Principles of Money Management

BUS-121

Principles of Money Management

​

Frank Paiano

Professor, School of Business

Welcome, Everyone!

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First – A Perspective

“It is a gloomy moment in history. Never has the future seemed so dark and incalculable. The United States is beset with racial, industrial and commercial chaos, drifting we know not where. Of our troubles, no one can see the end.”

Harper’s Magazine, 1847

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CHAPTER 1

Personal Financial Planning

“It is not money that brings happiness, it is lots of money.” – Old Russian Proverb

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Financial Planning, Definition

• Personal financial planning is the process of managing your money to achieve personal economic satisfaction
• Other definitions:
• The ability to use knowledge and skills to manage one's financial resources effectively for lifetime financial security
• The process of realizing more enjoyment from income and improving one’s standard of living while making adequate arrangements for a secure and comfortable retirement
• The process of identifying assets, determining the classification of those assets in regard to both current and future needs, analyzing debt, expenses, and consumption patterns, reviewing tax status, and addressing a host of other issues and concerns

How would you define personal financial planning?

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The Benefits of Financial Planning

• There are several advantages of effective personal financial planning
• Increased effectiveness in obtaining, using, and protecting your financial resources
• Increased control of your financial affairs
• A sense of freedom from financial worries obtained by being able to look optimistically toward the future
• Improved personal relationships
• What is the number 1 reason for divorce in America?

5

Developing a Flexible Financial Plan

• A financial plan is a formalized report that...
• Summarizes your current financial situation
• Analyzes your financial needs
• Recommends future financial activities
• Your financial plan can be created by you, done with assistance from a financial planner, or made using a money management software package

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The Financial Planning Process

1. Determine your current financial situation
2. Develop your financial goals
3. Identify alternative courses of action
4. Evaluate your alternatives
• Keep in mind opportunity costs and risks
5. Create and implement a financial action plan
• Write it down!
6. Reevaluate and revise your plan

“My Goodness! Does anybody really do all this?!”

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What is a More Realistic and Typical�Financial Planning Process?

1. Make money
2. Spend it
3. Make some more money
4. Spend that …

… and then spend some more

• Go into debt
• Panic!
• Take BUS-121, Principles of Money Management

“Lots of anybodies have done this!”

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Simply Put, It All Comes Down to �the Choices We Make!

• Opportunity cost
• What you give up by making a choice
• The opportunity cost is sometimes referred to as the trade-off of a decision
• It cannot always be measured in dollars. Sometimes the cost is your time or your health
• Consider the lost opportunities that will invariably result from your decisions

Example/Discussion: “There is no such thing as a free lunch!”

What are the opportunity costs of attending college?

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Opportunity Costs and Financial Results Evaluated When Making Decisions

Your Money or Your Life, Vicki Robin

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Every Financial Decision�Involves Evaluating Types of Risk

• Inflation risk
• Rising prices cause lost buying power
• Interest-rate risk
• Affect costs of borrowing and rate of return
• Income risk
• The loss of a job
• Personal risk
• Health or safety
• Liquidity risk
• Higher return may mean less liquidity
• Culture of Consumerism risk
• aka Die-Working-and-in-Debt-Up-to-Your-Eyeballs risk

Discussion:

Can you guard against all risks?

Should you try?

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Implementing Your Financial Plan

• Developing good financial habits
• Use a well-conceived spending plan to help you stay within your income, while allowing you to save and invest for the future
• Have appropriate insurance protection to prevent financial disasters
• Become informed about tax and investment alternatives
• Achieving your financial objectives requires…
• A willingness to learn, and
• Appropriate information sources

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Financial Planning Information Sources

• Printed materials
• Books, magazines
• Financial institutions
• Credit unions, banks, brokerages, etc.
• School courses and educational seminars
• Computer software and online information sources
• The Internet is an inexhaustible supply
• Sometimes useful, sometimes not…
• Financial specialists

Taking this course is a great start!

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Influences on Personal Financial Planning

• Marital status, household size, and employment
• Major events
• Marriage, Birth or adoption of child, Divorce!, Bankruptcy
• Values
• What are the ideas and principles you consider correct, desirable and important?
• Where are you in the Adult Life Cycle stage?
• “Traditionalist / Mature” – Before 1946 – 23 million
• “Baby Boomer” – 1946 to 1964 – 71 million
• “Gen Xer” – 1965 to 1980 – 65 million
• “Millennial” – 1981 to 1996 – 72 million
• (aka Digital Generation, Gen Y)
• “Gen Z” – 1997-2012 – 67 million

Life situation and personal values

Source: Statista.com from U.S. Census 2020

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Influences on Personal Financial Planning

Millennial tee-shirt worn by an SDSU student.

(continued)

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Influences on Personal Financial Planning

• Market Forces
• Supply and demand
• Production costs and competition
• Financial institutions
• Influence of the Federal Reserve Bank and the global financial markets
• Global influences
• Level of exports and imports
• Economic conditions....

