Would you put on a big party without planning? Not likely! First, you’d probably decide on the date and time. Then you’d figure out where to have it: at your house? At a restaurant? You would decide on the food, decorations, and music. Of course, you’d have to make a list of guests and send out invitations. Before the plans went too far, you’d have to make sure you could afford everything.
Planning for your financial future is much more important than planning a party. But it, too, involves answering a series of questions. What are your goals? Do you want to go to college? Buy a car? Buy a home? Build up a savings account? Start a family and then help your children become financially secure? Take an early retirement? All these things require money. And if you want to have money, you have to make a plan for how you’re going to get it and how you’re going to save and spend it.
This textbook is about life skills and career opportunities. The tools offered in this book and in this chapter provide knowledge about money, how it is used, spent, and invested. They provide a starting point for building an entire set of needed skills in life, as well as finding a good career.
This chapter will provide you with the knowledge and skills to make decisions about how to use money and plan for wise spending and saving throughout your lifetime.
The word finance refers to management of money, and personal finance refers to how you manage your money and other things of financial value. A personal financial plan can make the difference between being able to do the things you want to do and feeling that you’ll never reach your goals in life.
Why is a personal financial plan important?
p
Flag question: Question 2
Question 21 pts
Creating a Personal Financial Plan
The starting point in mastering your personal fi nance is to create a financial plan, or a document that outlines your financial goals and how you plan to reach them. A financial plan sets forth your decisions in six areas:
Managing Your Budget
Your budget is a detailed summary of expected income and expenses during a given period. Income (money coming in) is what is earned or made available to you that you expect to receive on a regular basis. Expenses (money going out) are amounts of money you spend to pay bills or for other needs and wants. Needs are things that you must have to sustain your livelihood. Basic meals, necessary school expenses, and transportation money to get to school are examples. Wants are things that you do not have to have, but would like to have, or own.
Let’s take a look at planning a school activity such as an awards banquet. Building a budget will allow you to make an informed decision about how many people to invite, how much food, drink, and decorations you can afford, and what type of entertainment to provide. You’ll also want to think about how many tables and chairs you may have to rent. You may have to consider how many tickets to sell. Some additional research will allow you to make better use of available money by checking local stores or catering services for the best deals in food and beverages.
To use a budget as part of a long-term financial plan, rather than for a specific event such as a party, you list your expected expenses and income over a certain period. A financial plan is a long-term document. Creating a plan allows you to set financial goals. The plan can be for next year, the next 10 years, or even a lifetime.
Based on the information in your long-term budget, you can decide if your income will be adequate to enable you to have the standard of living that you want to have. Your goal should be for your income to be greater than, not just equal to, your expenses. If this is the case, you will be able to save, and saving is essential for creating wealth and building a good future.
Managing Your Liquidity
A financial plan must take into account your liquidity. Liquidity is access to funds to cover a short-term cash need. Even though they’ve made good plans, people often need money for an unexpected expense. They might own valuable items, such as land, a house, or a car, but those items will be useless if they need cash quickly. In that case, they will need liquidity.
If liquidity is a problem, some people borrow money. Borrowing is usually necessary to finance a major expense, such as a college education, a house, or a new car. But borrowing has risks, as you’ll learn later in this lesson.
Financing Your Large Purchases
Financing is obtaining or providing money for a specific purpose. The person obtaining the money is the borrower, and the provider of the money (usually a bank) is the lender. Financing generally comes in the form of loans.
For example, if you plan to go to college, your parents or guardian may be able to pay part of the cost from their savings. You may be able to contribute something from your earnings. But college can be expensive, and you and your family may not have enough to pay for everything. In this case, you may want to take out a student loan. This loan will cover the difference between what you and your family can give and the total cost of your education.
Most people need to take out loans at one point or another. But you should never get dependent on loans, because you must pay all those loans back. And when you repay them, you’ll have to pay interest, which is a charge on borrowed money. Interest charges seem small, but they add up.
For example, say you borrowed $10,000 to pay for part of your college tuition. The interest rate on the loan was 5 percent per year. If you didn’t make any payments in the year after you got your loan, you would have to add 5 percent, or $500, to the $10,000 that you borrowed. If you made no payments on your loan for 10 years, your interest would total a whopping $6,289. Of that sum, $5,000 would be interest on the $10,000 you had borrowed. The remaining $1,289 would be interest on accumulated unpaid interest, which is called compound interest.
