Chapter 1

The Financial Planning Process

Learning Objectives
1. Explain why personal financial planning is so important. 2. Describe the five basic steps of personal financial planning.

3. Set your financial goals.

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Learning Objectives
4. Explain the personal finance lessons learned in the recent economic downturn. 5. Explain how career management and education can determine your income level.

6. List ten principles of personal finance.

7. Understand that achieving financial security is more difficult for women.

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Introduction
Its easier to spend than to save.

Personal financial planning is an ongoing processit changes as your financial situation and position in life change. Manage and control your finances with a personal financial plan.
It helps you achieve financial and lifestyle goals.

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Importance of Personal Financial Planning

Accumulate wealth for special expenses

Save for retirement

Cover your assets

Invest intelligently
Minimize payments to Uncle Sam

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Five basic steps to personal financial planning

1. Evaluate your financial health 2. Define your financial goals 3. Develop a plan of action

4. Implement your plan

5. Review your progress, reevaluate, and revise your plan

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Step 1: Evaluate Your Financial Health

Examine your current financial situation.
How much money do you make?
How much are you spending and on what?

Use careful record keeping to track finances and spending.

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Step 2: Define Your Financial Goals

Write or formalize your goals.

Attach a financial cost to each one.

When will you need the money to achieve the goal? Analyze and revise your goals.

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Step 3: Develop a Plan of Action

Flexibility:
Plan for life changes and the unexpected.

Liquidity
Immediate use of cash by quickly and easily converting an asset.

Protection
Prepare for the unexpected with insurance.

Minimize Taxes
Keep more of what you earn.
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Step 4: Implement Your Plan

Stick to it.

Use your financial plan as a road map to achieve goals.

Keep goals in mind and work towards them.

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Step 5: Review, Reevaluate, and Revise

Review progress.

Reevaluate and revise for changes in your life.

Be prepared to formulate a different plan to meet your goals.

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Figure 1.1 The Budgeting and Planning Process

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ESTABLISHING YOUR FINANCIAL GOALS

Short-termwithin 1 year Intermediate-term1 to 10 years Long-termmore than 10 years

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ShortTerm Goals
Accumulate Emergency Funds Equaling 3 Months Living Expenses Pay Off Bills and Credit Cards Purchase Insurance Purchase a Major Item Finance a Vacation

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Intermediate-Term Goals
Save for Older Childs College Save for a Down Payment Pay Off Major Debt Finance Large Items (Weddings) Purchase a Vacation Home

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Long-Term Goals
Save for Younger Childs College Purchase Retirement Home Create a Retirement Fund to Maintain Current Standard of Living Take Care of Elderly Family Members Start a Business

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Figure 1.2 Personal Financial Goals Worksheet

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Figure 1.3 A Typical Individuals Financial Life Cycle

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Stage 1 The Early YearsA Time of Wealth Accumulation

Prior to age 54

Develop a regular savings pattern:

How much can be saved? Is that enough? Where should the savings be invested?

Cost of raising children

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Table 1.1 The Cost of Raising a Child

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Stage 2 Approaching RetirementThe Golden Years

Transition years between ages 55-64.

Depends on preparation for retirement.

Reassess financial goals and decisions retirement, insurance protection and estate planning.

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Stage 3 The Retirement Years

After age 65, live off savings
Retirement age depends on savings.

Less risky investment strategy Consider extended nursing home protection. Estate planning decisions and documents are critical.

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Thinking About Your Career

A series of positions to show your skills. Is the job important, enjoyable, and satisfying? Does it provide for your desired lifestyle?

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Figure 1.4 Job Search Worksheet

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Figure 1.4 Job Search Worksheet (cont.)

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Figure 1.4 Job Search Worksheet (cont.)

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Choosing a Major and a Career

Effective self-assessment
Interests, skills, values, personal traits
Desired lifestyle

Research career alternatives and match with your skills and interests Research potential earnings

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Table 1.2 What Different College Majors Earn

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Getting a Job
Start early Prepare and practice for interviews Research the company

Dress appropriately, be confident, and follow-up

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Table 1.3 Most Common Interview Questions

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Being Successful in Your Career

Do good work.

Project the right image.

Understand and work within the power structure. Gain visibility.

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Being Successful in Your Career

Take new assignments.

Acquire new skills and keep up with technology.

Develop a strong network. Be ethical.

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What Determines Your Income?

Skills

Education
The wealthy are married

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Figure 1.5 Education and Earnings

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The foundation of personal finance.

Principle 1: The Best Protection Is Knowledge

Understand the basics of personal finance.

Take responsibility for your lifetime financial plan.

Seek professional advice wisely.

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Principle 2: Nothing Happens Without a Plan

Easier to think about spending than about saving. Saving must be planned. Putting off a financial plan means goals are harder to achieve.

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Principle 3: The Time Value of Money

Money received today is worth more than money received in the future. Understand how savings and investments grow over time Understand compound interest. Understand spending now and paying later

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Table 1.4 Importance of Starting EarlyJust Do It!to Accumulate $1 Million by Age 67 Investing Your Money at 12%

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Principle 4: Taxes Affect Personal Finance Decisions

Know the effect of taxes on the rate of return of investments. Compare investment alternatives on an after-tax basis. Understand tax laws.

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Principle 5: Stuff Happens, or the Importance of Liquidity

Plan for unexpected events

Have money or liquid funds available

Liquid funds should cover 3 to 6 months of living expenses

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Principle 6: Waste Not, Want Not - Smart Spending Matters

Differentiate want from need

Do homework before the purchase

Make the purchase at the best price

Maintain your purchase

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Principle 7: Protect Yourself Against Major Catastrophes

Have the right kind of insurance before a tragedy occurs. Know your insurance policy coverage.

Focus insurance on major catastrophes which can be financially devastating.

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Principle 8: Risk and Return Go Hand in Hand

Saving and investing grows money.

Investors demand a minimum return above anticipated inflation.

Investors demand higher return for added risk. Diversification by spreading money in several investments reduces risk.

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Figure 1.7 The Risk-Return Trade-Off

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Principle 9: Mind Games, Your Financial Personality, and Your Money Behavioral biases lead to big financial mistakes. Mental accounting impacts financial decisions. Sunk cost effect pours good money after bad money because of bias.

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Principle 10: Just Do It!

Taking the first step towards your goals is difficult. The following steps become easier. First step is to pay yourself firstsave then spend. Saving early can make a big difference.

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Women and Personal Finance

Tougher to achieve financial security.

Generally earn less.

Less likely to have pensions.

Qualify for less Social Security.

Live longer than men. Planning for financial independent more difficult for them than it is for men.
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Women and Personal Finance

Need to take charge of their money and financial future. Acquire knowledge.

Make things happenneed a plan.

See a financial planner about specific concerns.

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Summary
Personal financial planning allows you to manage your finances and achieve lifecycle financial goals. There are five basic steps to personal financial planning. Set your financial goals in order to achieve them with a financial plan.

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Summary
An emergency fund can help protect yourself in the event of an economic downturn. The more educated your are, the more you will earn. There are ten basic principles on which personal financial planning is built. Planning is especially important for the financial future of women.
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Figure 1.6 How Long Households Go Without Income Before Hardship Sets In

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