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Q1 Describe 2 Situations in Which You Could Use Time Value For Money Calculation For Achieving Various Personal Financial Goals

1. The time value of money is important to consider for retirement planning and choosing investment options. For retirement, calculating the future value of annual expenses accounting for inflation and investment returns is needed to determine how much to save. For investments, using time value can help analyze which option between a mortgage or other investments has a better return. 2. After reviewing personal finances, specific actions taken were organizing documents, creating a balance sheet to assess assets and liabilities, and paying down debts while maintaining an emergency fund by increasing work hours and pursuing passive income sources. 3. Financial ratios can be useful for planning personal finances. The liquidity, debt, and current ratios help evaluate short-term obligations, debt levels, and

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61 views4 pages

Q1 Describe 2 Situations in Which You Could Use Time Value For Money Calculation For Achieving Various Personal Financial Goals

1. The time value of money is important to consider for retirement planning and choosing investment options. For retirement, calculating the future value of annual expenses accounting for inflation and investment returns is needed to determine how much to save. For investments, using time value can help analyze which option between a mortgage or other investments has a better return. 2. After reviewing personal finances, specific actions taken were organizing documents, creating a balance sheet to assess assets and liabilities, and paying down debts while maintaining an emergency fund by increasing work hours and pursuing passive income sources. 3. Financial ratios can be useful for planning personal finances. The liquidity, debt, and current ratios help evaluate short-term obligations, debt levels, and

Uploaded by

StuartMarshall
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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Q1 Describe 2 situations in which you could use time value for money

calculation for achieving various personal financial goals.


The time value of money can and should be used when calculation the required
amount of money to supplement your retirement.
Consider this situation, where you required, for example, a minimum of 20 years
of annual costs worth of superannuation plus 20% extra to support your
retirement at the point of retirement, it would be easy to miscalculate the
amount required without taking into consideration the time value of money. Say,
for example you planned on reaching this 20x figure through investing through a
muse with as little risk as possible (beta) to reach this goal. Lets say that your
annual expenses amount to a present value $25K/yr. and that you currently have
$400K in your superannuation account. Assume buying power remains stable in
Australia in the next 30 years and that you plan to retire in 10 years time.
On face value, it would appear that you require a 50% return over the 10 years
as you require 600K (25K*20y*1.2) and you currently have 400K. By using
logarithmic math, (1+x)^10 = 1.5, where x is the required return, it would be
assumed that the annual required rate is 4.13%, which would require an ideal
investment with very little risk. However, the time value of money has not been
taken into consideration, as that 600k would give you far less purchasing power
in 10 years than it would today
Once the time value of money is taken into consideration (assuming 2% interest
rate), you would require 600x1.02^10 = 731.4K. 731.4 K in 10 years would hold
the same buying power in 1- years as $600K would today at a 2% inflation rate.
731.4K/400K = 1.8285 return over the next 10 years. (1+x)^10 = 1.8285, so x =
6.22% return/annum, meaning that in order to reach the goal presented, you
would require an investment much higher than the risk free rate, as the market
rate is ~8-10% and the 10 year risk free rate in Australia is presently ~2.8%
Note the time value of money does not need to be taken into consideration
after the retirement point as the non-liquid equity (the great majority) can be
placed in risk free investments equal to or greater than the inflation rate

Another situation whereby the time value of money could be used would be
choosing between two investment options. For example, if an investor has a
lump sum figure of 300k and was looking to buy an investment property with a
purchase price, the investor could potentially either pay the minimum 20%
deposit, pay the remaining 80% back with a mortgage and invest the remaining
amount in a portfolio or pay 50% of the house and mortgage the remaining 50%.
The time value of money is critical here in determining the opportunity cost and
the most profitable option, as is the cost of debt vs the cost of equity, the tax
breaks on negative gearing etc. etc. Depending on your financial and
geographical circumstances, either of these options may be preferable.

Q2 List 3 specific actions you took to help you achieve your various
financial goals.

After watching the first 3 lectures a week or so ago, The first thing I did was sort
out my receipts, statements and other personal documents into 10 specific filing
areas as recommended by the lecture slides, albeit slightly modified to an
Australia version, as the version included American specific files such as W2s
and SSNs. In doing so, I came across a year where I failed to lodge a tax return
and made a claim on it (cheering).
The second thing I did was analyse my financial situation and draw up a
summary of all personal assets and liabilities in the form of a balance sheet. In
doing so I realised (with knowledge from pervious semesters finance classes)
that I had effectively shorted a commodity, a commodity that is notorious for
being extremely volatile. In order to protect myself from being liable for a much
greater sum of money, I researched my options and am in the process of taking
out a 16 month interest free credit card to pay off the liability. In the scenario
whereby I cannot pay off the full amount owed in the 16 months, I can transfer it
to another 12-18mo credit card with no interest incurred.
The third thing I did was reassess my financial goals, which in the short term,
after assessing my financial position through the balance sheet, was to pay off
my debts while maintaining a small emergency fund. In order to do this, my
goals became to increase my working hours per week, particularly during
summer semester while balancing uni/work/other commitments and to try and
produce a steady, passive income through online and other mediums. I came to
this conclusion after analysing various potential courses of action and evaluating
the alternatives through the methods found in the lecture slides and others
found online (reddit was surprisingly helpful).

