Free Personal Financial Plans by MaryJeanMenintigar

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									                        PART 1
               THE BASIC FRAMEWORK:

                            FINANCIAL PLANNING:
                          WHY IT’S IMPORTANT TO YOU


Personal financial planning involves setting individual priorities and developing specific
financial goals. This building block approach provides a sound financial foundation in which
both short-term and long-term goals may be achieved. Financial success is determined by many
factors including the individual, economic conditions, and adequate financial preparation. The
decision to establish a plan should recognize the need to become familiar with the financial
planning process.

The development of financial goals corresponds closely with the life cycle. Thus, financial
planning and decision making directly parallel the different phases of the life cycle. Financial
decisions often involve marginal analysis. Marginal analysis is concerned with the comparison
of decision alternatives and the need to evaluate marginal costs and marginal benefits. In
addition, the examination of opportunity costs and the time value of money are critical in the
decision-making process.



I.     Why Study Personal Finance?
       A.     Your Goals in Life
              1.      Nonfinancial Goals
              2.      Financial Goals

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                   2   a.     Current Consumption
                   3   b.     Future Consumption
                   4   c.     Savings
       B.     Important Economic Trends
              1.       Continuing Inflation
              2.       Persistent Business Cycles
              3.       Continued Instability in Financial Markets
              4.       A High and Selectively Rewarding Tax System

II.    Achieving Financial Goals Through Planning
       A.     Life Cycle Planning
       B.     Major Financial Planning Areas
              1.       Consumption and Savings Planning
              2.       Debt Planning
              3.       Insurance Planning
              4.       Investment Planning
              5.       Retirement Planning
              6.       Estate Planning
              7.       Income Tax Planning
              8.       Career Planning
       C.     A Planning Approach

III.   Making Financial Decisions
       A.     Some Helpful Economic Insights
              1.       Marginal Analysis
              2.       Opportunity Costs
IV.    The Building Blocks of Success



1.     To understand why setting goals is an important first step in financial planning

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       The chapter distinguishes between financial and nonfinancial goals and explains that the
       former might assist in achieving the latter. The financial goals of consumption and
       savings force consumers to decide how they will allocate their current incomes.

2.     To appreciate that trends in the financial environment--inflation, taxes, and economic
       conditions-- affect financial success and enhance the need for planning

       Planning begins with a set of assumptions about the above factors. For example, students
       should see that a high rate of inflation might influence their planning in terms of selecting
       investments (stocks over bonds) and in terms of preferring current consumption to future
       consumption (buy now before prices go up).

3.     To see why life-cycle financial planning is important and to understand the nature of a
       planning approach

       Planning is a life-long process featuring changing goals over time and changing strategies
       to achieve goals. A planning approach focuses on major planning areas, such as debt
       planning, and it includes the critical steps of determining concrete goals and creating
       action plans to achieve them.

4.     To understand what is meant by marginal analysis and opportunity costs and to know
       how these concepts are used in financial decision making

       Many students already use these concepts in making decisions such as choosing one
       course over another or how to spend vacation time. Instructors need to highlight the
       importance of thinking in terms of opportunity costs associated with each critical
       financial decision and how to evaluate choices by focusing on marginal changes.

5.     To appreciate that financial success builds on a strong foundation and follows a
       building-block approach through time

       It is important that students understand the process of accumulating and protecting wealth
       through time. As an example, you shouldn’t buy a house that is outside your means and
       then not have sufficient funds to insure it. Nor should you try for a stock market “killing”
       until you have adequate liquid reserves.



The Internet is uniquely appropriate for financial planning. In this introductory chapter, students
should be encouraged to visit some or all of the sites listed in the margin notes. They can
experiment at a site by clicking on various icons to see what they offer. The Internet features
sites, which provide ample economic and financial data. By visiting the Economic Statistics

FINANCIAL PLANNING:    WHY IT’S IMPORTANT TO YOU                                                 3
Briefing Room, students can view the same data sets reviewed by key policy makers (including
the President) in setting fiscal and monetary policies.

Also, encourage students to visit Yahoo’s Stock Quotes to see how the overall market or specific
stocks are performing. It’s easy to have students set up a portfolio of stocks that they can monitor
throughout the term.



