GE1202

Managing Your
Personal Finance
Lecture 1
Introduction to Personal Finance
Management
Who Need to Know Personal Finance Planning?
• Every person has some money available
• Most people want to handle their finances so that they get full satisfaction
from each available dollar
• Financial Goals
• Buying a new car or getting a larger home
• Pursuing advanced career training
• Contributing to charity
• Traveling extensively
• Ensuring self-sufficiency during working and retirement years
• Holding a fantastic wedding party
Financial Planning
• As we have limited money, it is impossible to have all the goals to be
realized
• To achieve these goals, you need to identify and set priorities.
• The process of managing your money to achieve personal economic
satisfaction
• Personal money management or Personal financial planning

• Financial decision must be planned to meet the unique situation facing

each person.
• People in their 20s spend differently from those in their 50s
• Life situation/style – Adult Life Cycle
Adult Life Cycle
Financial Planning
• Financial Plan
• A formalized report that summarize your current situation, analyzes your financial
needs, and recommends future financial activities.

• Advantages of effective personal financial planning

• Increased effectiveness in obtaining, using, and protecting your financial resources
throughout your life
• Increased control of your financial affairs by avoiding excessive debt, bankruptcy, and
dependence on others
• Improved personal relationships resulting from well-planned and effectively
communicated financial decisions
• A sense of freedom from financial worries obtained by looking to the future, anticipating
expenses, and achieving personal economic goals
Goal-Setting Guidelines
• Financial goals should take a SMART approach.
• Specific – know exactly what your goals are and can create a plan to achieve those
objectives
• Measurable – can be measured by a specific amount
• Action oriented - provide the basis for the personal financial activities you will
undertake.
• Realistic – involve goals based on your income and life situation
• Time based – indicate a time frame for achieving the goal
Which is SMARTer?
• A fresh graduate just starts his career as a secondary school teacher.
• Plan A: Buy a flat in Kowloon Tong by 30.
• Plan B: Put $5,000 into the saving account each month for 8 years as the
down payment for a flat of $6M in Kowloon Bay.
Types of Financial Goal
• There are 3 different financial goals
• Consumable-Product Goals
• Food, clothing, entertainment
• Durable-Product Goals
• “Big ticket” items like appliances and cars
• Intangible-Product Goals
• Health, education, relationships, service
Types of Financial Goal
• There are 3 different time frames for achieving financial goals
• Short term goals
• Will be achieved within the next year
• Saving for a vacation, buying a new phone
• Intermediate goals
• Two to five years
• Further study, Wedding
• Long term goals
• More than five years
• Retirement, children’s education expenses
Components of Personal Financial Planning
• There are Eight major personal financial planning areas
• Obtaining – the receipt of income and other financial resources
• Planning – actions to determine future financial directions
• Saving – set aside funds for expected and unexpected expenses
• Borrowing – appropriate use of short-and-long-term credit plans
• Spending – analysis of purchasing decisions for wise money use
• Managing Risk – insurance and other methods to reduce financial uncertainty
• Investing – accumulation of funds for long-term financial security
• Retirement and Estate Planning – efforts to provide for post-career years and
transfer of assets
Factors Influence Financial Decisions
• Personal factors
• Age
• Income
• Household size
• Personal beliefs

• General factors
• Global economy
• Inflation rate
• Interest rate
Global Economy
• Economy influences financial planning
• Phases of the business cycle: expansion, peak, contraction, trough (takes 4-5 years
on average)

• Economics: the study of how wealth is created and distributed; strongly

influences financial planning
• Decisions made by Central Banks (e.g., interest rates, money supply)
Inflation
•  Inflation is a rise in the general price level
• The general price level is measured by the Consumer Price Index (CPI)
• CPI is the weighted average of the prices of a fixed basket of goods and
services

• Inflation rate is the % change in the CPI

Inflation
•   Product Price in 2015 Quantity in 2015 Price in 2016 Quantity in 2016
iphone $1000 10 $1100 12
iMac $2000 5 $2500 6
ipod $500 4 $550 3

=
• %
=
Inflation
•  Inflation erodes the purchasing power of money
• The quantity of goods that can be bought with a sum of money reduces

• Examples:
• How many apples can be bought with $100 if each apple costs $10?
• How many apples can be bought with $100 if each apple costs $11?
• You can buy 1 apple (10%) less when the price goes up by $1 (10%) with the $100

% △ Real value = % △ Nominal value – Inflation%

Interest
• To maintain the purchasing power of money, you may invest them into
interest-yielding assets.
• What is interest?
• Lender – compensation for giving up earlier availability of resources
• Borrower – cost of acquiring earlier availability of resources
• Investor – return on financial investment
• Interest on deposits
• Interest on bonds
• Dividend and capital gains from stocks
Interest
• Interest raises the nominal value of money
• You get back $110 a year later if you deposit $100 into a bank which pays interest
10% p.a.

• Real value of money may increase, decrease or remain unchanged with

interest during the time of inflation
• You save $100 into a deposit which gives interest 10% p.a. and the initial price level
is 100
Inflation rate %△ %△
(π) Nominal value Nominal value Real value Real value
0%
10%
15%
Time Value of Money
• Why do we need to pay interest?
• As people prefer early consumption to late, people place higher value on
current consumption
• The dollar received today is worth more than a dollar that will be
received one year from today
Time Value of Money
• Compounding
• The process of finding the future value from a current sum based on a certain
interest rate and period of time
• If you put $1000 into a bank deposit which offers an interest rate of 10% p.a., how
much will you get after 10 years?

