FINA1109 Notes
W1 W2 Personal Financial Planning & Human Capital ... 2
3 Key concepts ... 2
Effective decisions ... 2
5 Steps ... 2
Human Capital ... 3
Time value of money ... 3
Party trick ... 3
Record-keeping ... 4
W3 Reviewing Current finances ... 5
Equity or net worth ratio ... 5
Liquidity ratio ... 5
Basic Liquidity ratio ... 5
Savings Ratio ... 5
Debt ratio ... 5
Debt service (repayment) ratio ... 5
Consumption smoothing ... 5
W4 Debt ... 6
Types of loans ... 6
Credit ... 6
Credit reports ... 7
Interest ... 7
Debt Diversification... 8
W5 Buy or Rent? ... 9
Benefits of home ownership ... 9
Costs of renting ... 9
Costs of home ownership ... 9
Risks of home ownership ... 9
W6 Tax ... 10
Calculating Tax ... 10
Income ... 10
Tax Deductions ... 11
Tax offset/rebate ... 11
Investments ... 11
W8 Where can I put my money? ... 12
Main Asset classes ... 12
Risk & Diversification ... 12
Determining risk levels ... 13
Investing in Markets ... 13
Scams ... 14
W9 How do I put money there? ... 15
Shares ... 15
Debt instruments ... 16
Property ... 17
Managed Funds ... 17
Brokers ... 18
W10 Behavioral Finance ... 19
W11 Long-Term Retirement? Kids? Marriage? ... 21
Children ... 21
Marriage ... 21
Retirement ... 21
W12 Insurance ... 23
Risk Analysis ... 23
Risk management process ... 23
Insurance ... 23
2
W1 W2 Personal Financial Planning & Human Capital
3 Key concepts
Personal financial planning
o Process meeting your life goals through the proper management of your finances o Life goals such as getting a job, buying a home, round-the world holiday etc.
Personal financial planning process o Establish foundation
o Secure basic needs o Build wealth o Protect finances o Personal financial plan
Effective decisions
Key principles
o Use reasonable assumptions o Apply marginal reasoning
What changes because of your decision?
What changes at the margin?
o Consider opportunity costs
What are you missing out on?
What else could you have done?
Look at the next best alternative that could have been done with your money o Use sensitivity analysis
Predict what would happen if your assumption was wrong
What if ____ happens
Marginal costs
5 Steps
Analyse your current finances
o Look at Financial Position (net worth)
Use personal balance sheet
Assets – liabilities
Human capital is your biggest asset o Look at financial performance
Use personal cash flow statement
Establish your cash inflow/outflow over a period
Some are fixed expenses, some are variable expenses
Develop goals
Identify and evaluate strategies to achieve your goals
Establish and implement your plan
Reevaluate and revise your plan as needed
3
Human Capital
Determine Human Capital by discounting future salaries
A human capital derivative is moving some of the risk you face in your human capital to somebody else
Time value of money
Value of money generally increase with time at a rate
Hence we can accumulate/compound
o Example: $98 in an investment at 7%p. a would be worth $105 in the future
We can discount
o Example: $105 cash would be worth $98 in the future
One Equation to do all:
o Where r can stand for discount rate or interest or any other rate
= (1 + )
Factors that affect time value of money:
o Size – how big is the money?
Larger the future cash flows, the larger present values o Timing – how long you receive it?
More cash flows, more frequent larger present values
Longer you wait for cash flows, the smaller present values o Risk – how much are you discounting it?
Higher risk, higher discount rate, smaller present values
However, this formula cannot always be accurately used because there are many risks before you get the money:
risk, inflation, opportunity costs
Terminology
o Real price means the price with inflation into account, i.e. the real price stays same across time o Nominal price means the absolute amount of money need to purchase something, does not take into
account inflation
Party trick
Divide 72 by the number of years it takes to double principle value to get the interest rate o Example: if you double money in 9 years, rate =72/9= 8% p.a.
Divide 72 by the interest rate to get how long it will take for money to double
o Example: if you have an interest rate of 6 years, it will take 72/6= 12 years to double your money
4
Record-keeping
Short term Medium term Long Term
Credit card receipts
ATM and EFTPOS receipts Insurance
ATO (5 years) Credit, savings, loan statements
Superannuation statements Serial numbers of major assets
Birth certificate Marriage certificates Power of attorney Will
Passport details copies
Where to keep:
o Physical o Electronic
o Home safe
o Bank safety deposit box
Why to keep and check:
o Check bank statements, receipts etc. to protect against fraud o Check activity on your accounts
o Comply with the ATO – records need to be kept for 5 years o Track investments
o Track budget
o Claim warranty, insurance o Show proof of ownership
If there is a mistake
o Lodge a dispute with Financial Ombudsman Service Australia
5
W3 Reviewing Current finances
Equity or net worth ratio
Net worth
total assets=assets-liabilities total assets
Shows the proportion of assets that are owned
Example: 70% means that lenders own 30% assets of the individual
Can also use income instead of total assets
Shows gearing/leverage?
how important is it to own something? Is it cheaper to own it? Do you like to have control over it?
Liquidity ratio
liquid assets current liabilities
shows percentage of assets available to cover current debt
Basic Liquidity ratio
liquid assets monthly expenses
shows number of months you can survive on your current assets
should have money to cover 3-6 months of expenses, hence ratio should be at least 3
important to have financial buffer because shit happens
Savings Ratio
savings net income
shows percentage of income that is not spent
defining savings as what is leftover is fine - for ABS. but big mistake for you. Pay yourself first. be active.
May be low or negative for younger couple with small children and for old couple
Debt ratio
total debt net income
Percentage of income that can be used to pay off all the debt, will be usually greater than 100%
Sometimes total assets used instead of net income
Debt service (repayment) ratio
total monthly debt payments net income
Percentage of income that is going out to pay for credit card bills, loan etc.
Consumption smoothing
Suppose you inherit $2 million which you receive in 2035; what do you do now?
Lifecycle hypothesis:
o Sum lifetime earnings and divide by number of years for smooth consumption o This is called long division
Hence, debt is not good or bad because it allows us to bring in future cash flows to the present
Fun fact: being envious is dangerous to financial health, statistically it results in increase in bankruptcy