1.     Construct a simplified questionnaire about the personal finance course and “poll”
       students’ interests in major financial topics.

2.     Have students discuss those factors giving them happiness now and those factors that are
       likely to bring happiness in the future. Tell them to be specific and somewhat personal, if
       necessary. Then, ask them how finances might bear upon achieving their happiness goals,
       both now and in the future. For a more general discussion, pose the issue that money does
       not provide happiness.

3.     Discuss the importance of personal financial management, and explain how each
       individual can benefit from establishing goals and developing financial plans.

4.     Emphasize the usefulness of life-cycle planning and explain how each phase of the life-
       cycle will affect the decision-making process. Use examples and illustrate the difference
       in financial decisions with each phase of the life cycle.

5.     Have students compare their financial planning concerns with those of their parents and
       grandparents. Have them discuss similarities and differences. Use this exercise to
       highlight the nature of life-cycle financial planning.

6.     Identify each phase of the life cycle and identify the major goals and planning areas of
       each phase. Allow students to determine how their own financial decisions will become
       more complex as they progress through the life cycle.

7.     List several factors that influence the economic environment, and discuss how personal
       financial management is affected by economic conditions. Discuss specific economic
       conditions, such as inflation and unemployment, and determine what effect these
       conditions have on financial planning.

8.     Introduce the concept of opportunity cost to show how they may need to balance
       financial and non-financial goals. For example, the opportunity cost of buying an
       expensive new car may be the hours of family activity forgone because of the need to
       work longer hours away from home.

9.     Ask students if they know the current level of interest rates and whether the economy is
       growing or declining. Consider giving an Internet assignment for quick answers to these

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      questions. Then, ask them if a growing economy is a boon for the job market when they

10.   Tell students that a rich aunt has died and left them a legacy of $50,000. Ask them what
      they would do with it. Use the discussion to highlight a building block approach to wealth



1.    It appears that the Steeles have not really planned for the future in terms of setting
      realistic and achievable goals. Nevertheless, thinking (or dreaming) about the future is
      not a bad place to start the planning process. However, it must not end there.

2.    Nancy’s music lessons and perhaps the vacation to Hawaii are short range goals. The
      vacation condo, the European vacation, the children’s education, and retirement are long-
      range goals.

3.    The Steeles need to convert their dreams into clearly defined goals. Exactly what do they
      hope to achieve, how much will it cost, and how will they provide necessary funds to
      meet the costs are questions requiring specific answers. Instructors might wish to use this
      question as a prelude to the next chapter, which deals with goal planning in detail.

4.    The economic processes discussed in this chapter offer potential pitfalls and boons to the
      planning process. Rising inflation rates will make all future goals more expensive;
      contrarily, rising investment returns make them less expensive. A deep recession could
      lead to unemployment, making a liquid reserve fund very important. Instructors can use
      this question to highlight the importance of planning as an on-going process, rather than a
      single event.



1.    Financial success is defined as obtaining the maximum benefits from limited resources. It
      is difficult to measure financial success, since benefits are difficult to measure.

2.    Both financial and nonfinancial goals are important in the financial planning process.
      Financial goals can be easily defined for financial planning purposes since they involve
      measurable amounts for consuming--now and in the future--and saving. However,
      nonfinancial goals represent those items that are often difficult to define in monetary
      terms. Thus, personal financial planning should attempt to achieve a level of satisfaction
      that is consistent with both types of goals.

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3.    Financial independence is often thought of as having sufficient income or resources to be
      self-reliant. Of course, it can have different meanings; some people might think of it as
      having enough money to do whatever they want.

4.    Future consumption is simply that—consumption at a future point in time. Current
      consumption is consumption within the current period of time, which usually refers to a
      planning period, such as a year. One form of consumption is not necessarily better than
      the other—it’s simply a matter of priorities. Would you rather have an elegant life style
      now and be destitute in retirement; or, would you rather consume somewhat uniformly
      throughout your life? You are free to choose either alternative.

5.    The principle of diminishing marginal satisfaction provides help here. Without the ability
      to borrow, our consumption could never be greater than our income. However, since our
      incomes are not uniform through time (usually we have much higher incomes as we grow
      older) this means that in a sense we over-consume with high incomes (very low marginal
      satisfaction) and under-consume with low incomes (very high marginal satisfaction).
      Borrowing allows us to smooth the marginal satisfactions through time.

