PERSONAL FINANCIAL

PLANNING (FIN533)

CHAPTER 1
INTRODUCTION

Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Personal Finance Basics and Time Value of

Money
 Chapter 1
2
Learning Objectives
1. Analyze the process for making personal financial
decisions
2. Develop personal financial goals
3. Assess personal and economic factors that influence
personal financial planning
4. Determine the personal and financial opportunity
costs associated with personal financial decisions
5. Identify strategies for achieving personal financial
goals for different life situations
 The Financial Planning Process
3

Objective 1: Analyze the process for making personal

financial decisions
Personal Financial Planning is the process of managing your
money to achieve personal economic satisfaction.

This planning process allows you to control your financial

situation. Every person, family, or household has a unique
financial position, and any financial activity therefore must
also be carefully planned to meet specific needs and goals.

A comprehensive financial plan can enhance the quality of your

life and increase satisfaction by reducing uncertainty about
your future needs and resources.
 The Financial Planning Process
4

 Advantages of Personal Financial Planning are:

1. Increased effectiveness in obtaining, using and

protecting financial resources

2. Increase control of one’s financial affairs

3. Improved personal relationships

4. Sense of freedom from financial worries

 The Financial Planning Process
(continued)
5

Six-step procedure for Financial Planning

 Determine your current financial situation.
 Develop your financial goals.
 Identify alternative courses of action.
 Evaluate your alternatives.
 Create and implement your financial action plan.
 Review and revise your plan.
SIX-STEP PROCEDURE FOR
FINANCIAL PLANNING
 The Financial Planning Process
(continued)
7

Step 1: DETERMINE YOUR CURRENT

FINANCIAL SITUATION
 Determine current financial situation regarding
income, savings, living expenses, and debts
 Prepare a list of current asset and debt balances and
amount spent for various items
 Match financial goals to current income and
potential earning power
 The Financial Planning Process
(continued)
8

Step 2: DEVELOP YOUR FINANCIAL GOALS

 Identify feelings about money and the reasons for those
feelings
 Determine the source of your feelings about money
 Determine the effects of economy on your goals and
priorities
 Make sure that your goals are your own and are specific
to your situation
 The Financial Planning Process
(continued)
9

Step 3: IDENTIFY ALTERNATIVE COURSES

OF ACTION
 Possible courses of action can be:
 Continue the same course of action
 Expand the current situation
 Change the current situation
 Take a new course of action
 The Financial Planning Process
(continued)
10

Step 3: IDENTIFY ALTERNATIVE COURSES OF

ACTION (continued)

 Creativity in decision making is vital to effective choices

 “Do nothing” can be a dangerous alternative

 The Financial Planning Process
(continued)
11

Step 4: EVALUATE YOUR ALTERNATIVES

 CONSEQUENCES OF CHOICES
 Opportunity cost - What you give up
when you make a choice
 The cost or trade-off of a decision cannot always be
measured in ringgit. Sometimes the cost is your time
 EVALUATING RISK
 Uncertainty is a part of every decision.
 Best way to analyze and minimize risk is to gather
information from financial planning sources. (Exhibit 1-3)
 The Financial Planning Process
(continued)
12

Step 5: CREATE AND IMPLEMENT YOUR

FINANCIAL ACTION PLAN
 Develop an action plan that identifies ways to achieve
financial goals

 Possible action plans can be increasing savings,

reducing spending, or making provisions for taxes

 To implement action plans you may need assistance

from others
 The Financial Planning Process
(continued)
13

Step 6: REVIEW AND REVISE YOUR PLAN

 Financial planning decisions need to be assessed

regularly

 Complete review should be done at least once a year

 Regular reviews of decision-making process can help in

making priority adjustments to achieve financial goals
 Developing Personal Financial Goals
14

Objective 2: Develop personal financial goals

 TYPES OF FINANCIAL GOALS can be:
 Influenced by the time frame in which you want to
achieve your goals
 Influenced by the financial need that drives your goals
 TIMING OF GOALS
 Short-term, intermediate and long-term goals
 Long term goals should be planned in coordination
with short-term and intermediate goals
 GOALS FOR DIFFERENT FINANCIAL NEEDS
 Consumer product goals
 Durable-produce goals
 Intangible-purchase goals
 Developing Personal Financial Goals
(continued)
15

GOAL-SETTING GUIDELINES
 Goals should be realistic

 Goals should be stated in specific terms

 Goals should have a time frame

 Goals should indicate the action to be taken

Discuss some of your goals

 Influences on Personal Financial
16
Planning
Objective 3: Assess personal and economic factors
that influence personal financial planning

LIFE SITUATION AND PERSONAL VALUES

 Adult life cycle stage

 Marital status, household size, and employment

 Major events

 Graduation, marriage, career change, children,

retirement, etc
 Values

 What values are important to you?

