Chapter 1 Personal Finance and Career Planning Test 1 Study Guide Personal Finance is the study of how people spend saves invests and protect their financial resources Personal Finance Planning is the process of managing your finances to reach goals and to increase personal satisfaction Why it is important to study personal finance We live in an increasing complex world with more options than ever before Developing strategies to cope with these options is critical to one s sense of well being and security Of the slow growth in personal income wages and salary people have found other ways to save invest and make their money increase Step 1 Setting Financial Goals Financial goals should be based on o Values principles that guide behavior o Attitude likes and dislikes o Goals end results the things worth striving for o Needs what you must have o Wants what you would like to have Importance Opportunity Costs refers to what a person gives up in order to do or have something else Ex Going to law school after graduating college this puts off working full time for three years Risk is the possibility of experiencing harm suffering danger or loss In personal finance the emphasis is on the potential loss of or lack of money Income risk Losing a job or other source of income is always a possibility Inflation risk rising prices affect how far your dollars stretch If your investments aren t earning more than the cost of living increases each year then you are losing purchasing power Inflation is defined as a rise in price levels Over the last twenty years the inflation rate has averaged about three percent per year Interest rate risk changing interest rates can have a negative effect on your investments Liquidity refers to how readily something can be converted into cash Liquidity risk some investments are more difficult than other to convert into cash Personal risk Health safety and other risk involved in money decisions Status risk clothing neighborhoods brands and cellphones convey images Time risk how long can you afford to put off saving for a child s college tuition or your retirement Risk aversion is the avoidance of risk it assumes that an individual will try to avoid or reduce risk in order to minimize problems and maximize positive outcome Step 2 Creating and Activating Action Plans Staying on course holding onto the checking and saving account o Ex Exhibit 1 2 on page 6 Expanding adding new pieces such as increasing the amount of life insurance coverage on an existing policy or increasing your contribution to an already established retirement plan Cutting back spending less selling assets such as real estate or stock Embarking on a new course trying something for the first time such as having a regular savings plan or purchasing stock bonds or mutual funds Step 3 Monitoring Evaluating and Revising plans Goals need to be reexamined and updated investments have to be checked periodically to To keep up to date on your financial situation you should completely evaluate your see how they are progressing financial plan at least once a year The General Economy and Four Key Players Economics is the study of the economy how wealth is created and distributed and the forces of supply and demand Wealth total value of all items owned o Financial assets are intangibles or paper assets such as savings and securities o Tangible assets are physical assets such as homes or cars 1 Consumers information about products and services participate in the economy whenever they spend invest save or react to The average propensity to consume refers to the percentage of each dollar of income that the individual spends on average for current consumption Consumption is the using of goods and services o Levels of living current state of living but saves and invest to achieve Standard of living quality of life one seeks implies prosperity including the comforts luxuries and necessities one seeks 2 Government mediates or regulates the consumer business media exchange Federal Reserve the Fed System regulates the U S monetary system including 3 Business maintaining and adequate money supply provides goods services and employment Play an important role in the circulation of money as part of the free enterprise system demand The prices of goods and services are determined by the forces of supply and Business exist in a highly competitive market that is regulated by government 4 Media and consumer demand two major categories are print which includes newspaper and magazines direct mail and outdoor billboards advertisements on buses and broadcast which includes radio television cable and internet Media informs the public about currently happening or upcoming events services and products The Economy Cycle Four stages The economic cycle is sometimes referred to as a business cycle refers to periodic expansion and contractions in economic activity 1 Expansion growing economic activity low unemployment rate A preferred stage with prosperity o Time when consumers buy car homes and other expensive items since interest rates and inflation are relatively low and employment is high 2 Recession Temporary slowing of the economy or downturn in the economy when unemployment is higher than desired and economic activity is slow o Recurring period of decline in total output income employment and trade usually lasting from 6months to a year and marked by widespread contractions in many sectors of the economy 3 Depression an undesirable downwards trend featuring unemployment with 10 percent or more of the working age population unemployed and economic growth at a standstill 4 Recovery a hopeful stage when things start looking better the nation is emerging from a recession or depression the level of unemployment is lessening retail sales improve and the economy is moving forward Consumers start buying more and have more confidence in the economy Indicators of the Direction of the Economy Inflation rising of prices So as inflation increases the buying power of the dollar decreases Inflation devalues money The rate of inflation varies Index of leading economic indicators LEDI released every month by the U S Commerce Department s Bureau of Economic Analysis is a composition index averaging 11 components of growth from different segments of the economy A falling index over a 3 month period indicates a slowing down or decline in the economy where as a climbing index indicated a prosperity growth Consumer Price Index CPI widely used measure of
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