6.    Saving is simply income not consumed. People save for a variety of reasons—some save
      simply because they enjoy seeing their wealth grow—but the most basic reason for
      saving is that they wish to consume in the future. So, future goals are set and savings are
      planned to achieve them.

7.    Inflation has come down considerably over the past 25 years, from double-digit rates to
      rates below five percent. Estimating an inflation rate for the next 25 years is almost
      impossible. Most planners simply extrapolate current rates forward. In the present
      environment, a three percent rate seems appropriate for long-range goals.

8.    The economy is most often in an expansionary phase, however, recessions have occurred
      with some degree of regularity, the most recent being in 1990--1991. While no one
      knows for sure, it seems a very safe bet to guess that recessions will occur in the future.

9.    The stock market is a very poor place to put money that might be needed on short notice.
      The term safety usually implies that an investment will not decline in value. In this sense,
      the stock market fails to meet the test of safety since it frequently declines in value.

10.   Planners often use the stock market’s long-run average historical rate of return, which is
      around ten percent.

11.   Our tax law is not neutral and financial plans must consider potential tax impacts. A good
      example is the generous treatment of home ownership insofar as mortgage interest and
      property taxes are allowable deductions against income. All other things the same,
      owning a home is typically far cheaper than renting one.

12.   The life cycle is characterized by many different phases. These phases include young
      adult, family formation, family development, family maturity, and retirement. Planning
      for each phase is extremely beneficial to individual, as a specific area of interest may be

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      analyzed and thoroughly examined. In general, this approach provides the opportunity to
      establish specific plans for each phase of the life cycle.

13.   Financial planning involves a systematic decision-making process. A planning approach
      can be developed by analyzing four basic steps. The initial step is to state the goal in
      precise terms so that it is easily defined. The second step consists of creating an action
      plan that will assist in determining how this goal is to be achieved. The third step is the
      evaluation of the performance that is characterized by the action plan. The final step
      involves a reassessment of current goals and the development of new goals. The eight
      major planning areas are: career planning, consumption and savings plan, debt planning,
      insurance planning, retirement planning, estate planning, and income tax planning.

14.   Marginal analysis is concerned with the study of variables that affect the decision-making
      process. Marginal analysis focuses on changes that affect the final decision and the
      ultimate course of action. Opportunity cost is measured by determining the expected
      satisfaction to be received from a specific alternative. The expected satisfaction is often
      influenced by each decision alternative as the opportunity costs are used extensively in
      financial planning to evaluate the effectiveness of financial decisions. In addition, a
      thorough analysis of all feasible financial alternatives should assist the individual during
      the financial planning process.

15.   One should recognize the satisfaction to be received from making a specific decision and
      measure this satisfaction against the expected satisfaction of additional alternatives.
      Thus, the cost of spending a night at home is the pleasure you might enjoy by going out,
      or the income you give up by not working at a night job.

16.   (a) The extra 200 miles would require additional gas (let’s say, $15). Oil, lube, wear on
      the car would be minimal (let’s say $3). So, total marginal costs equal $18, while
      marginal revenue equals $40; it seems like a decent offer, and Martin should take it.

      (b) The main opportunity cost is the use of Martin’s time. A 200-mile side trip could take
      3 to 4 hours. Martin must decide what the alternative use of his time is worth and then
      weigh this amount against the $22 ($40 minus $18) net marginal revenue.

17.   A building-block approach refers to the process of securing basic financial safety before
      undertaking risky investments. Basic investments in housing, insurance, and liquidity
      come before speculative investments.

18.   Bryan should realize the potential losses with biotech stocks, which could easily decline
      50% in value over a short period of time. Suppose Bryan has a $1,500 car repair bill arise
      unexpectedly. What does he do if his nest egg has fallen to $1,000?



Case 1.1     The Haggertys’ Financial Planning

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1.    Yes, the Haggertys can certainly benefit from financial planning, as it provides a means
      that may assist them in achieving their financial goals. A definite plan for buying a house
      would indicate important details such as the date of purchase, the down payment, and the
      expected purchase price. In addition, a financial plan would enable them to make
      specific decisions concerning the purchase and financing of a new house. A financial plan
      might also resolve some apparent conflict about the importance of buying a house.

