finance by HnwtdKH

VIEWS: 7 PAGES: 21

									 BASIC FINANCIAL
PLANNING ―TOOLS‖
BASIC WEALTH
ACCUMULATION PRINCIPLES
 1.  FINANCIAL PLAN
 2.  INVESTMENT ―MARGIN‖
 3.  EMERGENCY FUND
 4.  TAX TREATMENT
 5.  THE EMERGENCY FUND
 6.  INVESTMENT ―MARGIN‖
 7.  TIME VALUE OF MONEY (―MAGIC‖
          OF COMPOUND INTEREST)
 8. IMPORTANCE OF CONSISTENT
          GROWTH
 9. DOLLAR COST AVERAGING
 10. DIVERSIFICATION
INVESTMENT ―MARGIN‖
GROSS INCOME
     - TAXES
= NET INCOME
     - NECESSITIES
= SPENDABLE INCOME
     - LUXURIES
= INVESTIBLE FUNDS
          EMERGENCY FUND
PURPOSE

TYPE OF INVESTMENTS

AMOUNT
FINANCIAL PLANNING
      TOOLS
OTHER INVESTMENT PREREQUISITES?
LIFE INSURANCE?



HOME OWNERSHIP?



OTHER?
IMPORTANCE OF CONSISTENT GROWTH
MR. A AND MR. B EACH INVEST $10,000 ON
JANUARY 1 OF EACH YEAR FOR 10 YEARS.
MR. A EARNS 10% EACH YEAR. MR. B EARNS:
YEAR         RATE               YEAR          RATE
1            10%                6             8%
2            12%                7             12%
3            50%                8             10%
4            40%                9             -50%
5            8%                 10            10%
WHAT IS THE AVERAGE RATE OF RETURN EARNED BY EACH?
WHAT IS THE AMOUNT OF MONEY ACCUMULATED BY EACH?
       A $175,313
       B $111,247
DOLLAR COST AVERAGING ($10,000 PER YEAR)
     STOCK     # OF SH.            CUMULATIVE
YEAR PRICE     PURCHASED           # OF SHARES

1    $100      100                 100
2    $90       111.11     211.11
3    $60       166.67           377.78
4    $120      83.33            461.11
5    $180      55.56            516.67
6    $90       111.11     627.78
7    $48       208.33           836.11
8    $90       111.11     947.22
9    $36       277.78           1,225.00
10   $115      86.96            1,311.96

     AVERAGE PRICE = $____________
     AVERAGE COST = $____________
   MONTE CARLO SIMULATION
Here is what you should learn from playing Game 1.

1. Returns are Volatile
   Average Returns are meaningful over the long-term, but the actual
   Returns you get year-to-year will vary greatly, just as they do when
   you pick your own cards. Over short time periods, you may do
   much better or far worse than the average.
2.   The Sequence of Returns Matters if You Are Making
     Additions
        If you are making Additions to your Portfolio, and get the
        Average Return you expect over some specific period of time,
        the future value of your Portfolio can still vary greatly
        depending on the actual Sequence of Returns you get each
        year. If your big gains come in early years and your losses
        come in the late years, you will accumulate less money than
        if the Returns occur in the reverse order.

        If you simply invest a lump-sum of money and let it grow
        without Additions, the Sequence of Returns does not affect
        the ending value, as long as you obtain the Average Return
        over the entire period.
3.      Plan for a Range of Possible Outcomes
        You shouldn't plan for a specific future Portfolio Value, but
        instead expect your result to fall within a range of possible
        values, depending on the Sequence of Returns you get.
        There is no way to project any specific future value. The
        best you can do is plan for a reasonable range of possible
        outcomes.

