CHAPTER 1 INTRODUCTION TO PERSONAL FINANCIAL PLANNING A professor once confided as he was approaching completion of a research project that he was close to either success or failure. Effective financial planning can mean the difference between success and failure as we approach long-term goals such as financing college education for our children or personal retirement for ourselves. Organized financial planning helps produce desired financial results; it helps determine where you are, where you'd like to go and what it will take to get there. How many of us know if we are making satisfactory progress towards meeting our long-term financial goals? Most Americans do informal financial planning, such as watching their checking account to see if their balance is rising or falling. Far fewer of us take the time to or know how to do comprehensive financial planning. Most people hope that advances in age and salary will automatically leave them in a reasonably comfortable financial position. Often, however, expenses rise as fast or faster than income. Many people with large incomes do not plan wisely and are left with meagre assets. Why don't more people do comprehensive personal financial planning? Likely reasons include: * It is too expensive to pay someone to help. * The process is not well understood and involves too much number crunching. * The process is considered tedious and time consuming. Personal Financial Planning Made Easy: A Path to Prosperity was developed to solve these problems. This productivity tool for the IBM PC and compatibles consists of a 169 page manual and 3 diskettes. Use Personal Financial Planning Made Easy (EZ-$-PLAN). * It gives practical financial information and examples at an affordable price. * It provides preprogrammed spreadsheet software so that it is easy to do the financial calculations. * It saves you time and makes the financial planning process more enjoyable. Preformatted spreadsheet software yields quick results. DO I NEED A FINANCIAL PLAN? Personal financial planning is the development and implementation of a systematic process to achieve one's overall financial objectives. The initial focus is on the definition of ones total financial objectives. The focus then shifts to how to achieve your financial objectives and the implementation of the plan. A variety of financial instruments are usually employed. The implementation 2 Chapter One process is facilitated by adoption of personal financial policies to guide the choice among financial instruments to include in a portfolio. Opportunities abound in America today. Our financial options are many, but for many Americans, financial problems are becoming more complex. The world economy is changing at a rapid pace. Examples of economic changes and their effects on our lives are given by Naisbitt (8). (1) Moving from an industrial economy towards an information, service and high technology economy. The most highly-paid high- skill jobs will go to the most motivated and highly-educated people. The cost of this education is increasing rapidly requiring improved financial and career planning. (2) Moving towards a world economy with worldwide competitive pressures. To be successful, companies and individuals face an increased need to plan more wisely and to work smarter. (3) Increasing interest in and opportunities for entrepreneurial endeavors. People wish greater independence, greater job satisfaction and greater financial rewards. Most successful entrepreneurs need good ideas, a willingness to work hard and good business and personal financial planning. (4) Increasing costs of retirement. Greater savings is needed for a comfortable retirement. Advancements in medical science and improved health habits have increased our life expectancy. We hope to have more years than our forefathers did to enjoy retirement. By the year 2000, there will only be three active taxpayers supporting each person receiving social security. Thus, better financial planning will generally be needed for those wishing to have a timely, comfortable retirement. There is an increasing need to do better financial planning to respond to and take advantage of these changes. Preparing a financial plan will help you decide on your life's goals, set them in priority and take steps to meet them. Planning helps to motivate you to increase savings rates and to spend your time and income in more productive ways. All people who have financial assets and financial responsibilities have some need for personal financial planning. The implementation of the personal financial planning process will increase the likelihood of achieving financial goals. Setting objectives, systematically analyzing alternatives to meet those objectives and implementing those options that are considered best is the systems approach. Such a process has had wide use and success for decades in engineering and social applications by private organizations and government. Depending upon your responsibilities to family or other dependents, the need exists to identify your potential risks and to take protective action. Depending upon the magnitude of your assets, you need to properly manage these assets to maximize the accumulation of 3 Chapter One capital or income at acceptable risks while achieving your financial goals. More sophisticated techniques of financial planning are more appropriately applied by those who have significant family responsibilities and are more affluent, with higher incomes, expenditures and net worth. Such individuals are confronted more frequently with the need for decisions on financial problems such as the implementation of investment strategies, solutions to tax problems, real estate planning or insurance planning. To help you decide if you should spend the extra effort to