Chapter 1 Flashcards
What are the 3 steps of personal financial planning?
- Setting financial goals
- Creating and activating plans
- Monitoring and evaluating and revising plans
What should financial goals be based on?
Values: principles that guide behavior
Attitudes: likes and dislikes
Goals
What is a basic goal of financial planning?
Maximize income and wealth
Separate needs from wants
Characteristic of successful goals
Flexible
Realistic (based on income and life situation)
Specific and measurable
Prioritization
Action oriented (achievement of goals requires action)
Opportunity costs
What a person Gives (time and money) up in order to do or have something else
(Trading off 3 years worth of income for 3 years worth of law school)
Risk
Income risk
Inflation Risk
Risk: possibility of experiencing harm, loss, damage, harm
Income risk: losing job or other source of income
Inflation risk: risk of rising prices. Risk of investment not earning more than the cost of living increases
Interest rate risk Liquidity risk Personal risk Status risk Time risk
Interest rate risk: real value of an investment eroding due to rising cost of living
Liquidity: how readily something can be converted into cash
Personal risk: health, safety, and other risk
Status risk: clothing, neighborhood, brands, cell phones
Time risk: how long can you afford to put off savings?
Risk aversion
It is assumed that individuals will try to avoid or reduce risks in order to minimize problems and maximize positive outcome
What is the risk/return tradeoff?
Historically, investments that produce higher returns generally are riskier so that not taking some risk may result in the risk of earning less money by being too conservative
Key factors that determine type of investor:
Risk tolerance (ability to accept risk) Goal time horizon
Aggressive approach
Conservative approach
Aggressive approach to risk: substantial volatility and short term financial setbacks are accepted as part of growth
Conservative: inability to tolerate more than minimum volatility with the goal of preserving principal
what are possible courses of action in achieving financial goals?
Staying on course
Expanding (increase investment, adding to savings)
Cutting back (spending less, selling assets)
Embark on new course (getting savings plan, purchasing new stocks, bonds etc)
How often should you reevaluate your financial plan?
At least once a year
Common to due when preparing tax forms
May require more frequent if more significant changes occur (going to grad school, getting married, buying a house etc)
Four key players of the general economy
Consumers: use up goods and services
Government: mediates or regulates consumer-business-media exchange as well as providing some services
Business: provides goods,services and employment
Media: inform public about occurrences and upcoming events
Economics
Wealth
assets
Economics: study of how wealth is created and distributed
Wealth: total value of all that is owned
Tangible assets: physical assets (home, car)
Financial assets: intangible (paper assets, savings, stocks and bonds)
Average propensity to consume
Level of living
Standard of living
Average propensity: percentage of each dollar of income one spends
Level of life: current state of financial living
Standard of living: state of living one saves and invests in seeking to reach
Who is the single largest employer in the US?
Federal government
Federal reserve system
Nation’s central bank
Regulates US monetary and banking system including maintaining adequate money supply
Influences interest rate and buying and selling securities
Economic cycle
Periodic expansions and contractions in economic activity
Expansion: unemployment low, retail sales and economic activity is growing
Recession: temporary slowing of economy, unemployment higher than desired, economic activity is slow usually lasting 6 months to year
Depression/decline: 10% or more unemployment, economic growth at standstill
Recovery: emergence from recession or depression, economy moves upward
Indicators of direction of the economy
Inflation
Index of leading economic indicators (LEI): Averages 11 components of growth
Consumer price index (CPI)
Interest rate
Gross domestic product : market value of goods and services produced by a country in one year (govt. Purchases, domestic investment, net exports )
Time value of money
The theory that the value derived from the use of money
Over time increases its total by investment and reinvestment.
A dollar today may be worth more than a dollar received in the future, due to inflation.
First chairperson of federal reserve system
What are his/her responsibilities?
Janet yollen
Prevent recession
Bring down unemployment
Increase recovery and growth
What is the most important indices of future wealth?
Current employment or salary
What age group has the highest median income?
45-54
