Lesson 1- Overview of financial planning Flashcards
Define personal financial planning. What types of decisions are involved in a personal financial plan?
Personal financial planning is the process of planning your spending, financing, and investing activities, while taking into account uncontrollable events such as death or disability, in order to optimize your financial situation. A personal financial plan specifies your financial goals, describes the spending, financing, and investing activities that are intended to achieve those goals, and the risk management strategies that are required to protect against uncontrollable events such as death or disability.
What is an opportunity cost? What might be come of the opportunity costs of spending 10$ per week on lottery tickets?
An opportunity cost is what you forgo as the result of a decision. Some of the opportunity costs of spending 10$ on lottery tickets every week might include foregoing lunch out once a week, reducing debt by an additional 40$ per month, or having 520$ in savings at the end of the year.
How can an understanding of personal finance benefit you?
An understanding of personal finance enables you to make more informed decisions about your financial situation. You would also be able to judge the advice of financial advisers better. You might even pursue a career as a financial adviser.
What are the five key components of a financial plan?
- Budgeting and tax planning
- Managing you financial resources.
- Protecting your assets and income
- Investing your money
- Planning your retirement and estate
How is your net worth calculated? Why is it important?
Net worth is the value of what you own ( assets) minus the value of what you owe ( liabilities). Net worth is a measure of your total wealth and budgeting strategies can help increase your net worth, and thereby your wealth. For example, you can build your net worth by setting aside part of your income to invest in additional assets or reduce your liabilities.
What factors influence income? Why is an accurate estimate of expenses important in budge planning?
Income is influenced by your life stage. If expenses are not accurately estimated, any budget surplus available for saving may be inaccurate and it may become difficult to reach savings goals.
Should you wait for a milestone to be reached before creating a personal financial plan? Explain.
No, waiting for milestones before creating a personal financial plan can be very dangerous because you may not have any time to prepare.
Define budget planning. What elements must be assessed in budget planning?
Budget planning (budgeting) represents the process of forecasting future expenses and savings. A first step in budgeting involves evaluating your current financial position by assessing your income, your expenses, your assets, and your liabilities.
What are the key financial considerations during the early career life stage?
The key financial considerations during the early career life stage are to adopt the pay-yourself- first principle, manage your debt, buy furnishings for your own place or a car for your first job, and build your investment portfolio.
How do tax laws affect the budgeting process?
Many financial decisions are affected by tax laws, such as certain types of income being taxed at a higher rate than others. Knowledge of tax laws allows you to make more favourable choices and maximize after-tax cash flows and wealth.
What is liquidity? What two factors are considered in managing liquidity? How are they used?
Liquidity means having access to ready cash, including savings and credit, to cover unexpected expenses. In managing your liquidity consider money management and credit management. Money management deals with deciding how much money to retain in a liquidfrom and how to allocate the funds among short-term investment instrument. Credit management deals with decisions about how much credit you need to support your spending and which sources of credit to use.
What is an emergency fund? What is an alternative to establishing an emergency fund?
An emergency fund contains the portion of savings that you have allocated to short-term needs, such as unexpected expenses, in order to maintain adequate liquidity. An alternative to establishing an emergency fund would be to rely on credit to supplement your liquidity.
What factors are considered in managing your financial resources?
Factors include how much money to maintain in ready cash versus the use of credit as a source of funds. With respect to a loan, factors such as the size of the loan you afford you borrow, the lenght of time for the loan, and selecting a loan that charges a competititve low interest rate.
What is the primary objective of investing? What else must be considered? What potential investment vehicles are available?
The primary objective of investing is to use funds not needed for liquidity purposes to earn a return. Most investments are subject to risk, and you need to understand your tolerance to risk to manage it. Potential investments include stocks,bonds, mutual funds and real estate.
What are the three elements of planning to protect your assets? Define each element.
A plan to protect your assets requires insurance planning, retirement planning, and estate planning. Insurance planning involves determining the types and amount of insurance that you need such as automobile, homeowner’s, and life. Insurance reimburses you for damages to your assets, limits your exposure to potential liabilities, or protects your income. Retirement planning involves determining how much money you should set aside each year for retirement and how you should invest those funds. Retirement planning must begin well before you retire so that you can accumulate sufficient money to invest and use after you retire. Estate planning is the act of planning how your estate will be distributed before and/or after you die. Effective estate planning can protect your wealth against unecessary taxes and ensure that your wealth is distributed to your family in the manner that you desire.
What is retirement planning? When should you begin the process of retirement planning? Explain.