do more comprehensive financial planning, ask yourselves these questions: (1) Are we spending our hard-earned income wisely in a way that best meets both the short- and long-term needs and wants of the family? For example, are we adequately budgeting for education, housing or retirement needs? What should our spending priorities be? (2) Is our family adequately insured in case of a financial or health emergency, property loss, liability situation or the loss of a family breadwinner? (3) Do we have our assets invested to give the best combination of return on investment, safety and liquidity? (4) Are we arranging our affairs so as to legally minimize the tax bite consistent with other goals? (5) Are we contemplating a change in our lives, such as buying a house or entering retirement? If so, are we sure what effect this change will have on our finances? Do you feel that you need better answers to the above questions than you currently have? If so this book will help you organize your financial affairs and prepare your personal financial plan! SHOULD I PREPARE MY OWN PLAN? Given the desire for a more comprehensive plan, should I prepare my own or should I turn to professional help? Professional financial planners might say, "you need a better plan? You need a financial planner!" Fee-type financial planners have the advantage that they do not profit from any particular recommendation, so their recommendations should be objective. A plan from a fee-type planner may easily cost $500. Those with moderate incomes may not get adequate value for this high an expense. Commission-type financial planners generally offer free planning services and generally end up recommending whatever financial product they have to sell, be it insurance or load-type investments. Before hiring an expensive consultant, why not first use this book - Personal Financial Planning Made Easy - and EZ-$-PLAN software? 4 Chapter One We believe that with the help of this book, software and worksheets, most people will get the most value by preparing their own financial plan. By preparing your own plan you'll have a better understanding of your situation, goals and adjustments needed to reach those goals. You'll also be better able to frequently update your own plan and ask those "what-if" questions. Many people have the background and interest to do their own basic planning. A personal computer and the spreadsheet software included in EZ-$-PLAN make preparing your own financial plan easier and more fun. Several valuable newspapers and magazines that help you keep abreast of new developments in the economy and your personal finances are: The Wall Street Journal, Money Magazine, Changing Times and Consumer Reports. These sources of information are enjoyable to read, stimulate your thinking and will help you arrange and plan your financial affairs. For those who desire to improve their overall comprehension of the subject of personal financial planning, the book by Hallman and Rosenbloom (5) is highly recommended. Of course, when major decisions are made it is good to seek help from qualified legal, tax, securities and financial advisors. Having a considerable personal financial planning capability will make you a wiser and better consumer of the services from these specialists. FINANCIAL OBJECTIVES Each person's financial objectives differ in terms of his or her individual circumstances, goals, attitudes and needs. However, the total objectives of most people can be categorized as follows: (1) Protection against the personal risks of premature death, disability income losses, medical care expenses, property and liability losses and unemployment; (2) Capital accumulation for emergency fund and family purposes; (3) Provision for retirement income; (4) Reduction of the tax burden during lifetime and at death; (5) Planning for heirs (estate planning); and (6) Investment and property management. From the above general concepts, the total financial objectives of a particular family, here called Bill and Hope Planner, could be formulated as follows: (1) To provide protection for self and family from various personal financial risks of premature death, disability income losses, medical care expenses, property and liability losses and unemployment; (2) To accumulate capital and develop income over the years to provide sufficient funds for: emergencies, a standard of living to which we aspire over our lifetime including retirement, benevolent purposes, and for various family purposes, i.e., buy a 5 Chapter One house, raise a family, college expenses for children, recreation, vacation, and travel; and (3) To establish a personal financial planning system to accomplish objectives (1) and (2) that includes: insurance, a general investment portfolio, real estate, investment and property management, planning for heirs (estate planning) and reduced tax burden during our lifetime and at death consistent with the law. When the total financial objectives of Bill and Hope Planner are written down for their lifetime, these objectives represent a major set of goals. There is a time sequencing of these objectives, however. It depends where you are in your life cycle which objectives are history, present, near term, or long-term future. Consider the concept of a personal economic life cycle made up of a combined sequence of family events of an ecological, social and economic nature. Such a sequence of significant events for your generation is: birth, start school, start earning, marriage - form new family unit, start accumulating capital and investing, obtain house, have children, need for a larger house, college education for children, children become independent and leave home, retirement, demise of principal income earner. The present, near term, and long-term objectives evolve depending upon where you are in the personal economic life cycle. The needs of the family unit, the uncertainty of personal risks and the need for risk aversion and the time sequence of financial problems for decision all evolve as we live through our life cycle. What are the principal financial problems that require decisions in your life cycle? We believe that five critical financial issues occur in most peoples' life cycle; they are: buying a house, having children, college education for children, retirement income and expenditures, and demise of principal income earner. WHAT IS THE FOCUS OF THIS BOOK? The focus of this book is to help you use EZ-$-PLAN personal computer software tools to do your own personal financial planning. Personal Financial Planning Made Easy is organized into 13 chapters and 12 groups of software. Highlights of the chapters and software topics are as follows: * Chapter 1, Introduction to Personal Financial Planning, covers preliminary issues and helps you get started quickly with EZ-$- PLAN. * Chapter 2, Your Personal Data Base, describes how to keep track of your personal data, reminder of important dates and locator for your important documents. 6 Chapter One * Chapter 3, Income and Expense Analysis, explains how to organize your income and expense data, analyze this data and to modify income and expense patterns to help prepare to meet your financial goals. * Chapter 4, Assets, Liabilities and Net Worth, discusses how to prepare your personal balance sheet and use this information to track progress against plans. * Chapter 5, Planning to Meet Your Life's Goals, covers the process of setting realistic and desirable goals, planning near term tasks and make correct decisions. * Chapter 6, Tax Planning, spreadsheets help you prepare your 1988 Federal Income Tax, ask and get quick answers to those "what-if" questions. (Not included in SHAREWARE version). * Chapter 7, Life Insurance, spreadsheet helps you calculate how much life insurance to buy and decide which type of insurance to buy. (Not included in SHAREWARE version). * Chapter 8, Financial Calculator, explains how to easily solve compound interest and annuity problems using EZ-$-PLAN software. * Chapter 9, Portfolio Management, gives a review of investment principles and describes 26 EZ-$-PLAN software tools provided to help you manage your investments. (Not included in SHAREWARE version). * Chapter 10, Real Estate Planning, helps you calculate what mortgage amount and house price is right for you; comparison shop for mortgages, analyze real estate investments and do real estate calculations including payments on a home mortgage, mortgage amortization, mortgage refinancing, balloons, buying notes at discount. (Not included in SHAREWARE version). * Chapter 11, Financial Planning Simulation, helps you develop software simulations of your financial affairs to help you make major financial decisions. (Not included in SHAREWARE version). * Chapter 12, Financing a College Education, helps forecast college costs and savings program. (Not included in SHAREWARE version). * Chapter 13, Retirement Planning, describes several approaches to forecast retirement income and expenses and to decide when to retire. Some financial issues are analyzed using a limited number of pertinent components of the financial plan. For other complex and interdependent issues a financial planning simulation model is used for analysis. A balanced financial plan evolves as you progress through your life cycle and encounter new financial problems requiring decisions. While this book and software addresses many topics and financial problems of personal financial planning, it is by no means altogether complete. It is up to you to digest and apply the information provided to your own situation and to use and extend the EZ-$-PLAN tools to develop your own financial plan. We believe that this can be done with the information provided. 7 Chapter One GETTING STARTED WITH EZ-$-PLAN The SHAREWARE version of Personal Financial Planning Made Easy, EZ- $-PLAN for short, consists of this book and a Lotus 1-2-3 compatible EZ-$-PLAN software disk. AS-EASY-AS software can be provided or is available from SHAREWARE suppliers. First, the chapters describe various personal finance topics. Completed spreadsheet examples are discussed and analyzed. The EZ-$-PLAN software consists of Lotus compatible spreadsheet files, i.e., programs, templates and examples, and programs written in BASIC language. You can call up spreadsheet templates and AS-EASY-AS spreadsheet software to organize data and calculate results for each topic. In concept, EZ-$-PLAN AS-EASY-AS files are run as follows: (1) Load DOS. (2) Load AS-EASY-AS - simplified instructions for a quick start are given in an appendix.The text description assumes a PC configuration with 1 floppy and 1 hard disk drive. (3) Consult the index or the table of contents to locate the topic or problem at hand. Find the corresponding file name in the text. 4) Load the chosen file, insert your particular data and EZ-$-PLAN produces a calculated result or database report. As with all newly purchased software, step 1 should be to duplicate the EZ-$-PLAN diskette provided using the DOS DISKCOPY command. Store the master diskettes in a safe place. Use your working copy for applications. It should be noted that EZ-$-PLAN diskette has only a little free space. Those with a hardware configuration containing 2 floppy drives and no hard disk will need to manage their diskette storage space carefully. When you use one of these EZ-$-PLAN files and want to store your application on the same diskette, make sure beforehand that adequate space exists. You can copy a frequently used EZ-$-PLAN file to a blank diskette and provide ample storage space.