Financial Planning: A Comprehensive Guide to Effective Money Management, Quizzes of Finance

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Advantages of Planning

Increased effectiveness in obtaining, using, and protecting financial resources Increased control of one's financial affairs Improved personal relationships Sense of freedom from financial worries TERM 2

6 Steps in Financial Planning Process

DEFINITION 2 Determine current financial situation Develop your financial goals Identify alternative courses of action Evaluate alternatives Create and implement your financial action plan Review and revise the financial plan TERM 3

Determining your current financial situation

(1)

DEFINITION 3 Evaluate income, savings, living expenses, and debts Prepare list of current asset and debt balances and amount spend for various items Match financial goals to current income and potential earning power TERM 4

Developing your financial goals (2)

DEFINITION 4 Identify feelings about money and the reasons for those feelings Determine the sources of your feelings about money Determine the effects of the economy on your goals priorities Make sure that your goals are your own and are specific to your situation TERM 5

Identifying alternative courses of action (3)

DEFINITION 5 Possible courses of actions : continue the same course of action, expand the current situation, change the current situation, take a new course of action Creativity in decision making is vital to effective choices "Do nothing" can be a dangerous alternatives

Evaluate your alternatives (4)

Consequences of choice Evaluating risk Financial Planning information sources TERM 7

Create and Implement your Financial Action

Plan (5)

DEFINITION 7 Develop an action plan that identifies ways to achieve financial goals Possible action plans can be increasing savings, reducing spending, or making provisions for taxes To implement action plans you may need assistance from others TERM 8

Review and Revise your plan (6)

DEFINITION 8 Financial planning decisions need to be assessed regularly Complete review should be done at least once a year More frequent reviews may be required for changing personal, social and economic factors Regular reviews of decision making process can help in making priority adjustments to achieve financial goals TERM 9

Influences on Personal Financial Planning

DEFINITION 9 Life situation and personal value The Financial System Economic factors Global influences TERM 10

Path to Financial Security

DEFINITION 10 save for emergencies and the future maintain a low level of debt have a risk management plan avoid investment scams communicate with others

Goal Setting Guidelines

-Can be influenced by timeframe or financial need that drives your goals-Should be SMART: Specific Measurable Action - Oriented Realistic Time- based TERM 12

Financial Opportunity Costs

DEFINITION 12

• Time Value of Money increases in an amount of money as a result of interest earned saving today means more money tomorrow; spending means lost interest saving and spending decisions involve considering the trade-offs. Current needs can make spending worthwhile TERM 13

Interest Calculations

DEFINITION 13

• Three amounts are required to calculate the time value of money Principal Interest Rate Time TERM 14

Time Value of Money

DEFINITION 14 Future Value of a Single Amount Future Value of a Series of Deposits Present Value of a Single Amount Present Value of a Series of Deposits TERM 15

Financial Plan

DEFINITION 15

• formalized report that: Summarizes your current financial situation Analyzes your financial needs Recommends future financial activities

Money Management

• the day to day financial activities needed to manage personal economic resources, while working toward long- term financial security TERM 17

Components of Money Management

DEFINITION 17 Storing and maintaining personal financial records and documents Creating personal financial statements Creating and implementing a plan for spending and saving (budgeting) TERM 18

How long should records be kept?

DEFINITION 18 Birth certificates, wills, and social security information = permanently Records on personal property and investments = as long as you own them Documents related to the purchase and sale of real estate = indefinitely Copies of tax returns and supporting data = 7 years TERM 19

Balance Sheet

DEFINITION 19

• New Worth Statement or Statement of Financial Position- Preparation of Balance Sheet requires using 3 steps : List items of value Determine amounts owed Compute net worth (what you own - what you owe) TERM 20

Cash Flow Statement

DEFINITION 20 Total Cash received during the time period - Cash outflows during the time period = Cash surplus or deficit Personal Income and Expenditure Statement Prep: Record Income, Record Cash Outflows, Determine Net Cash Flows (can be a surplus or deficit)