Economic factors:

(continued)

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Changing Economic Conditions

• Consumer Prices and Inflation
• Consumer Spending
• Interest Rates
• Money Supply
• Unemployment
• Housing Starts
• GDP: Gross Domestic Product
• Trade Balance (aka Trade Inbalance!)
• Budget Deficit
• Financial Markets

But since none of us has much, if any, control over these matters, we will focus on the things that we can and do have control over.

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Components of Financial Planning

• Planning (chapters 1, 2)
• Taxes (chapter 3)
• Payments and savings (chapter 4)
• Borrowing (chapter 5)
• Spending (chapters 6, 7)
• Managing risk (chapters 8, 9, 10)
• Investing (chapters 11, 12, 13, 14, 15)
• Retirement and estate planning (chapter 16)

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Developing Personal Financial Goals

• Types of financial goals include those...
• Influenced by the time frame in which you want to achieve your goals
• Influenced by the financial need that drives your goals
• Timing of goals must be identified
• Short-term, intermediate-term and long-term goals
• Financial goals should...
• Be realistic, be stated in specific, measurable terms, have a time frame, have a priority, and indicate the action or actions to be taken

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Timing of Financial Goals

• Short-term – up to 1 year “or so”
• Intermediate-term – 2 to 5 years
• Long-term – more than 5 years

The above are the most common time frames. Here are others:

• Short-term – 1 to 3 years
• Intermediate-term – 3 to 5, 6 or even 7 years
• Long-term – 7 years or longer (10 to 30 years)

The first set of time frames are more in line with the general consensus within the financial industry (brokerage firms, mutual funds, etc.) The second set of time frames are more common in the life insurance industry.

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Financial Goal: Example

• Pay off VISA
• Balance: $3,500
• Time frame: Within 12 months
• Actions to be taken
• Reduce dating and clubbing to twice a month
• Cancel cable service and mobile phone
• Stop buying coffee at FiveBuck$
• Pay extra $300 per month
• Priority: High

Which time frame does this belong to?

How would you measure the success of the goal?

Is the goal reasonable?

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Financial Goal: Example

• Save up for a Home Theater system
• Amount needed: $2,000
• Time frame: Within 12 months
• Actions to be taken
• Take part-time job at Home Cheapo
• Put $150 per month into a special savings account at the bank
• Priority: Medium

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Financial Goal: Example

• Save for down payment on a condo
• Amount needed: $15,000
• Time frame: 5 years
• Actions to be taken
• Set up $200 automatic investment per month to be taken from our checking account
• Expected rate of return: 7%
• Priority: High

Will $200 per month at 7% be enough to reach this goal?

We are going to learn how to calculate the future value of this stream of investments.

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Non-Financial Goal: Example

• Be able to do 15 “good” push-ups
• Can currently only do 7 “good” push-ups
• Time frame: Within 3 months
• Actions to be taken
• Start with 7 push-ups, three times a day
• Increase by 2 or 3 push-ups every three to four weeks
• Work up to 15 push-ups within 3 months
• Priority: Medium

Is this goal reasonable?

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Goal Setting

Which of the following goals would be the easiest to implement and measure its accomplishment?

​

1. Spend less so we can save more each month
2. Save $10,000 for a down payment on a condo
3. Save $100 each month to create a $4,000 emergency fund in 40 months by canceling the cable service
4. Save enough for a $4,000 vacation next year

The correct answer is (C).

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The Financial Goal of Most Americans

Spend everything that you earn!

And then spend some more!

Most Americans Live Beyond Their Means

Discussion: How do we do it? Why do we do it?

“Honey, Can We Make It to the Next Paycheck?”

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The Most Important Financial Goal!

Spend less than you earn!

“Pay Yourself First” – 10%?

“Live Beneath Your Means”

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The Most Important Financial Goal!

• Pay Yourself First
• By having the money come out of your paycheck or checking account automatically, most individuals easily adjust to investing
• Works like a pay raise, only in reverse
• The 10% Solution
• Many financial planners recommend saving at least 10% of your income for long-term, compounded growth
• The Wealthy Barber, David Chilton

Is 10% a reasonable goal?

(continued)

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The Most Important Financial Goal!

“The magic of compound interest. Thirty dollars a month, a dollar a day, can magically turn into over a million dollars. And do you know what is even more impressive? You know someone who has done it,” Roy, our barber, said proudly.

“Thirty-five years ago, I started my savings with thirty dollars a month, approximately 10% of my earnings. I have achieved just under 13% return per year. In addition, as my income rose, my savings rose accordingly. Thirty dollars a month became sixty dollars, then a hundred, and eventually hundreds of dollars a month.”

“You three are looking at a very wealthy man.”

The Wealthy Barber, David Chilton

(continued)

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The Most Important Financial Goal!