Q3- How might financial ratios be used when planning and


implementing personal financial activities.
Ratios are an awesome way to quickly assess your current financial position and
future economic goals
Liquidity ratio is an effective way to estimate your current ability to pay liabilities
and other expenses if emergencies arise and you no longer have an income/ as
much income.
For example, if your current liquidable assets amount to $4000 and your monthly
expenses were $2600, your liquidity ratio would be 1.54. That is, you could pay
your financial obligation for 1.54 months with no income. In terms of planning
and creating goals, the recommended emergency is 3-6 months of expenses, so
using the liquidity ratio, this would require between $7800 and $15600 of
liquidable assets.
The debt ratio shows the relationship between your debt and net worth, which
can be helpful in creating future goals and looking at future projects and
opportunities. Although he slides say that the debt ratio is better, debt financing
is actually a very good thing in Australia not only is it better than equity
financing in nearly all situations (as long as you are in a strong financial position think opportunity costs that equity can produce 10%+ returns elsewhere until
the stress from debt outweighs the benefits usually at about 50% or so, while
debt costs 4% to 5%/annum) but the tax benefits provided from debt financing in

Australia also make debt financing very popular. The debt ratio can therefore be
used to analyse the stress from debt funding, although the debt/total asset ratio
may be better.
For example, if you have a $600000 mortgage outstanding and a house worth
$700000 and no other assets or liabilities, your debt ratio would be 600000/
(700000-600000) = 6, which is obviously very high. Your debt to equity ratio
would be 6000000/700000 = 0.857, which is highly undesirable in terms of
starting any other investment opportunities through debt financing
The current ratio is fantastic for quickly identifying your short term ability to pay
off liabilities and can be used in conjunction with the liquidity ratio in determining
a suitable level of liquidable assets.
The Debt-payments ratio is a simple tool to estimate your current
percentage/ratio of income that is spent on debt payments. This can be used
when preparing future goals debt payments are often an easy way to minimise
unnecessary spending, as it is often associated with depreciating asset expenses
and can be a good area to focus on when increasing saving and minimising
expenses The debt payment ratio is also a handy tool when estimating current
expenses and can also be used in estimating monthly expenditure and
emergency/liquidable funds.
The savings ratio is a simple ratio that expresses the degree to which you are
saving your income. This can be very helpful in terms of predicting future saving
levels and therefore helping to analyse potential investment alternatives. It can
also be used to assess current spending activities.

Q4- what are the long term effects of low savings for both the individual and the
overall economy.
Low savings for an individual often has very negative long term effects, as the
individual will most likely be unable to purchase a home under a mortgage with a
deposit or participate in other financial that people at his age would commonly
be doing, such as purchasing retirement homes, taking holidays or accumulating
college finds. With the way investing works, Investing at a young age is
important as it allows returns to work their magic with 2, 3, 4x returns possible in
a short space of time.
However, the long term effects are not necessarily all negative. It has been well
publicised that high saving rates and high levels of debt can increase stress and
anxiety, with the majority of income designated to investment payments. Lower
saving levels can often indicate investment in lifestyle and enjoyment.
The effect on the economy depends on the state of the economy in most
economies higher spending and lower saving has a positive effect on the
economy increased spending and turnover is what the customer wants. We
have seen in the past in poor economic times, governments have urged
customers to spend, with schemes such as the Kevin Rudd rebate scheme for
~$900. However, in times of exponential and unsustainable growth, such as the

2007 housing bubble, higher spending is a negative thing, as is worsens an


already bad situation. Economists have since (and some did at the time) that the
increased spending, particularly on investments, was up significantly despite the
fact that the average wage was not moving, meaning that the spending was
derived from debt financing.
However, higher spending in standard economies can be a bad thing, if a certain
level of savings (albeit low) isnt maintained. In America, the savings rates of the
average American are unusally low, with up to 20% of people saving absolutely
nothing and 50% saving less than 5%. This indicates that the economy may not
be in as good a state as it is claimed, with the high spending rate coupled with
the stagnant average wage since 2000 for the bottom 90%

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