Most people pay back their loans gradually. Their interest payments go down, rather than up, over the years. Still, interest payments add up, and you need to be aware of and keep track of them. More importantly, you should not become dependent on loans since interest payments are funds lost to you, and gained by someone else (the lender).
Protecting Your Assets
An asset is something of value that you own. Maybe you own a car. Or you might own stock in a company. Perhaps your collection of baseball cards is valuable. Or you may have inherited a gold ring from your grandmother or a piece of equipment from your grandfather’s wood shop. These are tangible assets. Tangible means a physical item that you can touch.
In making a financial plan, you will want to protect your assets. You can do this by buying insurance. Insurance is an agreement between two parties under which one party— usually an insurance company—guarantees the other that if an asset is lost or destroyed, the insurance company will pay for it. To insure an asset of any kind, you must pay a monthly fee, or premium, to the insurance company.
Insurance also covers intangible assets—assets that are not tangible. For example, you can insure your health or your life. Health insurance covers medical benefits. Life insurance pays a certain amount of money, or benefit, should you die.
You will want to insure your most important assets. For example, if you buy a car you will need to buy insurance. Then, if you have an accident and the car is damaged, your insurance policy will pay for the repairs.
Investing for the Future
Investments are an important part of a financial plan because they are one of the best ways to help you increase your wealth over a desired period or over your lifetime. An investment is something you own that you expect to increase in value over time. At some point, you may buy a house and expect it to increase in value. That’s an investment. One type of investment to consider is stocks, which are funds raised by companies through the sale of shares. Shares are equal parts into which company stocks are divided. Investors may buy shares, thereby giving them part ownership in a company. When you purchase a bond, another kind of investment, you are investing to help a company or government agency raise funds for a return greater than the money you invested. A third popular investment is a mutual fund, an investment that often includes a mix of stocks, bonds, or other securities purchased in shares.
Some people buy art or jewelry because of its investment value. A car is not an investment because it typically decreases in value over time.
Investing in Your Retirement
A financial plan is a long-term document, so retirement should be a part of it. Retirement is the period (usually later in life) during which you no longer work full time at a job.
People retire at different ages. In the past, many people retired at age 65, when they qualified for Social Security benefits. However, recent federal law has changed the ages for Social Security eligibility, depending on a person’s year of birth. Today, many don’t qualify until they are older than 65. In addition, many private retirement plans have changed. In general, retirement ages have gone up because people are living longer and can work longer.
If you entered military service, you could retire after just 20 years of service (although you may need to get another job at that time, possibly allowing you a second retirement income when you reach retirement age).
During retirement, you will not be getting a paycheck as you did when you had a full-time job, but you will still need money to live. So making sure you have enough money for retirement is important. And the better you plan for your future, the more likely you can choose when to retire. If you love your job and want to go on working into your 70s, that’s fine. However, if you would rather retire and move on to something else, you will need a steady source of retirement income.
You probably think that retirement seems so far away that it’s not worth thinking about. But just ask a grandparent or another older adult. Retirement age comes a lot quicker than most people think it will. If you start planning for retirement now, you’ll be glad you did. The longer you save money, the more it will earn for you over the years between the time you save or invest and the time you retire.
2. What are the six areas for decision making when creating a personal financial plan?
1 answer
The six areas for decision-making when creating a personal financial plan are:
Managing Your Budget: This involves creating a detailed summary of expected income and expenses during a certain period, helping you understand your financial situation and set financial goals.
Managing Your Liquidity: This focuses on ensuring you have access to cash or liquid assets to cover short-term needs and unexpected expenses.
Financing Your Large Purchases: This involves understanding how to obtain or provide money for major expenses, such as loans for college, a home, or a car, and managing the implications of borrowing and interest.
Protecting Your Assets: This includes safeguarding valuable items through insurance, which covers both tangible assets (like cars and property) and intangible assets (like health and life coverage).
Investing for the Future: This entails making investments in various forms (stocks, bonds, mutual funds, real estate, etc.) to grow wealth over time and enhance financial security.
Investing in Your Retirement: This centers on planning financially for retirement, ensuring you have sufficient funds to support your lifestyle when you are no longer working full-time.
1 answer