Retirement planning involves determining how much money you should set aside each year for your retirement and how you should invest those funds. Retirement planning must begin well before you retire so that you can accumulate sufficient money to invest and use after you retire.
What is the purpose of estate planning?
Estate planning is the act of determining how your wealth will be distributed before and/or after your death. The purpose of estate planning is to protect your wealth against unnecessary taxes and ensures that your wealth is distributed in a timely and orderly manner.
How does psychology affect your cash flow?
When people focus on their desire for immediate satisfaction and/ or the pressure they feel from their peers, they may spend excessively. For example, the desire for immediate satisfaction provides a strong dose of pleasure. However, the boost provided by the “ shopping therapy” may quickly vanish, so that additional therapy (shopping) is needed. The spending can become addictive. The behaviour of people who spend based on immediate satisfaction and peer pressure causes them to spend excessively now, which leaves nothing for the future.
How does each element of financial plannig affect your cash flows?
Budgeting and tax planning focuses on how cash received (from income or other sources) is allocated to spending, taxes and savings (increase in available cash). Financing your purchases focuses on depositing a portion of your excess cash in an emergency fund ( use of cash). Protecting your assets and income focuses on determining your insurance premiums ( use of cash). Investing your money focuses on using some of your excess cash to build and grow wealth ( use of cash). Planning your retirement and estate dictates the wealth that you will accumulate by the time you retire and its distribution before and/or after your death ( use of cash). Refer to exhibit 1.7.
What are the six steps in developing a financial plan?
- Establish your “ SMART” financial goals.
- Consider your current financial position.
- Identify and evalulate alternative plans that could achieve your goals.
- Select and implement the best plan for achieving your goals.
- Evaluate your financial plan.
- Revise your financial plan
How do your financial goal fit into your financial plan? What is a SMART goal ?
Setting your goal will identify the amount of money you need to set aside, and when, to achieve the goals. A SMART goal is a goal that is specific, measurable, action-oriented, realistic, and time-bound. For example, a goal could be specific in a that you may want to save a specific amount of debot to improve your creditworthiness, or have a specific cash flow at retirement. A goal is measurable when you can quantify your objective and measure your progress towards achieving the goal. An action-oriented is a goal in which you have listed specific action steps that will help you meet your goal. Realistic goals have a stronger likelihood of being accomplished. Short-term goals are those to be accomplished in less than a year such as saving 500$ for Christmas gifts. A medium- term goal takes from one to five years to accomplish, such a paying off a 3 year-loan. A long-term one takes more than 5 years to accomplish. For example, saving for retirement over a set number of years.
Name some factors that might affect your current financial position.
Some factors that might affect your current finacial position are your level of debt, your martial status and family responsability, your age and your level of wealth accumulated.
How do your current financial position and goals relate to your creation of alternative financial plans?
Your goals are where you want to be and your current financial position is where you are. Your alternative financial plans will “map” how to get from one position to the other. Several alternative financial plans are possible given one’s current financial position and goals. For example, two alternative plans may involve different amounts of savings.
Once your financial plan has been implemented, what is the next step? Why is it important?
Once you have developed and implemented a plan, you must monitor it. Monitoring the plan will ensure that you are following the plan and that the plan is working as intended.
Why might you need to revise your financial plan?
You may find you need to revise the plan to make it more realistic. In addition, your life circumstances and financial condition may change. As your financial conditions change, your goals may change, especially as the results of specific events such as graduating from a post-secondary institution, getting married, or the birth of a child.
List some information available on the internet that might be useful for financial planning. Describe one way you might use some of this information for financial planning purposes.
-Bank deposit rates: buy now vs. save decision
-Prices of homes and cars in your area: planning for purchase
- Financing rates on car loans, personal loans, and home loans: deciding how much of a loan you can afford
-Stock price quotations and quotations on other investments: deciding when to invest and where to invest
-Insurance quotations based on your needs: getting the best value for your insurance dollar
-Tax rates: for tax planning
-Retirement rules: retirement planning
-Financial calculators: determining how your savings will grow or what your mortgage payment will be
What are some of the different types of unethical behaviour financial planners might engage in? How can an understanding of personal financial planning help you deal with this potential behaviour?
There are several different levels of unethical behaviour by financial planners. Some planners are involved in Ponzi schemes and are focused on stealing your money. A more modest level of unethical behaviour is providing advice that is intended to benefit the planner, not you. An understanding of personal financial planning will enable you to make some decisions without a planner. If you require a planner, you will be better prepared to determine which advice is truly intended to benefit you.
