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BA 96 – Personal Finance1/26/09
Elements of personal finance
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understanding income and expenditures
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managing taxes
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Effective use of consumer credit
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Making major purchases (transport, home, education)
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Managing risk with insurances
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Investments and planning for retirementLife cycle planning
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Income and expenditure don’t match over time
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Most people’s major expenditures are predictable at certain points in time
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Save ahead or borrow and pay back to cover gaps btwn income andexpenditure
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Don’t necessarily save constantly throughout life; sometimes save more,sometimes borrow more
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Leasing makes sense sometimes, for exampleRecent societal changes
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Parents support children then children support parents
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Now parents support children until adulthood and children don’t carefor parents
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Pensions were tied to lifetime work at a firm
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Now pensions move with employees – 401ks and such
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Much more risk for individuals!Subsistence
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Half the world lives at subsistence level (enough to live but no discretionaryincome)
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1 billion live on <$1/day
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Few super-rich, but most of us are middle class (some discretionary income)
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How many jeans do I own? Yikes.Life choices - we make a lot of discretionary expenditures
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What’s a ‘good’ income for me? Now, with a 20% raise, what would I spend iton?
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“no matter how much you make, you can always make yourself miserable bywanting something more”
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Choices
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Cousin’s CC tuition or lease a Lexus for me?
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Retire at 40 or keep working for a 2
nd
home?
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Pay for kids’ grad school or give grandparents $1000 a month?
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Remodel kitchen or backpack thru Patagonia?
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Choices come from values – what are mine?
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Education
 
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Fame and prestige
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Financial security
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Luxury
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Personal growth
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Charity
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Family
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Leaving money to family
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 Travel/adventure
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Building a collection Typical income pattern
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S-shaped curve
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Rational people want equal income over lifetime
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Modest living in 40s to avoid poverty in 80s
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Some lean years to make it up laterIncome and expenditure
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Income (more is better)
expenditure (spend on things that feel good);repeat
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Sometimes save some (deferred expenditure)
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Sometimes investments (not always deferred expenditure, can createwealth)
Grow over time, unlike savings
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Net worth = non-financial assets + savings + investmentsIncome vs. net worth
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3 cars and no retirement savings (income all to expenditure)
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‘janitor millionaires’ (over-saving but never spending)Savings vs. investment
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Saving: keep up with inflation, use current income for later expenditure
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Investment: earn returns greater than inflation, grow net worth
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‘net’ = assets – liabilities (own – owe)What can net worth do for me?
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Keep growing it (janitor millionaire)
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Leave money to others (dynastic wealth)
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Values issue – why might I do that?
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Enjoy it (nicer cars)
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Use it for income (retire early, do good things)
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Old people are scared of outliving their money
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Anyone who is currently retired is
screwed 
Major expenses are predictable
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Early 20s – pay for school
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Mid 20s – household formation, wedding expenses
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Late 20s – graduate education
 
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Early 30s – home purchase, childcare
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Late 30s – kids’ expenses
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40s – kids’ college, plan for retirement
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50s – retirement funding, ‘reward’ expenditures
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60s – cutting back on work, prepping for retirement
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70s+ – manage wealth for income and bequestsSummary:
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Financial well-being comes from good planning
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Consumers have choices to make based on personal values
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Realize what’s important to you in young adulthood
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Income and net worth are predictable over lifetime
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Most people face similar life events that need careful planningCompounding
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Compound interest is nice
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$100 at 5% for 30yrs = $432; at 6% is $574
long time periods are good
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Saving a little while young is way better than saving a lot when you’re oldWhy taxes are important
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If investments aren’t tax-protected, you’re earning more like 4.27% if yourr=7%
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IRA, roth-IRA, etcFinancial planning industry
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Not regulated
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How to pick? How are those planners being paid?
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If they don’t charge you, then they’re getting a commission – maybenot the best fit for you
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Consider an independent ‘fee only’ planner if needed
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When do you need one? Exceptional life events
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How to spend inheritance money
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Grandparent moves into a nursing home, needs to use their income +assets to pay
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Marrying someone with 2 kids and no college fund
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When you don’t need one
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When to buy first home?
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Lease a car?
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Pay off student loans before buying things?
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Making a down payment before bonus comes through?
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What can a planner do?
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Risks and payoffs from certain investments
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Balance portfolio
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Recommend alternative investments
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Calculate probability of achieving financial goal (outliving savings)
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Providing objective assessment of your plans
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Rational steps
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