monetary Assets o Cash, checking, savings, CDs, MMAs, Emergency funds Investments (nonretirement) o Stocks, bonds, mutual funds, real estate Retirement Assets o Value of IRAs, 401 (K) Tangible assets: o Automobiles Value of Automobiles o Personal property Collectables, clothing, furnishings, etc. Other o Anything else owned that is not listed above o Value (equity) of any businesses you own o Money owed to you Balance sheet Liabilities What you legally owe TODAY! Current liabilities due within 1 year o Payable Net worth What you’re ‘worth’ (in money), your ‘wealth’ NOT a measure of selfworth Want your net worth to be positive o If negative you are insolvent o College students tend to be negative Want net worth to grow over time Income statement Tracks your money over a period of time Cash accounting o Record when cash changes hands Easier to do on a monthly basis than to do on an annual one Income statements help o Identify ways to reduce spending o Project budget for the future Income List ALL sources of income o Gross salary/wages (before taxes) o Tips, commissions, bonuses o Scholarships, grants, welfare, “GI Bill”, gifts o Investment income Interest earned Dividends (cash or stock) o Other income such as garage sale **Advice: after you graduate, try to have 12 months of savings built up Expenses Housing o Rent, repairs, utilities, property taxes, etc. Food o Groceries, food away from home, meal plan Clothing and personal care o Clothes, toothpaste, haircare, toilet paper Transportation o Auto loan payments, rental/lease o Gas, repairs, etc. Medical o Copays, prescription, tests, etc. Insurance premiums o Auto, life, health, LTC, etc. Recreation o Need to classify what you consider “recreation” o Movies, T.V., football games, etc. (entertainment) Other: anything not listed above o Savings, investments, retirement, etc. Don’t double count credit card payments!! o Include under proper expense category Nonregular payments o Insurance premiums Investments as expenses o Savings, investment, retirement, etc. Expenses BEWARE!! Main mistakes: o Double counting o Forgetting what you pay only once or twice a year o Tuition o Investments in expense Budgeting Build savings o 2025%, 10% at least Incorporate “fudge factor” of 10%20% o Unexpected situations Main Financial Ratios: 1. Months Living Expense: Total monetary assets / total monthly living expenses a. 36 months is the bench mark 2. Debt Payment/Income: Total debt payments / Gross income a. 38%40% is the bench mark 3. Savings Ratio Savings and investment / Gross income a. 10% is the bench mark Green – low risk (good) Yellow – Caution area (slow down and try making changes) Red high risk (STOP!) Record keeping People keep records mainly for taxes Keeps track CYA “Cover You’re A**” in case of lawsuit Emergencies and the 5 D’s o Disease o Disability o Divorce o Disasters o Death Where to keep records Filing cabinets QuickBooks Fireproof safe Safe deposit box (at the bank) Keep tax records for 37 years Keep debt records for life of loan and 3 years’ after Time Value of Money $1 today is worth more than $1 in the future 3 main reasons to take money today (RIO) Risk: may not receive money Inflation: increase in general price level Opportunity cost: can do things with $1 today Types of Problems Future Value (lump sum) Present Value (lump sum) Annuities and loan payments o Constant streams of cash flow (per month, per year) Future value of Annuities Present value of Annuities Perpetuities *Lump sum: 1time investment of cash The Chart N= # of periods I= Interest rate PMT= payments PV= Present Value FV= Future Value END/BGN= on the calculator **I have some Example problems for you to practice in Personal Finance 3 if you want to try them Compound interest interest on top of interest (airplane gaining altitude)
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