Introduction to Personal Finance Beginning Your Financial Journey Third Edition John Grable and Lance Palmer Chapter 3 Earnings and Income The Building Blocks of Your Financial Journey For screen reader users This file contains Animations For improved screen reader experience it is recommended to disable Animations before proceeding further in this file Copyright 2024 John Wiley Sons Inc Chapter Outline Learning Objectives 1 3 LO 1 Discuss how to create wealth through increasing income limiting expenses and investing in your human capital LO 2 Identify the different forms of employee earnings LO 3 Compare the financial pros and cons of self employment and ways to structure a business Copyright 2024 John Wiley Sons Inc Chapter Outline Learning Objectives 4 6 LO 4 Discuss the sources and characteristics of unearned income LO 5 Explain how to use capital assets to produce income and build wealth LO 6 Explain financial safety net programs available to employees and those living in the United States Copyright 2024 John Wiley Sons Inc Income Produce More Than You Spend LO 1 Discuss how to create wealth through increasing income limiting expenses and investing in your human capital Copyright 2024 John Wiley Sons Inc L O 1 Creating Wealth To accumulate wealth you need to generate a surplus which is the money left over after all your expenses have been paid Income Living Expenses Surplus Generating a surplus is the primary way to build wealth over your lifetime Copyright 2024 John Wiley Sons Inc L O 1 Using an Income Surplus to Create Wealth Copyright 2024 John Wiley Sons Inc L O 1 The Power of Saving Early in Life Strive to generate a surplus and begin saving the surplus as early as possible to keep your money working for you Example Suppose two individuals save 5 000 at the beginning of each year earning 8 Copyright 2024 John Wiley Sons Inc L O 1 The Dangers of a Deficit Failing to generate a surplus is unwise Worse continuously incurring a deficit expenses exceed income is unsustainable and can lead to extreme financial stress 1 Overspending leads to more borrowing loan or credit card 2 Borrowers end up paying more interest each month rather than earning interest on savings 3 The interest plus the continued overspending will require more borrowing more interest etc 4 This quickly depletes wealth over time and makes it more difficult to achieve long term financial goals Copyright 2024 John Wiley Sons Inc L O 1 The Downward Spiral of Deficit Spending Copyright 2024 John Wiley Sons Inc L O 1 Saving Your Income Surplus Targeted Savings Ratio Indicates the percentage of income that you are actively saving as calculated by the following formula Savings Ratio Savings Income Targeted Savings Rate The savings ratio over a specific time period for example if you are o 30 your target should be to save 12 toward retirement o 30 to 40 your target savings rate should be at least 15 o 40 you will need a target retirement savings rate of 20 per year for each year until age 65 Copyright 2024 John Wiley Sons Inc L O 1 Savings Strategies One strategy a payroll deduction occurs when an employer takes money automatically from your paycheck contributes it directly to a retirement savings plan or other savings account Another strategy Save More Tomorrow suggests Commit to putting half of every future raise toward creating an income surplus Copyright 2024 John Wiley Sons Inc L O 1 Accelerating Effect of Saving Half of All Future Raises Start of Year Savings Rate Year 1 3 0 Employer Save Half of Raise 5 0 Raise 2 5 End of Year Savings Rate 5 5 2 3 4 5 6 5 5 8 0 10 5 13 0 15 5 5 0 5 0 5 0 5 0 5 0 2 5 2 5 2 5 2 5 2 5 8 0 10 5 13 0 15 5 18 0 Copyright 2024 John Wiley Sons Inc L O 1 Escaping the Perils of Debt The total debt to income ratio shows the percentage of your income that you are spending to pay down your debts The ratio is calculated as follows Total Debt to Income Ratio Total Required Debt Payments Gross Income 100 Add up all of your monthly debt payments Divide the total monthly payments by your gross Figure out your gross monthly income monthly income and multiply the result by 100 Copyright 2024 John Wiley Sons Inc L O 1 Investing in Yourself As a student you may be struggling to just keep your finances afloat while avoiding debt This is a totally reasonable financial strategy You should be focused on doing well in school and building your human capital You may only be able to work part time or work full time at jobs that are flexible with your schedule You might end up taking out student loans which can be a valuable and necessary source of income during college Copyright 2024 John Wiley Sons Inc L O 1 Employment Earnings LO 2 Identify the different forms of employee earnings Copyright 2024 John Wiley Sons Inc L O 2 Overview of Earnings Income versus Earnings Income is a broad term used to describe all sources of money obtained by individuals and households and can include Earnings are just one form of income Compensation received for services performed for an Public benefits gifts interest payments dividends etc employer Copyright 2024 John Wiley Sons Inc L O 2 Sources of Earnings A wage what an employer pays an employee to work usually wages are based on an hourly rate A salary payment for work for a set period of time usually an annual amount A commission payment based on the sale of a product or service A bonus an extra payment usually based on performance Copyright 2024 John Wiley Sons Inc L O 2 Minimum Wage The U S minimum wage is currently 7 25 per hour 2023 This wage is periodically reset by Congress through the Fair Labor Standards Act which was passed in 1938 Before the Fair Labor Standards Act was enacted employees had to negotiate their personal wage rate and the number of hours they would work per week which some employers took advantage of Thus this law was put in place to protect those paid by the hour Copyright 2024 John Wiley Sons Inc L O 2 Overtime Workers who fall under the Fair Labor Standards Act must be paid at least 1 5 times time and a half their regular wage when they work overtime Overtime is defined as working more than 40 hours in one week Overtime pay boosts earnings but it is unwise to plan to earn overtime over a long period of time Employers try to limit overtime as it is costly for the business Copyright 2024 John Wiley Sons Inc L O 2 Who Makes More Money Annual Average Pay Hourly Average Pay Average American Mechanical engineer Bus driver Accountant or auditor