 Influences on Personal Financial
17
Planning (continued)
ECONOMIC FACTORS

 Forces of Supply and Demand and prices

 Study of how wealth is created and distributed

 Economy includes different institutions

 Influences on Personal Financial Planning
(continued)
18

GLOBAL INFLUENCES
 Global marketplace influences financial activities
 Economy affected by both financial activities of foreign
investors and competition from foreign companies
 Balance of exports and imports
 Interest rates
 Money supply
 Influences on Personal Financial
19
Planning (continued)
ECONOMIC CONDITIONS

Consumer The value of the dollar

prices changes in inflation

Consumer The demand for goods and

spending services by individuals and
households

Interest rates The cost of money; cost of

credit when you borrow; return
on your money when you save
or invest
 Influences on Personal Financial
20
Planning (continued)

Financial
Personal Acquisitions
Opportunity Costs (automobile,
(time, effort, health) home, college
education,
Financial investments,
Opportunity Costs insurance,
(Interest, liquidity, retirement fund)
safety )
 Opportunity Costs and the Time Value of
Money
21

Objective 4: Determine the personal and financial

opportunity costs associated with personal financial
decisions
 Every financial decision involves giving up something to

obtain something else

PERSONAL OPPORTUNITY COSTS

 Time
 Other personal opportunity costs can be related to health,
leisure etc.
 Personal resources like financial resources require careful
management
 Opportunity Costs and the Time Value of
Money (continued)
22

FINANCIAL OPPORTUNITY COSTS

Time Value of Money

 Increases in an amount of money
as a result of interest earned.
 Saving today means more money tomorrow. Spending
means lost interest.
 Saving and spending decisions involve considering the
trade-offs. Current needs can make spending
worthwhile.
 Opportunity Costs and the Time Value of
Money (continued)
23

INTEREST CALCULATIONS

 Three amounts are required to calculate the time value of

money
 Principal
 Interest rates
 Time
 Opportunity Costs and the Time Value of
Money (continued)
24

COMPUTING SIMPLE INTEREST

(Amount in savings) x (annual interest rate) x (time
period) = (interest)

For Example:
RM100 x 5% x 1 (1 year)
100 x .05 x 1 = RM 5.00

In one year you have RM100 in principle plus

RM5.00 in interest for a total of RM105 at the end of
the year
 Opportunity Costs and the Time Value of
Money (continued)
25

FUTURE VALUE OF A SINGLE AMOUNT

 Future value is the amount to which current savings
will increase based on a certain interest rate and a
certain time period
 Future value is also call compounding - earning
interest on previously earned interest

FUTURE VALUE OF A SERIES OF DEPOSITS

 Future value can be computed for a single amount or
for a series of deposits called annuities
 Opportunity Costs and the Time Value of
26
Money (continued)
PRESENT VALUE OF A SINGLE AMOUNT
 Present Value is the current value of a future amount based
on a certain interest rate and a certain time period
 Present value calculations are also called discounting
 The present value of the amount you want in the future will
always be less than the future value
PRESENT VALUE OF A SERIES OF DEPOSITS
 Present value can be computed for a single amount or for a
series of deposits
 Achieving Financial Goals
27

Objective 5: Identify strategies for achieving personal

financial goals different life situations

COMPONENTS OF PERSONAL FINANCIAL PLANNING

 Obtaining
 Planning
 Saving
 Borrowing
 Spending
 Managing risk
 Investing
 Retirement and estate planning
 Achieving Financial Goals (continued)
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DEVELOPING A FLEXIBLE FINANCIAL PLAN

 A financial plan is a formalized report that...
 Summarizes your current financial situation
 Analyzes your financial needs
 Recommends future financial activities

 Your financial plan can be created by you, with

assistance from a financial planner, or made using a
money management software package
 Achieving Financial Goals (continued)
29

IMPLEMENTING YOUR FINANCIAL PLAN

 Develop good financial habits
 Use a well conceived spending plan to help you stay
within your income, while allowing you to save and
invest for the future
 Have appropriate insurance protection to prevent
financial disasters
 Become informed about tax and investment
alternatives