Budgeting

• a budget is a spending plan- the main purpose of a budget are to help you: Live within your income Spend your money wisely Reach your financial goals Prepare for financial emergenices Develop wise financial management habits TERM 22

The Budgeting Process

DEFINITION 22 Set financial goals Estimate income Budget an emergency fund and savings Budget fixed expenses Budget variable expenses Record spending amounts Review spending and savings patterns Revise your goals and budget allocations TERM 23

Characteristics of Successful Budgeting

DEFINITION 23 Well Planned Realistic Flexible Clearly communicated TERM 24

Factor affecting the choice of investments

DEFINITION 24 Safety and risk Risk- return trade off Risk tolerance Calculating rate of return Investment income, growth, and liquidity TERM 25

Risk

DEFINITION 25 measure of uncertainty about the outcome

Investment Pyramid

Financial Security ( Cash, CDs, money-market mutual funds, and U.S gov.bonds) Safety and Income (U.S securities, selected corporate and municipal bonds, income stocks, conservative mutual funds) Growth (growth stocks, growth-oriented mutual funds, rental property) Speculation (spec.Stocks, options, commodities, high risk) TERM 27

Calculating Risk of Return

DEFINITION 27 Add increase or subtract decrease in investments value Plus annual investment income Divide by the original investments value TERM 28

Components of the Risk

Factor

DEFINITION 28 Inflation risk - during periods of high inflation, your investment return may not keep pace with the inflation rateInterest rate risk - you may invest in a bond at 6& but when rates for comparable bonds later go up to 8%, it means your bond price fallsBusiness failure riskMarket riskGlobal investment risk TERM 29

Investment Income

DEFINITION 29 Safest investment: predictable income (savings accounts, Cd's, U.S savings bonds, U.S T-Bills) Higher potential income investments : municipal bonds, corporate bonds, preferred stock and income common stocks, income mutual funds, real estate rental property TERM 30

Asset Allocation

DEFINITION 30

• the process of placing your assets among several types of investments which lessen your investment risk

Time

Factor

-the longer that you are invested the better your opportunity for increasing returns TERM 32

Your age

DEFINITION 32 -the type and style of your investments should change with your age TERM 33

Mutual Funds

DEFINITION 33 Investors money is pooled and invested by a professional fund manager Provides diversification to reduce risk You buy shares in the fund Funds range from conservative to extremely speculative Match your needs with a funds objective Be aware of fees depending upon different fund chosen TERM 34

Investment Alternatives

DEFINITION 34 Stocks Bonds Mutual Funds Real Estate TERM 35

A Personal Plan for Investing

DEFINITION 35 Establish realistic investment goals Determine the amount of money needed to meet your goals Specify the amount of money available to fund your investments List different investments you want to evaluate Evaluate risk and potential return for each Reduce possible investments to a reasonable number Choose at least tow different investments Continue to evaluate your investment program

Why Corporations Issue Common Stock

To raise money for start-up costs and help pay for expansion and ongoing business activities They don't have to repay the money a stockholder pays for stock The stockholder may sell a share of stock to another investor TERM 37

Why Investors Purchase Common

Stock

DEFINITION 37 Investors want the larger returns that stocks offer even though they are aware of the potential losses Investors can make money in 3 ways: Income from dividends in the form of cash or additional stock, Dollar appreciation of stock value, Possible increased value from stock splits (happen when the shares owned by existing stockholders are divided into a larger number of shares) TERM 38

Preferred Stock

DEFINITION 38 Investors in preferred stocks receive cash dividends before common stockholders are paid any cash dividends A middle investment and presents an ownership position between common stock and corporate bonds You are the owner of the stock but have a known rate of return. Shares are after than common stock because the dividends are more secure Investors that need a more predictable source of income will choose preferred rather than common stock TERM 39

