Ch. 11 - Personal Finance Flashcards
Financial Literacy
The ability to understand and effectively use various financial skills
True or False: People with higher financial literacy make better financial decisions and manage money better
True
Why is it desirable for governments to ensure that people are financially stable throughout their lives?
Financial stability is needed to maintain law and order. Otherwise, people’s basic needs (e.g. hunger) will not be met and more people will turn to crime
True or False: Most adults understand the time value of money (TVM)
It depends on the country. A 2015 OECD survey shows that only 57% of Canadian adults understand the time value of money. Meanwhile, only 14% of Indonesian adults understand the time value of money.
Is there a difference between the quality of investment decisions made by men and women?
Yes. On average, women make better investment decisions since men have a higher tendency of being overconfident
Human Capital
A person’s ability to produce cash in the future (present value of future earnings)
What is typically an adult’s most valuable asset?
Human Capital
True or False: It is rational to spend more than you earn when you are younger
This is mostly true. If you are investing to develop and improve your human capital, spending more than you earn is rational. Note that frivolous spending is not rational
True or False: Your human capital at age 65 is 0 (assuming you retire)
False. Even at age 65, your human capital can be $150 000 to $600 000.
Financial Plan
Includes an analysis of your overall financial situation (debt, income, savings, and cash flows). It also considers insurance to protect assets, retirement and estate planning, and tax strategy
Budget
An estimate of income and expenditure over time. The balance should be zero (since everything should be accounted for).
Financial Planning Process
- Identify current financial situation
- Identify your goals
- Analyze your assets, liabilities, cash flows, current insurance coverage, investments, tax strategies, etc.
- Identify choices and alternative courses of action
- Evaluate alternatives
- Develop an action plan
- Put your plan in action; re-evaluate and revise as necessary
Investment
An asset acquired with the goal of generating income and/or capital appreciation
What factors need to be considered when determining how much you need to save up for retirement?
- How long do you expect to live?
- How long do you expect to be in retirement?
- How much do you think you will need each year?
Retirement
Point in your life when you rely on your financial capital instead of your human capital to survive
Asset Classes
Grouping of investments that exhibit similar characteristics:
- Defensive Assets
- Growth Assets
Defensive Assets
Provide long-term stable returns with lower volatility. Examples include:
- Cash
- Fixed interest (bonds, indentures)
Growth Assets
Assets which generate a return both from capital growth and from the distribution of profits through dividends. Examples include:
- Property
- Alternative investments
- Shares
Consumption smoothing
Shifting cash from the future to the present (borrow cash and repay it later)
Why do people have a tendency to engage in consumption smoothing?
Most people expect to be better off in the future. They feel comfortable borrowing now to smooth out their consumption over one’s life
Secured Loans
Loan where a security is offered by the borrower. Usually attracts a lower interest rate (since security can be confiscated if the borrower fails to pay off the loan)
Unsecured Loans
Loan where no security is offered by the borrower. These loans are generally for smaller amounts and have higher interest rates than secured loans
Co-borrowers
People who are jointly responsible (equally liable) for a loan or credit
Guarantors
People who are responsible for paying off a loan or credit if the borrower does not pay
