HACE 2100 1st EditionExam # 2 StudyGuideDollars and Sense➢ Financial Illiteracy ○ more than ⅙ US teens are unable to make simple, everyday choices about spending, andonly 1/10 can solve complex financial tasks○ 17.8% of students don’t even reach baseline level of financial proficiency○ the financial literacy and education commission was established under the fair andaccurate credit transactions act of 2003■ the commission was tasked with developing a national financial educationwebsite (mymoney.gov), and a national strategy on financial education■ chaired by the secretary of the treasury and the vice chair is the director of theconsumer financial protection bureau ➢ So what do you need? Sound financial plans!○ what will plans do? they will help you...■ achieve your financial goals■ achieve financial independence ■ invest intelligently■ minimize payments to the government■ cover your assets (insurance) ➢ The Life Cycle of Financial Planning○ Stage 1: The Early Years - a time of wealth accumulation■ develop savings plans and set your initial goals of all lengths■ establish long range investment strategy ■ invest in stocks and mutual funds during this time■ through age 54○ Stage 2: Approaching Retirement - the golden years■ realize intermediate term goals and re-evaluate your plan to match current goals■ plan for retirement■ ages 55-64○ Stage 3: The Retirement Years ■ reduce investment risk and concentrate on preservation of assets rather thangrowth (invest in bonds!) ■ plan for the transfer of your estate■ age 65+➢ The Person Financial Planning Process○ Step 1: evaluate your financial health ■ evaluate current income, spending, and wealth situation■ assess whole financial picture■ you can’t get to where you want until you know where you are○ Step 2: define your financial goals■ specifically define and write down your goals to reflect your situation■ attach a cost to each goal and set a date for when the money is needed toaccomplish the goal■ goals: the cornerstone of a financial plan● goals keep future in mind by reminding you of rewards; goals entice youto keep plan in effect; goals provide tangibility for the question “why” ■ time horizons for goals● short term: within 1 year● intermediate term: 1-10 years● long term: more than 10 years○ Step 3: develop plan of action■ what must i do to achieve goals? ■ flexibility: ability for your plan to change as situations/goals change■ liquidity: your ability to convert non-cash assets into cash with relative ease■ protection: your ability to meet unexpected large expenses without destroyingyour plan■ minimization of taxes: your ability to pay as little as possible to uncle sam○ Step 4: implement your plan■ your plan = road map ■ use common sense & moderation; don’t track every single penny■ remain positive■ stay on track○ Step 5: revise your plan■ review progress, match plan to goals, be prepared to start over if your plan nolonger meets your needs➢ Using a Balance Sheet to Measure Your Wealth○ personal balance sheet: a statement of your financial position on a given date; it is asnapshot of the present○ it lists your assets and your liabilities■ assets: what you own● monetary assets: those that can be easily liquidated (e.g. cash, checkingaccount, savings account) ○ short term goals● investment assets: assets that are invested for the future (e.g. stocks,bonds, cash value life insurance) ○ intermediate/long term goals ● retirement plans: investments by you/your employer to save forretirement (e.g. IRAs, 401(k) plans) ○ 403(b) plan: education retirement plan○ Keogh: self employed people○ SEP-IRA: self employed people● real estate: tangible asset such as land or a dwelling○ represents most of your savings and hopefully appreciates invalue○ tangible assets: physical asset that you can use, feel, and touch ○ usually the biggest financial asset you will ever have● automobiles/other vehicles: tangible assets that must beinspected/licensed○ reported as fair market value, but usually depreciates ● personal property: tangible assets that represent your lifestyle; usuallyemotional in value, but economically speaking, depreciates ■ liabilities: what you owe ● long term: those that extend beyond a year, e.g. home mortgage, autoloans ■ your net worth: a measure of your wealth ● assets - liabilities = net worth● insolvent: condition in which you owe more money that your assets areworth ➢ Using a Personal Income Statement to Trace Your Money○ personal income statement tells you where your money comes from and where it hasgone ○ it is a “motion picture” of the past (vs. snapshot of the present for balance sheet!) ○ income statement is based entirely on actual cash flows ○ expenditures: where your money goes■ the two major expenditures categories: taxes and living expenses ■ fixed expenses: those that you don’t directly control, e.g. mortgage/cablepayments■ variable expenses: those that you can control, e.g. food, entertainment ➢ Using Ratios: A Financial Thermometer○ analyzes the raw data from your balance sheet and income statement to identify yourfinancial strengths and weaknesses, and allows you answer the following questions...○ do you have adequate liquidity?■ ratios to determine whether or not you have enough monetary assets● enough to pay for unexpected large expenses● enough to get you through periods of reduced or eliminated earnings■ current ratio: monetary assets/current liabilities ● shows whether you have enough liquid assets to cover expensescurrently due ● ratio should be greater than 2■ month’s living expenses covered ratio: monetary assets/(annual livingexpenses/12) ● rule of thumb: 3-6 months of expenses covered ○ can you meet your debt obligations?■ ratios to determine whether or not you can meet current/long term debtobligations■ debt ratio: total liabilities/total assets● tells whether or not you could pay off all of your liabilities if youliquidated all of your assets● if ratio is, for example, .4118, that means one’s assets are 41.18%financed through debt, but yes, one could pay off all debt if needed■ long term debt coverage ratio: