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Chapter 1
Overview of a Financial Plan
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n Chapter Overview
Every individual and family needs to develop a financial plan to make the best use of resources to achieve
financial goals. Financial planning will help them clarify their goals and ensure that spending, financing,
and investing decisions are aligned with those goals.
Chapter 1 discusses the benefits of financial planning. Sound financial planning enables you to create
greater wealth over time, and it also helps you make career decisions that have a lasting impact on your
finances. Several types of financial decisions are listed with two individuals making different decisions
about choice of major and college. Students will understand how to make their own financial planning
decisions, judge the advice of financial advisers, and evaluate the career of financial adviser.
This chapter also focuses on how most decisions have financial consequences. Some of these decisions,
such as the choice of career and skills you develop, will have a long term impact on your income level. We
will discuss career choice more in later chapters.
In addition, this chapter briefly discusses the six component plans that make up the overall financial plan.
These components are budgeting and tax planning, managing liquidity, planning and financing large
purchases, protecting wealth and income through various types of insurance plans, investing money, and
retirement and estate planning. Different life events quite often necessitate a change in the financial plan
and goals.
Each component of a financial plan impacts cash inflows and outflows, and all the components are
interrelated. Understanding these relationships is the key to creating and following a personal financial
plan. Your budget identifies cash inflows and outflows and helps determine liquidity needs. Your financing
decisions determine monthly payments and protecting your wealth requires cash outflows, both of which
feed back into your budget. Investments and retirement planning require living today on less than you earn
in order to have funds for future consumption (i.e., to invest today).
Creating a financial plan requires six steps. First, an individual must establish financial goals. Once these
are established, the individual must consider his or her current financial position. Next, alternative plans
that could help achieve the goals should be identified and evaluated. At this point, one plan should be
chosen and implemented. In the final two steps, the individual evaluates his or her financial plan and
revises it as needed.
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, Chapter 1 Overview of a Financial Plan 3
n Chapter Objectives
The objectives of this chapter are to:
• Explain how personal finance can enhance your wealth.
• Identify the key components of a financial plan.
• Describe the process for making your key personal finance decisions.
n Teaching Tips
1. Discuss this quote with students: “Most people don’t plan to fail; they fail to plan.” Ask students
for examples of situations (financial or otherwise) where they have seen this happen. Guide the
discussion toward financial matters.
2. Compare financial planning to planning a trip.
Steps in Financial Planning Steps in Planning a Trip
Set goals Decide where you are going
Determine your current financial position Locate your home on the map
Identify and evaluate alternative plans Identify and evaluate alternate routes
Choose and implement a plan Pick a route and start the journey
Evaluate plan Is the trip going smoothly?
Revise plan as needed Road construction causes major delays,
so you pick an alternate route
A financial plan is just a financial road map.
3. Many younger students have difficulty in recognizing the benefits of devising a financial plan now
and saving for the future at a young age. The compounding of money can be easily demonstrated
using the “Rule of 72.” The Rule of 72 can be used as an indicator of how long it will take a single
sum of money to double in value at a given interest rate or rate of return percentage. The length of
time is calculated by dividing 72 by the interest rate. For instance, at 8% a sum of money would
double every nine years. Provide this example for students:
What if your parents had been able to invest $1,000 at 8% the day you were born?
Age Value of Investment Age Value of Investment
0 $ 1,000 45 $ 32,000
9 2,000 54 64,000
18 4,000 63 128,000
27 8,000 72 256,000
36 16,000 81 312,000
, 4 Madura • Personal Finance, Eight Edition
This concept can also be used further to determine the rate of return necessary to achieve a financial
goal by simply dividing 72 by the number of periods available to reach the financial goal. This
answer will provide the percentage return needed to reach that goal. For instance, you want to have
$10,000 for a down payment on a house in nine years. Currently, you have saved $5,000. You would
need a return of 8%. Other considerations, such as amount of risk to be taken, would then also need to
be assessed, but this is a quick tool to make preliminary estimates.
4. Have students develop a written set of goals. Suggest a minimum of two goals for each time frame—
short-, intermediate-, and long-term goals. One of the short-term goals should be achievable by the
completion of the course. Remind students that goals need not only to be written but also should
include a definitive dollar amount, should be monitored, and should be assessed periodically to
determine the progress toward overall life goals. Evaluate the students’ goals to ensure that they are
realistic given their anticipated income from their future profession.
5. Teams—At the beginning of the semester/class, divide students into teams of three to five students. In
many chapters, these teams can be used to discuss concepts and issues and to review quantitative
materials and quizzes.
6. Discuss with students that goals are not stagnant. They change as an individual’s life changes. If you
marry or have a child or change your career or job, for example, you should review and perhaps
modify your financial goals. Changes in the economic environment can affect the achievement of
financial goals positively or negatively. The last decade, unfortunately, had negative effects on most
consumers’ financial goals, including delaying the purchase of a house, retiring, or changing careers,
etc. Encourage students to share their family experiences relative to loss of jobs, foreclosures,
postponing or eliminating education plans, etc.
7. A good team exercise to introduce the members to each other and to generate discussion is to
distribute a “financial goals/interests” questionnaire. Each member of the group gives an answer,
which is recorded on the questionnaire. This discussion readily shows how different people are in
their approach to their finances, and how important it is to know each other’s financial goals in a
relationship.
Sample questions:
• How much will you need annually to live comfortably in retirement?
• How much do you need for an annual clothes budget?
• What percentage of your income do you intend to save?
• What type of vacation do you envision on an annual basis?
• Will you support your children through college?
• How much do you need to spend to have a nice dinner at a restaurant?
• Do you believe in using credit cards for long-term purchases, or do you believe you should pay the
balance in full each month?
• Do you need a new car, or are you content with used cars?
8. Survey the class by a show of hands: Which job would you accept?