• Discounting
• The process of finding the current value from a future sum based on a certain
interest rate and period of time
• How much do you need to put into your bank account which offers an interest rate
of 10% p.a., how much will you get after 10 years?
Compounding
• If you put $100 into your bank account for 3 years with an interest of
10%p.a., how much should you expect to get back?
• To find the future value of a Single amount
 

FV = Future Value; PV = Present Value; i = interest rate; n = time periods

Compounding
• If you put $100 into your bank account in the beginning of each year for
3 years with an interest of 10%p.a., how much should you expect to get
back?
• A stream of constant amount is called Annuity
• To find the future value of a Series of equal amounts

 
Compounding

3rd $100 What is the

sum of these
2nd $100 amounts?
1st $100

0 1 2 3
Compounding
• If you put $100 into your bank account at the end of each year for 3
years with an interest of 10%p.a., how much should you expect to get
back?
3rd $100 What is the
2nd $100 $110 sum of these
1st amounts?
$100 $110 $121

0 1 2 3

 
Discounting
• How much should you put into your bank account with an interest of
10%p.a. so as that you can get back $133.1 after 3 years?
• To find the present value of a Single amount
 
𝐹𝑉
𝑃𝑉=
( 1+𝑖 ) 𝑛  
Discounting
• If you wish to withdraw $100 at the end of each year for 3 years from an
account that earns interest 10% p.a., how much you should deposit not?
• To find the present value of a Series of equal amounts

 
 Discounting

What is the $100 1st

sum of these
$100 2nd
amounts?
$100 3rd

0 1 2 3
Opportunity Cost
• Opportunity cost is what you give up by making a choice
• Trade-off of a decision

• Example 1:
• You may spend $200 to have meal with your friend or to buy the textbook.
• What is your opportunity cost for you to buy the textbook?

• Example 2:
• You may spend $200 to buy the textbook or save it to earn an interest of 10%
• What is your opportunity cost for you to buy the textbook?

• Interest rate is the opportunity cost for current consumption.

A Plan for Personal Financial Planning
• We all make hundreds of decision each day
• Some are complex and have long-term effects on our personal and
financial situations
• Few people consider how to make better decisions
• Six-step financial planning process
1. Determine your
6. Review and 2. Develop your
current financial
revise the plan financial goals
situation

5. Create and 4. Evaluate 3. Identify alternative

implement alternatives courses of actions
your plan
Step 1: Determine Your Current Financial
Situation
• Check out your current financial situation
• Income
• Savings
• Living expenses
• Debts
• Prepare your personal financial statement
• A list of current asset and debt balances and amounts spent for
various items
• The foundation for financial planning activities
Step 2: Develop Your Financial Goals
• Analyze your financial values and goals periodically
• Differentiate your needs from your wants

• Your financial goals can range from spending all of your current income
to developing an extensive savings and investment program for your
future financial security
Step 3: Identity Alternative Courses of Action
• Possible courses of action usually fall into these categories
• Continue the same course of action
• Expand the current situation
• Change the current situation
• Take a new course of action

• Not all of these categories will apply to every decision

• Consider all of the possible alternatives will help you make more
effective and satisfying decisions
Step 3: Identity Alternative Courses of Action
• Example:
• You are saving $1000 into your bank account every month. What are
the possible courses of action available to you?
• Continue to save the same amount.
• Save $500 more
• Invest it into the stock market
• Pay off your credit card debts
• Do nothing!!!
Step 4: Evaluate Your Alternatives
• Evaluating the alternatives, you should always keep in mind the following
two aspects:
1. Consequences of choices
• Every decision has an opportunity cost.
• The trade-off cannot always be measured in money, but the resources you give
up have a value that is lost
• Example:
• You are considering to take a Master degree after finishing your undergraduate
degree or take up a job offer by a famous company.
• What is your opportunity cost if you end up with taking the master degree?
• Income; working experience; skills
• Job satisfaction
Step 4: Evaluate Your Alternatives
2. Evaluating risk
• Uncertainty is also a part of every decision
• Different decisions involve difference degree of risk
• In many financial decisions, identifying and evaluating risk are difficult.
• Common risk to consider
• Inflation risk
• Interest rate risk
• Income risk
• Personal risk
• Liquidity risk
Step 4: Evaluate Your Alternatives
• The best way to consider risk is to gather information based on your and others’
experience and to use financial planning information sources.
• Common sources
• The Internet
• Media sources
• Financial institutions
• Financial specialists

• A larger amount and more advanced information is needed when more risks are
associated with a decision.
• Some more things to consider
• Your life situations; personal values, current economic conditions, etc
Step 5: Create and Implement Your Plan
• Develop an action plan to achieve your goals
• The plan has to be realistic and achievable
• Example
• Your friend is planning to have his own home after 3 years from graduate
• He is targeting on a flat of size 600 sq. feet, which selling at $5M
• He is expecting to get a job paying him $30,000 per month
• He will save $28,000 per month and get it accumulated to $1M in 3 years for the down
payment
• What will you say to your friend?
• God Bless You!!!
Step 6: Review and Revise Your Plan
• Financial planning is a dynamic process
• Regularly assess your financial decisions
• A complete review should be done at least once a year
• Changing personal, social, and economic factor may require more
frequent assessments
• A regular review will help you make priority adjustments that will bring
your financial goals and activities in line with your current life situation