The Financial PlanCHAPTER 2

Chapter Objectives Describe the purpose of a financial plan

Identify the key components of a financial plan

Objective 1DESCRIBE THE PURPOSE OF A FINANCIAL PLAN

Financial Plan Involves specifying financial goals

Describing in detail the plans for:1. Spending2. Financing 3. Investing

It’s important to have a personal financial plan because it becomes your roadmap that serves as a detailed guide that will help you achieve your goals.

Financial PlanBest description of a financial plan: It’s like a blueprint for a builder.

1. How to accumulate and grow wealth2. How to provide for emergencies3. Ensures you make steady progress towards your financial goals

7 Key Components of your Financial Plan

Objective 2 IDENTIFY THE KEY COMPONENTS OF A FINANCIAL PLAN

Component 1 – Plan for Your Budgeting and Taxes

About 40% of teens 12-17 years old have a savings or checking account in their name

BUDGETING: process of forecasting future expenses and income

Purpose of a budget is to plan your spending and saving, given your current income level so you can meet your needs and wants.

4 Steps to Creating a Budget

1. Determine your net worth

2. Establish your income

3. Identify your expenses

4. Consider the impact of taxes

Step 1: Determine Your Net Worth

Knowing your net worth is important because it helps you know where you are beginning in your quest to reach your goals.

Where are you right now financially?

Do you have money in the bank?

Do you owe people money?

Do you have a job?

What are your expenses?

FORMULA FOR FINDING YOUR NET WORTH: Net worth = Assets – Liabilities

Vocabulary Assets: anything owned, such as cars, motorcycles, and homes

Liabilities: what we owe, or our debt

Net worth: the differences between your assets and liabilities

Equity: the amount of a specific asset that we own after subtracting any liabilities

Asset = Car Worth $5,000Liability = Amount Owed - $2,000Net Worth = $3,000

Equity also = $3,000 because equity means ownership (Equity: the amount of a specific asset that we own after subtracting any liabilities)

Net Worth for Emily Emily’s car is worth $5,000

Emily still owes $1,000

She also has $500 in a savings account

What is Emily’s net worth? (hint: Net worth = Assets – Liabilities)

$5,000 + $500 (Assets) = $5,500 - $1,000 (Liabilities)

Net Worth = $4,500

Step 2: Establishing Your Income

Income is the money coming in through wages earned, allowance, or other sources

Income is the major means by which a person:◦ Saves money◦ Builds wealth◦ Acquires assets ◦ Fulfills wants and needs

A person’s income depends on decisions he/she makes about education and career choicesThe more education or specialized training, the more income made

Step 3: Identifying Your Expenses

Estimate how much money you’re spending every month◦ Knowing expenses makes it possible to determine if your income is sufficient to meet your needs.

Typical expenses might be clothing and entertainment

Some may have car payments and related expenses

Use accurate estimates

Step 4: Consider the Impact of Taxes

Income taxes – money owed to government on earned income

The more money you make, the more you’ll pay in taxes

As your income level increases you’ll want to include tax planning in your financial plan

Components of Your Financial PlanCONTINUED (STEPS 2 – 7)

Component 2: A Plan for Managing Your Liquidity

You go to the store and don’t have enough money. That’s a LIQUIDITY problem.

You didn’t have enough liquid assets to cover your purchase.

Your level of liquidity is how much readily available cash you have on hand for immediate wants and needs.

People without enough liquidity often use credit to cover immediate shortfalls. (costly)

Liquidity is different than net worth

Having assets that aren’t liquid (examples?) will be no use to you when facing a short-term financial need.

Example: If you need $20 and have a car worth $5,000, it will do little to help you.

Liquidity ManagementMONEY MANAGEMENT

Making decisions about how much cash/liquid assets to keep in reserve

How much should you invest in less liquid assets, such as REAL ESTATE? (buildings and land)

Money management helps you determine how much money to keep liquid to avoid cash downfalls.

CREDIT MANAGEMENT

Making decisions about getting credit and using credit. (borrowing money)

Used to cover immediate cash shortfalls, so it increases liquidity.

Lender charges interest.

Interest is rent on money borrowed.

Don’t use credit if you can’t pay back quickly.

Limit your amount of cards and credit limit.

Component 3: A Plan for Your Financing

Financing - Taking a loan out to pay for a portion of a major purchase, such as a car or house.

Example: You have $1,000 down payment for a $4,000 car. You FINANCE the remaining ???

Payment Terms Include: The interest rate the lender will charge you – 8%

Time period for paying back the loan – 4 years

Down payment amount (if applicable) - $2,000

CREDITWORTHINESS: an assessment of how likely you are to pay back the loan

Payment schedules for long-term loans use monthly payments.

Credit-card financing is usually available AT A HIGHER COST TO a borrower compared to longer-term financing for a major purchase.

Component 4: A Plan for Managing Your Risk (Insurance Planning)

Risk – the possibility of a financial loss

Without insurance on a major purchase, the owner assumes all of the risk.

Types:◦ Life insurance – protects loved ones left behind◦ Home insurance – protects your house◦ Car insurance – protects your vehicle

Component 5: A Plan for Your Investing

People invest money so they can make more money◦ Stocks◦ Bonds◦ Mutual funds

Remember that different types of investments have different levels of risk

Riskier investments can produce great returns—but also may experience significant losses

In a typical budget, money for investing tends to be money remaining after paying bills.

Component 6: A Plan for Your Retirement

People who plan for retirement while they are young often retire early

Retirement planning involves determining how much to save for retirement and how to invest that money AS EARLY AS POSSIBLE.

Component 7: A Plan for Communicating and Keeping Records

Communicate your financial plan to your family

Keeping good records of your finances is equally important

These records will help you when you file your taxes and calculate your net worth

Your heirs may also need these records at some point as well