Personal Finance: Chapter 1

Personal Finance (personal financial planning)- The process of planning your spending, financing, and
investing activities, while taking into account uncontrollable events, such as death or disability, in order
to optimize your financial situation over time.

Personal Financial Plan- A plan that specifies your financial goals and describes the spending, financing,
and investing activities that are intended to achieve those goals and the risk management strategies
that are required to protect against uncontrollable events, such as death or disability.
- Excessive debt levels affect your ability to achieve important financial goals.

Per Capita Debt- The amount of debt each individual in Canada would have if total debt (consumer debt
plus mortgages) were spread equally across the population.

Each of your spending decisions has an opportunity cost, which represents what you give up as a result
of that decision. By spending money for a specific purpose, you forgo alternative ways that you could
have spent the money and also forgo saving the money for a future purpose.
- Opportunity cost will also affect your savings decisions

Generally, the savings in an emergency fund—a short-term goal—will earn less interest than your
investments in a retirement plan—a long-term goal. Although an emergency fund is very important to
your personal financial plan, saving too much for short-term needs does limit your opportunity for
long-term growth.

FP Canada- A national professional body working in the public interest that is dedicated to championing
financial health for all Canadians by certifying professional financial planners and leading the
advancement of professional financial planning in Canada.

It should be clearly stated, though, that most planners cannot make decisions for their clients. An
individual must give permission to the financial planner before any action can be taken

Must complete the Certified Financial Planner (CFP)® designation before becoming a financial planner as
well as 5 steps.

Complete financial plan contains your personal finance decisions related to five key components:

1. Budgeting and tax planning

2. Managing your financial resources
3. Protecting your assets and income (insurance)
4. Investing your money
5. Planning your retirement and estate
Budget planning (also referred to as budgeting)- the process of forecasting future income, expenses, and
savings goals. That is, it requires you to decide whether to spend or save money.

A first step in budgeting should be to evaluate your current financial position by assessing your income,
your expenses, your assets (what you own), and your liabilities (debt, or what you owe). Your net worth
(or wealth) is the value of what you own minus the value of what you owe.

As you save money, you increase your assets and therefore increase your net worth. Budgeting enables
you to build your net worth by setting aside part of your income to either invest in additional assets or
reduce your liabilities.

Your budget is influenced by your income, which in turn is influenced by your life stage.

Short-term cash needs and unexpected expenses, such as emergencies, must be covered. Your ability to
cover these expenses depends on your liquidity. Liquidity refers to your access to ready cash, including
savings and credit, to cover short-term or unexpected expenses.

Money management involves decisions regarding how much money to retain in liquid form and how to
allocate the funds among short-term investment instruments. If you do not have access to money to
cover short-term needs, you may have insufficient liquidity. An emergency fund contains the portion of
savings that you have allocated to short-term needs such as unexpected expenses in order to maintain
adequate liquidity

As an alternative to establishing an emergency fund by investing some of their savings for short-term
needs, many individuals rely on credit to supplement their liquidity. Credit management involves
decisions regarding how much credit to obtain to support your spending and which sources of credit to
use. Credit is commonly used to cover both large and small expenses when you are short on cash, so it
enhances your liquidity. Credit should be used only when necessary since you must repay borrowed
funds with interest

Risk can be defined as exposure to events (or perils) that can cause a financial loss. Risk management
represents decisions about whether and how to protect against risk.

To protect your assets, you can conduct insurance planning, which determines the types and amount of
insurance that you need.

Any savings that you have beyond what you need to maintain liquidity should be invested.

Because these funds normally are not used to satisfy your liquidity needs, they can be invested with the
primary objective of earning a return. Potential investments include stocks, bonds, mutual funds, and
real estate.

Since investments are subject to investment risk (uncertainty surrounding their potential return and
future potential value), you need to understand your personal tolerance to risk in order to manage it.
Risk can most easily be defined as a potential loss of return and/or loss of capital. Your ability to accept
such potential losses is your risk tolerance.

Retirement planning involves determining how much money you should set aside each year for
retirement and how you should invest those funds.

Money contributed to various kinds of retirement plans, with the exception of tax-free savings accounts
(TFSAs), is sheltered from taxes until it is withdrawn from the retirement account. Money contributed to
a TFSA is not only tax sheltered but also tax free when it is withdrawn.

Estate planning is the act of determining how your wealth will be distributed before and/or after your
death. Effective estate planning protects your wealth against unnecessary taxes and ensures that your
wealth is distributed in a timely and orderly manner.
 1. Budgeting focuses on how cash received (from income or other sources) is allocated to savings,
spending, and taxes. Budget planning serves as the foundation of the financial plan, as it is your
base for making personal financial decisions.
2. Financial resources because you must have adequate liquidity
3. Plan for financing your major purchases such as a new car or a home. Insurance is used to
protect your wealth.
4. Investment alternatives such as stocks, bonds, and mutual funds.
5. Retirement and estate planning focuses on the wealth that you will accumulate by the time you
retire.

How psychology impacts your financial plan?

Some people allow their desire for immediate satisfaction and their focus on peer pressure to influence
most of their financial planning decisions. This causes them to spend excessively, meaning that they
make purchases that are not necessary. Some people allow their desire for immediate satisfaction and
their focus on peer pressure to influence most of their financial planning decisions. This causes them to
spend excessively, meaning that they make purchases that are not necessary. This type of behavior may
be referred to as “shopping therapy” or “retail therapy”

People who spend based on peer pressure may purchase a new car that they cannot afford, even when
they already own a reliable car, just because their friends or neighbors have a new car. While they
receive immediate satisfaction from having a new car, they may now also have the obligation of a $500
monthly car payment for the next four years.
Another psychological force is a hopeless feeling that is used to justify spending. Some people think that
if they can allocate only a small amount, such as $500 for saving or other forms of financial planning,
they will never be able to achieve any long-term goals. Thus, they use this reasoning to justify spending
all of their income. Their logic is that they might as well enjoy the use of the money now.

Developing the Financial Plan

Step 1: Establish your financial goals

- goals should be specific (S), measurable (M), action-oriented (A), realistic (R), and time bound (T)

Step 2: Consider Your Current Financial Position

- A person with little debt and many assets will clearly make different decisions than a person
with mounting debt and few assets. And a single individual without dependents will have
different financial means than a couple with children, even if the individual and the couple have
the same income. The appropriate plan also varies with your age and wealth.

Step 3: Identify and Evaluate Alternative Plans That Could Help You Achieve Your Goals

Step 4: Select and Implement the Best Plan for Achieving Your Goals

Step 5: Evaluate (monitor/ review) Your Financial Plan

Step 6: Revise Your Financial Plan

- If you find that you are unable or unwilling to follow the financial plan, you need to revise the
plan to make it more realistic
- May need to adjust your financial goals