Classification of Stocks

DEFINITION 39 Blue Chip Stock Cyclical Defensive Growth Income Large , Mid, Small , Micro, Penny Stock TERM 40

Earnings Per Share (EPS)

DEFINITION 40 after tax earnings / # outstanding shares of common stocks an increase in earning is generally a healthy sign

Price - Earnings Ratio

P/E

price per share / earnings per share TERM 42

Dividend Payout

DEFINITION 42 Annual dividend amount/ EPS TERM 43

Dividend Yield

DEFINITION 43 Annual dividend amount/ Price per share TERM 44

Total Return

DEFINITION 44 Dividends + Capital gain TERM 45

Annualized holding period yield

DEFINITION 45 Total return / Original investment * (1/n)

Beta

• a measure of volatility compared to the S&P 500 stock index TERM 47

Book Value per Share

DEFINITION 47 Assets - Liabilities / Shares outstanding TERM 48

Market - to - Book ratio

DEFINITION 48 Market value per share / Book value per share a low market to book may indicate an undervalued stock a high market to book may indicate an overvalued stock TERM 49

Investment Theories

DEFINITION 49 Fundamental Analysis vs. Technical Analysis vs. Efficient Market Hypothesis TERM 50

Completing Stock Transactions

DEFINITION 50 Market Order: request to buy or sell stock at the current market valueLimited Order: request to buy or sell a stock at a specified priceStop-loss order: request to sell a stock at the next available opportunity after its market price reaches a specified amount

Long - Term techniques

Buy and hold Dollar cost averaging Direct investment and dividend reinvestment plans (DRIPS) TERM 52

Short- Term Techniques

DEFINITION 52 Day trading Buying stock on margin (Borrowing money) Selling short (borrowing stock) Trading in options (predetermined price) TERM 53

Characteristics of Corporate Bonds

DEFINITION 53 Corporations written pledge to repay a specified amount of money with interest The Face Value is the dollar amount that the bondholder will receive at the bond's maturity date, usually $ Bondholders receive interest payments every six months at the stated interest rate The legal conditions are described in a bond indenture A trustee is a financially independent firm that acts as the bondholders representative TERM 54

Why Corporations Sell Bonds

DEFINITION 54 To get funds for major purchases To fund ongoing business activities When it is difficult or impossible to sell stock To improve financial leverage Interest paid to bondholders is a tax deductible business expense that can be used to reduce the federal and state taxes corporations must pay TERM 55

Types of Bonds

DEFINITION 55 Debenture Mortgage Subordinated Convertible High Yield ("junk bonds")

Provision for Repayment

Call feature Sinking fund Serial bonds TERM 57

Why Investors Purchase Corporate

Bonds

DEFINITION 57 bond are another way to use asset allocation to diversify your investment portfolio investors consider government and corporate bonds a safer investment when compared to stocks because a bond must be repaid at maturity bonds must provide more growth and income potential than other conservative options TERM 58

Interest Income

DEFINITION 58 investors receive interest every six months the annual interest is computed by multiplying the interest rate by the face value of the bond Registered bonds, registered coupon bonds or bearer bonds TERM 59

Dollar Appreciation of Bond Value

DEFINITION 59 May be able to sell the bond to someone else at a higher price if the interest rate on the bond is higher than the interest rate of new bonds of comparable quality Approx. Mkt Value = Dollar amount of annual interest / comparable interest rate Inverse relationship between bonds market value and overall interest rates in the economy TERM 60

Three levels of government issue bonds

DEFINITION 60 Federal ( no state income tax on the interest) State Local municipalities

• Government Bonds and debt securities are sold to obtain money to finance the national debt and the ongoing costs of government

State and Local Government Securities

Municipal bonds - for local projects General obligation bonds Revenue bonds - repaid by finances from project TERM 62

Bond Formulas

DEFINITION 62 Taxable equivalent yields : Tax exempt yield / 1- tax rateCurrent yield on corporate bond : Annual income amount / Current market valueYield to Maturity : Amt. Annual Interest