2.    The suggestion to invest in growth stocks should be analyzed carefully, as many common
      stocks investments are extremely risky. The anticipation of earning 20% is too optimistic.
      Jan and Mickey should develop a specific plan for the purchase of a new house and
      evaluate their risk preferences associated with alternative investments. In addition, they
      should also consult with a financial planner or a stockbroker to determine an appropriate
      investing strategy. If they wish to purchase a house within the next several years, stock
      investment may be too risky. A longer horizon could allow for greater short-term
      variability and would support a larger equity allocation of their funds.

3.    The idea to wait and invest in common stocks when their prices fall is sound investment
      strategy; however, it is not certain that a recession will occur and prices will decline.
      Therefore, Mickey should question the recommendation of a friend and the reliability of
      this forecast. Forecasting, at best, is an educated guess that may or may not yield
      favorable results. Both Jan and Mickey should acknowledge that a successful financial
      plan must be specific, but also flexible as to specific economic environments.

Case 1.2     Lou Pirella and Vicki Wright: Two College Students

1.    The major opportunity cost of her MBA degree is the income she could earn during the
      period she is in school. Additional opportunity costs include the higher compensation
      level she would have by working, plus any budgeted savings. Another opportunity cost is
      the tuition and related expenses, in the sense these funds could be used for the other

2.    The decision Vicki faces can be analyzed as follows:

             Total tuition costs taking 15 credit hours
             Each semester (4 semesters @ $3,000 each) $12,000

             Total tuition costs taking 20 credit hours
             Each semester (60 @ $250 each)                $15,000

             Marginal cost of accelerated program          $ 3,000

      The benefit of the accelerated program is graduating one semester earlier. Thus, the
      opportunity cost of the slower program is the additional income Vicki could earn during
      the “saved” semester.

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3.    Since Lou is entering the work force, his days of cavalier living as a student are over. He
      needs to get his act together, and he can start by at least determining the interest rate on
      his credit card. Lou seems content with not paying off the card’s balance, while at the
      same time he intends to make aggressive stock market selections. It’s highly unlikely that
      the rate of return on Lou’s investments will equal the interest rate on his credit card. For
      openers, then, he should consider paying off the card’s balance. Then, he ought to
      consider suitable disability, life, and property and auto insurance. He doesn’t seem to be
      at the point where he might realistically consider aggressive investing.

Marie Wilson Goal-Planning Exercise

      This exercise is meant to be somewhat open-ended, so instructors can expect a wide
      variety of responses. The primary purpose of the exercise overall is to encourage students
      to think of their own personal financial situations as they help Marie with her financial
      planning. Actually, encouraging students to set goals may be the single most important
      lesson we provide during the course. A business firm seldom runs efficiently if it lacks
      financial targets that it attempts to achieve. At a more abstract level, business managers
      are encouraged to have a “vision” for the firm, in the sense of where it should be in five
      or ten years. So, too, students need visions, which lead to dreams, and ultimately to
      concrete goals.
              The table below indicates some possible goals and when Marie anticipates
      achieving them. Instructors might ask students if they believe that Marie has a broad
      vision of what she would like her life to be. While the case does not probe the issue to
      that extent, it can certainly be added to a classroom discussion.

FINANCIAL PLANNING:   WHY IT’S IMPORTANT TO YOU                                                9
Form 1.1 Identifying Financial Goals         Date to         Number of
Current Date________________               Achieve Goal Years in the Future

A. Short-Range Goals (1-2 Years)
1. Enroll in law school                                         1,2
2. Buy a new car                                                 1
3. Pay off all credit card debt                                 1,2
4. Pay off school loans                                         1,2

B. Intermediate-Range Goals (2-10 Years)
1. Continue law school                                          3,4
2. Sending Jake to college                                       5
3. Continue paying off school loans                          3,4,5,6,7,8

C. Long-Range Goals (Over 10 Years)
1. Down payment on a condo                                       10
2. Sending Jake to college                                  14,15,16, 17
3. Having a retirement nest egg                                  40
D. Discussion of goals

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