The analysis is based strictly on Historical Returns for the selected 30
year period, which may or may not have any relationship to future
results.
        INVESTMENT RETURNS
CURRENT YIELD

    BEFORE TAX:
        current annual income /
        current market price

    AFTER TAX:
        current annual income (1 – t)
        / current market price

    Can be used with bonds, stocks, and other
    investments. Says nothing about capital gains
    but can be useful for meeting income needs.
         HOLDING PERIOD RETURN
BEFORE TAX:
      Total current income + total capital appreciation /
      total initial investment

      EXAMPLE: Stock purchased for $1,200; $50 in
      dividends received; sold for $1,500.
             ($50 + $300) / $1,200
             = 29%

AFTER TAX:
     Total current income (1-t) + total capital
     appreciation (1-t2) / total initial investment

      EXAMPLE: The tax rates might be different, say,
      25% and 15%
           $50 (1 - .25) + $300 (1 - .15) / 1,200 = 24%
          APPROXIMATE YIELD
BEFORE TAX APPROXIMATE YIELD

ANNUAL         FUTURE PRICE – CURRENT PRICE
               ______________________________
INCOME +            NUMBER OF YEARS
______________________________________
     FUTURE PRICE + CURRENT PRICE
       _____________________________
                  2
     TAXATION OF MUNICIPAL BONDS
MUNI BOND YIELD    5%
TAXABLE BOND YIELD 6%
IF t = 15%, WHICH BOND SHOULD BE PURCHASED?
                      Tax-exempt yield
  Equivalent fully =  ____________________
  taxable yield            1-t

OR
                      .05
                    ____________
               =
                      .85

               =    5.88%
THE INVESTOR WOULD BE BETTER OFF TO
BUY THE TAXABLE BOND

6% - (.15)(6%)

AND AFTER TAX YIELD WOULD BE

6% - .9% OR 5.1%
                DIVERSIFICATION
DIVERSIFICATION CAN BE ACHIEVED BY:
    TYPE OF ASSET
         Cash equivalents, bonds, stocks, real estate, etc.

   MATURITY DATE

   GEOGRAPHY

   INDUSTRY

 SPECIAL TRAPS ARE:
       Company stock
       Industry-employment related
A LOOK AT THE ―TOOLS‖ AS PRESENTED
IN THE TEXT (The ―Golden Principles‖ of
Financial Planning)

1. Cover your assets before taking greater risk.
2. Seek first a return of principal before a return on principal.
3. No risk, no reward.
4. Without both liquidity and marketability, there is no flexibility.
5. A successful investor has to be right three times.
6. An investor should never put all his eggs in one basket.
7. Put yourself on your own payroll—at the top of the payroll.
8. Capitalize on the miracle of the ―forgotten‖ automatic investment.
9. It is as important to increase the rate of investing as it is to
   increase the rate of return.
10. Let purpose define the level of risk taken.
11. Assets and income maintain their utility only to the extent they
    maintain or increase their purchasing power.
12. Increase expenditures (especially nondeductible ones) at a lower
    rate than you increase your income.
13. Think of security only in terms of the bottom line. (It’s not what
    you earn, its what you keep).
14. He is wise who can turn top tax dollars into assets or spendable
    income without undue risk. (Estate planning, deductions, and
    deferrals).
15. The essence of risk management is protecting the ground that’s
     already gained without losing more in the process.
16. It’s not enough just to make money, an investor has to create
    automatic mechanisms to make money with the money he’s
    made.
17.   Always use the lowest risk solution that satisfies the need.

18.   At a certain point, action must replace cogitation and
      articulation.

19.   No tool or technique is without cost.

20.   Patience and discipline are the parents of financial success.

21.   Whether it’s better to “own” or “loan” depends on one’s own
      situation. (debt versus equity).

22.   Debt, like spending, should be at the discretion of and fully
      controlled by the investor.

23.   Tax leverage is a concept similar to financial leverage and can
      provide similar advantages. (e.g. deferral).

24.   The after-tax return on the repayment of debt is essentially
      risk free.
25.   When planning for retirement, the wise planner and client will assume
      a lower than hoped for rate of return on investments, a higher than
      anticipated level of inflation and cost of living, and put less reliance on
      social security or a pension will provide.

26.   When doing estate planning, the wise planner will assume the
      highest reasonable liquidity demands and the lowest reasonable
      cash to meet those needs.

27.   The best investment, bar none, is education.

28.   Before making any suggestion to a client regarding any investment
      or any tool or technique, the planner should ask and answer these
      questions:
         a) What are the advantages and disadvantages of viable
             alternatives?
         b) Which of the viable alternatives provides the highest return
             at the least cost with the greatest certainty?
         c) What happens if the client takes no action?

								
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