• (Face value - Market value)/ TERM 63

Why Investors Purchase Mutual

Funds

DEFINITION 63 Professional Management Diversification TERM 64

Close - end funds (2% of funds)

DEFINITION 64 shares are issued by an investment company only when the fund is organized after all original shares are sold you can purchase shares only from another investor who is willing to sell actively managed by portfolio managers TERM 65

Exchange- Traded funds (8% of funds)

DEFINITION 65 ETF funds invest in the stocks or other securities contained in a specific stock or securities index Not actively managed by a portfolio manager

Open- end Funds (90% of funds)

shares are issued and redeemed by the investment company at the request of investors investors can buy and sell shares at the net asset value (NAV) TERM 67

Net Asset Value

DEFINITION 67 Value of the funds portfolio - liabilities / # of shares outstanding TERM 68

Types of Mutual Funds

DEFINITION 68 Loan Fund (front end load Class A) No- Load Fund Contingent deferred sales load (back end load Class B) TERM 69

Stock Funds

DEFINITION 69 Aggressive growth funds : buy stock in small, fast growing companies Equity income funds: invest in stock of companies with a long history of paying dividends Global stock funds : buy stock in companies in the U.S and other countries Growth stock Funds:buy stock in companies with higher than avg. revenue and earnings growth Index funds: buy stocks that mirror an index International funds: invest in foreign stocks sold in securities markets throughout the world Large cap: invests in stocks of companies with cap. of 10 billion or more TERM 70

Stock Funds continued

DEFINITION 70 Mid cap: 2-10 billion Regional funds: buy stock in companies in a specific region of the world Sector funds : buy stock in companies in a particular industry such as biotech. Small Cap: less than 2 billion Socially responsible: avoids investing in companies that produce harmful products

Bond Funds

High Yield / Junk Intermediate Corporate bond Intermediate U.S bond funds Long term corporate bond funds Long term U.S bond funds Municipal bond funds Short term corporate bond funds short term U.S government bond funds World bond funds TERM 72

Other Funds

DEFINITION 72 Asset Allocation Balanced funds Funds of Funds Lifecycle funds Money Market TERM 73

Family of Funds

DEFINITION 73 A family fund exists when one investment company manages a group of mutual funds Each fund in the family has a different financial objective Exchange privileges allow you to move your money from one fund to another within the fund family with little or no charge for the transaction TERM 74

Active vs. Index

DEFINITION 74 Most active funds are managed funds which means there is a professional fund manager or a team of managers choosing the investments--majority have failed to outperform the S&P 500 index over a long period of time An index mutual fund is a mirror image of a specific index and has a lower expense ratio TERM 75

Fund Transaction

DEFINITION 75 Open - end funds : can be bought directly from the investment company by phone, mail, online, or from a discount brokerClosed-end or exchange traded funds : are purchased through a securities exchange or in the over-the- counter market

Income dividends

earnings a fund pays to shareholders from dividend and interest income (taxed as regular income) TERM 77

Capital Gains

DEFINITION 77 occur when shares are sold at a price greater than what you paid on a short term or long term bases depending on the length of time the funds are held capital gain distributions - payments to shareholders from sale of securities held by the fund. Taxed as long term capital gains regardless of how long you own shares in the mutual fund Income and capital gain distributions can be automatically reinvested TERM 78

Taxes and Mutual Funds

DEFINITION 78 Dividend income and capital gains distribution that are reinvested in the purchase of additional shares are still taxableThe "turnover ratio" measures the percentage of the fund that has been replaced in one year , in funds that are not tax deferred this will affect your tax liability TERM 79

Purchase and Withdrawal Options (Mutual

Funds)

DEFINITION 79 Automatic investments : money is taken from your checking account monthly and invested in a fund Reinvestment Plan : income from dividends and capital gains distributions are automatically used to repurchase additional shares Telephone switching; Call your fund and move money from one fund to another in the same family Withdrawals: Various withdrawals options: You can withdraw funds by phone, letter, online, etc. TERM 80

