💰Personal Financial Management Unit 15 – Personal Finance Strategies

Key Concepts in Personal Finance

• Personal finance focuses on managing an individual's money, including earning, spending, saving, investing, and protecting financial resources
• Time value of money is a fundamental concept that recognizes the potential of money to grow in value over time through compound interest
• Opportunity cost represents the potential benefits an individual misses out on when choosing one alternative over another
• Liquidity refers to how quickly an asset can be converted into cash without affecting its market price
• Solvency measures an individual's ability to pay their long-term debts and financial obligations
• Inflation erodes the purchasing power of money over time as prices for goods and services rise
• Diversification involves spreading investments across various asset classes (stocks, bonds, real estate) to minimize risk

Setting Financial Goals

• SMART goals are Specific, Measurable, Achievable, Relevant, and Time-bound, providing a clear framework for setting and achieving financial objectives
• Short-term goals are typically achievable within a year (saving for a vacation or paying off a credit card balance)
• Mid-term goals usually require two to five years to accomplish (saving for a down payment on a house or starting a business)
• Long-term goals extend beyond five years (saving for retirement or a child's college education)
• Prioritizing goals helps individuals allocate limited financial resources effectively
• Regular review and adjustment of goals is necessary to accommodate changing life circumstances and financial situations
• Automating savings and investments can help individuals stay on track to reach their financial goals consistently

Budgeting Basics

• A budget is a plan that allocates future income towards expenses, savings, and debt repayment
• Fixed expenses remain relatively constant from month to month (rent, mortgage payments, car payments)
• Variable expenses fluctuate based on consumption (groceries, entertainment, utilities)
• Discretionary expenses are non-essential and can be adjusted based on financial priorities (dining out, subscriptions, hobbies)
• The 50/30/20 rule suggests allocating 50% of income to needs, 30% to wants, and 20% to savings and debt repayment
• Tracking expenses helps identify spending patterns and areas for potential improvement
• Regularly reviewing and adjusting the budget ensures it remains aligned with financial goals and changing circumstances

Saving and Investing Fundamentals

• Pay yourself first by allocating a portion of income to savings before spending on discretionary items
• An emergency fund covering three to six months of living expenses provides a financial buffer against unexpected events (job loss, medical emergencies)
• Compound interest allows savings and investments to grow exponentially over time as interest is earned on both the principal and accumulated interest
• Asset allocation refers to the strategic distribution of investments across various asset classes based on risk tolerance and financial goals
• Stocks represent ownership in a company and offer the potential for capital appreciation and dividend income
• Bonds are debt securities that provide a fixed stream of interest payments and return of principal at maturity
• Mutual funds and exchange-traded funds (ETFs) pool money from multiple investors to purchase a diversified portfolio of securities

Managing Debt and Credit

• Credit scores (FICO, VantageScore) measure an individual's creditworthiness and influence the ability to secure loans and favorable interest rates
• Revolving credit, such as credit cards, allows borrowing up to a preset limit and carrying a balance from month to month
• Installment credit involves borrowing a fixed amount and repaying it in regular payments over a set term (auto loans, mortgages)
• High credit utilization, or using a large portion of available credit, can negatively impact credit scores
• Prioritizing debt repayment, starting with high-interest obligations (credit card balances), can minimize total interest paid
• Debt consolidation combines multiple debts into a single, lower-interest loan to simplify repayment and potentially save on interest
• Avoiding unnecessary debt and living within one's means are crucial for long-term financial stability

Insurance and Risk Management

• Insurance transfers the financial risk of loss from an individual to an insurance company in exchange for a premium
• Health insurance covers medical expenses, including preventive care, treatments, and prescription drugs
• Disability insurance provides income replacement if an individual is unable to work due to an illness or injury
• Life insurance offers financial protection for dependents in the event of the policyholder's death
  • Term life insurance provides coverage for a specified term (10, 20, or 30 years)
  • Permanent life insurance (whole life, universal life) combines a death benefit with a savings component
• Property insurance protects against loss or damage to personal assets (homeowners, renters, and auto insurance)
• Liability insurance covers legal defense costs and damages if an individual is found responsible for causing harm to another party
• Regularly reviewing insurance coverage ensures adequate protection as life circumstances change

Tax Planning Essentials

• Progressive tax systems (U.S. federal income tax) impose higher tax rates on higher levels of income
• Marginal tax rate is the tax rate applied to an individual's next dollar of taxable income
• Effective tax rate represents the average rate at which an individual's total income is taxed
• Tax deductions (charitable donations, mortgage interest) reduce taxable income, lowering the overall tax liability
• Tax credits (Earned Income Tax Credit, Child Tax Credit) directly reduce the amount of taxes owed
• Retirement accounts (401(k)s, IRAs) offer tax advantages to encourage long-term saving
  • Traditional accounts provide tax deductions on contributions and defer taxes until withdrawal in retirement
  • Roth accounts require after-tax contributions but allow tax-free growth and withdrawals in retirement
• Proactive tax planning, including maximizing deductions and credits, can help minimize an individual's tax burden

Retirement and Estate Planning

• Retirement planning involves setting income goals and choosing appropriate savings vehicles to maintain a desired lifestyle in retirement
• Social Security provides a foundation for retirement income, with benefits based on an individual's earnings history and retirement age
• Employer-sponsored retirement plans (401(k)s, pensions) allow workers to save for retirement with potential employer contributions
• Individual Retirement Accounts (IRAs) are tax-advantaged savings vehicles that individuals can establish and fund independently
• Annuities are insurance products that provide a guaranteed stream of income in retirement in exchange for a lump sum or series of payments
• Estate planning involves arranging for the management and distribution of an individual's assets after death
• A will is a legal document that specifies how an individual's assets should be distributed upon death
• Trusts are legal arrangements that allow a third party (trustee) to hold and manage assets on behalf of beneficiaries
• Advance directives (living wills, powers of attorney) provide guidance on medical care and financial decisions if an individual becomes incapacitated