“One of my early students only followed the ‘Pay Yourself 10% First’ lesson. He bought the wrong life insurance, abused credit cards, overpaid for his mortgage, did not take advantage of his 401(k) at work, and lost all $15,000 of an inheritance playing the commodities market.”

“This is a real upbeat, encouraging story, Roy,” said Tom.

“Today, his net worth is $850,000, Tom. $300,000 of it is the equity in his house but the rest is his 10% savings.”

“He did everything else wrong but –” Cathy started.

“Because he had saved 10% of each paycheck and invested it for long-term, compounded growth, today he is in great shape,” Roy finished.

The Wealthy Barber, David Chilton

(continued)

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The Rule of 72

But let us get more precise…

• A Quick ‘n’ Dirty Method for Calculating Compound Interest (or Inflation)
• Divide the interest (or inflation) rate into 72
• That is approximately how long it will take the amount to double
• Example: 10% Interest Rate
• 72 / 10 = 7.2 years – It will take about 7 years for your investment to double if you earn 10%
• Example: 3% Consumer Price Index (inflation)
• 72 / 3 = 24 years – It will take about 24 years for prices to double if inflation runs about 3%

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Simple versus Compound Interest

Simple Interest – (Will be used in chapter 5)

Interest = Principal * Rate * Time�Interest = $100 * 6% * 1 year = $6.00�In one year you have $106 ($100 + $6.00)

Compound Interest – (We use the future value tables in this chapter 1)

But the next year, you will earn interest on your interest…

$106 x 6% x 1 = $6.36

After the next year, you will have $112.36

I know what you are thinking, “Big Deal, Paiano!”

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Time Value of Money

(discounting)

Increases in an amount of money as a result of interest earned

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Future Value of Money

• The amount to which a sum you invest now will increase based on a specified interest rate and time period
• Future value is also called compounding
• Future value can be computed for a single amount – aka a lump sum or principal
• Future value can also be determined for a series of deposits – aka stream of investments, “annuity”

Start investing now to take advantage of the future value of money.

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Future Value of Money

• Future value formula for Lump Sum Principal

(continued)

Future Value = Principal * (1 + Rate)^Time

• Future value formula for Series of Deposits

(1+Rate)^Time - 1

Future Value = Deposit * ──────────

Rate

Do not worry about the math. We use the future value of money tables.

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Present Value of Money

• The current value for a future amount based on a certain interest rate and a certain time period
• Present value is also called discounting
• Present value of a single lump sum
• Present value of a series of withdrawals

​

Not only is present value harder to comprehend, it is also not as important for personal finance. (We use present value extensively in the BUS-123, Introduction to Investments, class.)

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Present Value of Money

• Present value formula for Lump Sum

(continued)

Lump Sum

Present Value = ───────────

(1 + Rate)^Time

• Present value formula for Series of Withdrawals

1

1- ───────

(1+Rate)^Time

Present Value = Deposit * ───────────

Rate

Please do not drop the class. We are not going to do any present value calculations.

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Future Value of Money

Okay, let us do some exercises…

Future value handouts

Please, please, please work through the Future Value handouts. These problems will be on exam #1!

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Hope For Your Future

Data as of December 31, 2023

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Financial Aspects of Career Planning

• A Job –
• An employment position obtained mainly to earn money, without regard for interests or opportunities for advancement
• A Career –
• A commitment to a profession that requires continued training and offers a clear path for occupational growth

Do you have a Job or a Career?

“A job is something you do for a paycheck. A career is something you do regardless of the paycheck.”

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How Education Relates to Income

�

Source: Bureau of Labor Statistics, 2021

https://www.bls.gov/emp/chart-unemployment-earnings-education.htm

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Service Industries Expected to Have�the Greatest Employment Potential

• Computer Technology
• Health Care
• Business Services
• Social Services
• Sales and Retailing
• Hospitality and Food Services
• Management and Human Resources
• Education
• Financial Services

“Biotechnology.”

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But What Is Your Career Goal?

• Most people believe you must become a doctor or lawyer or high-powered executive to become wealthy
• But what if you want to be a writer or a teacher or an artist or a janitor or mechanic or plumber?
• Can you become wealthy while doing what you love...
• Even if it does not command a large salary?
• As we saw, the answer is, “Yes!”

The key is to set a goal for yourself & start investing early.

In fact, your career is not your most important financial decision.

But if your career is not your most important decision, what is?

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What is Your Most Important Financial Decision?

Who You Marry!

And then subsequently divorce …

“Marriage is grand. Divorce is more like $100 grand.”

– Anonymous

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The March of Civilization

​

Hunting & Gathering

Agrarian

Simple

Advanced

Industrial

Information (?)

60 to 80 hours per week

40 hours per week

25 hours per week?

25 hours per week

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Our Secret Weapons!

NutritionFacts.org

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Could not have said it better myself…

• “Choose a job you love, and you will never have to work a day in your life.”

Confucius

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