Types of Real Estate Investments

DEFINITION 80 Direct Commercial Undeveloped Land Indirect

Direct Real Estate Investments

As the investor, you hold legal title to the property Types: Single family home, Vacation home, Duplex, Apt., Land, Property, Foreclosure TERM 82

Your Home

DEFINITION 82 A place to live Shelter income from taxes if you have a large mortgage; interest is deductible Possible hedge against inflations. Possible real estate bubbles Prices have been volatile in the last decade TERM 83

Your Vacation Home

DEFINITION 83 Tax advantages depend on if the IRS vies it as your second home or as a rental property If you don't rent it more than 14 days a year, then you can write off mortgage interest and property tax (a second home) Primary reason to own a vacation home is because you want to use it TERM 84

Commercial Property

DEFINITION 84 Land and buildings that produce lease or rental income Most common investment of this type is a duplex or small apartment building. It also includes hotels, office buildings, stores and many other types of commercial establishments Tax deductions, such as depreciation and property taxes, are limited to the amount of rental income you receive TERM 85

Undeveloped Land

DEFINITION 85 Can offer tremendous gains but this type of investment poses enormous risk. All the money is riding on a single parcel of land Most people buy land with the idea of subdividing the land

Indirect Real Estate Investments

Real Estate Syndicates or Limited Partnerships Syndicate: temporary association of individuals or firms organized to perform a specific task that takes a large amount of capital. Can be organized as a corporation, trust, or limited partnership--provide professional management and limited liability as well as diversification Limited Partnerships: has a general partner who has unlimited liability and sell participation units to the limited partners. The limited partners liability is limited to the extent of their initial investment TERM 87

Real Estate Investment Trusts (REIT)

DEFINITION 87 -Indirect similar to a mutual fund or investment company and trade shares on stock exchanges or over the counter Equity REITs own and operate income - producing properties : 90% of REITs Mortgage REITs loan money or invest in mortgages; 7% of REITs Hybrid REITS own both properties and mortgages TERM 88

Participating Certificates

DEFINITION 88 -Indirect A risk proof real estate investment Equity investment in a pool of mortgages that have been purchased by one of several government agencies such as Ginni Mae and Freddie Mac TERM 89

Advantages of Real Estate Investments

DEFINITION 89 Possible hedge against inflation Easy entry as a limited partner Limited financial liability - limited partners liability is initial investment No management concerns from limited partnerships, REITs, mortgages or participation certificates Financial leverage - use of borrowed funds for investment purchases allows you to acquire a more expensive property than you could buy on your own TERM 90

Disadvantages of Real Estate Investments

DEFINITION 90 Illiquidity Declining property values Lack of diversification Lack of a tax shelter for real estate syndicates Long depreciation period Management problems - direct real estate

Investing in Precious Metals, Gems, and

Collectibles

A hedge against inflation A safe haven during political or economic upheaval Need a storing place Can be risky due to price variations TERM 92

Gold

DEFINITION 92 Lower interest rates often result in higher gold prices Bouillon includes bars and wafers Gold bouillon coins Gold Stocks Gold Certificates TERM 93

Precious Stones

DEFINITION 93 can be a hedge against inflation appeal to investors because of their small size, ease of concealment, inflation hedge, and great durability TERM 94

Risks of Precious Stones

DEFINITION 94 Not easily turned into cash Difficult to know if you are getting a good stone DeBeers Consolidated Mines of South Africa controls 85% of the World supply of rough diamonds Expect to buy at retail and sell at wholesale TERM 95

Collectibles

DEFINITION 95 can be a good investment and a hobby, or a financial disaster Its "buyer beware". Be careful of investment scams and forgeries Know dealers reputation and be wary of promises. Get a second opinion Use common sense ad comparison shop