Write a 700- to 1,050-word personal finance mission statement that describes where you want to be financially and how you can get there.

Include the following: 

o An analysis of your personal values as related to finances.

o An analysis of your specific financial goals and future vision.

o Formulate one simple action to take to meet goals and vision.

Formulate one complex action to take to meet your goals and vision. 

Assignment Content

1.

Top of Form

Write a 700- to 1,050-word personal finance mission statement that describes where you want to be financially and how you can get there.

Include the following: 

· An analysis of your personal values as related to finances.

· An analysis of your specific financial goals and future vision.

· Formulate one simple action to take to meet goals and vision.

Formulate one complex action to take to meet your goals and vision. 

Bottom of Form

1 Understanding Personal Finance

YOU MUST BE KIDDING, RIGHT?

Lauren Crawf

or

d invests $300 per month through her employer-sponsored 401(k) retirement account. If the investments she has chosen average an 8 percent annual return, how much money will she have in the account over and above the amounts contributed after 35 years?

A. $126,000

B. $352,800

C. $562,200

D. $688,200

The answer is C, $562,200 ($688,200 − $126,000). Lauren will contribute $126,000 ($3600 × [$300 × 12] × 35). Lauren makes the big money ($562,200) from “the annual compounding of money, “ not just on the amounts she puts into her retirement plan each month. Growing wealth is all about the magic of compound interest!

LEARNING OBJECTIVES

After reading this chapter, you should be able to:

 

Recognize the keys to achieving financial success.

 

Understand how the economy affects your personal financial success.

 

Apply basic economic principles when making financial decisions.

 

Perform time value of money calculations in personal financial decision making.

 

Make smart decisions about your employee benefits.

 

Identify the professional certifications of providers of financial advice.

WHAT DO YOU RECOMMEND?

Na Yeon Choi, age 23, recently graduated with her bachelor’s degree in library and information sciences. She is about to take her first professional position as an archivist with a large civil engineering firm in a rapidly expanding area in California. While in school, Na Yeon worked part time for that firm, earning about $10,000 per year. For the past two years, she has managed to put $1000 each year into an individual retirement account (IRA). Na Yeon owes $35,000 in student loans on which she is obliged now to begin making payments. Her new job will pay $55,000. Na Yeon may begin participating in her employer’s 401(k) retirement plan immediately, and she can contribute up to 8 percent of her salary to the plan. Her employer will contribute 1/2 of 1 percent for every 1 percent that Na Yeon contributes.

What do you recommend to Na Yeon on the importance of personal finance regarding:

1. Participating in her employer’s 401(k) retirement plan?

2. Understanding the effects of her marginal tax rate on her financial decisions?

3. Considering the current state of the economy in her personal financial planning?

4. Using time value of money considerations to project what her IRA might be worth at age 63?

5. Using time value of money considerations to project what her 401(k) plan might be worth when she is age 63 if she were to participate fully?

YOUR NEXT FIVE YEARS

In the next five years, you can start achieving financial success by doing the following related to understanding personal finance:

1. Stay up to date with current economic conditions.

2. Use marginal and opportunity costs and time value of money calculations when making financial decisions.

3. Harness the power of compounding by starting early to save a consistent amount each month for long-term goals.

4. Take responsibility for managing your own financial success.

5. Take advantage of tax sheltering through your employer’s benefits program.

Can you successfully manage your personal finances in today’s economy? Yes you can. But it will be challenging. Most people now realize that consuming less, paying off credit cards, and saving and investing more are the keys to long-term financial stability and success. That is good advice for you, too. In the years ahead many opportunities will arise for you to take smart actions to help assure your future financial success. You can do these things if you put in practice what you will learn in your personal finance course.

Personal finance

 is the study of personal and family resources considered important in achieving financial success; it involves how people spend, save, protect, and invest their financial resources. Topics in personal finance include financial and career planning, budgeting, tax management, cash management, credit cards, borrowing, major expenditures, risk management, investments, retirement planning, and estate planning. A solid understanding of personal finance topics offers you a better chance of success in facing the financial challenges, responsibilities, and opportunities of life. The best of all the successes is the sense of freedom from financial worries that comes with effectively planning your personal finances.

personal finance
The study of personal and family resources considered important in achieving financial success; it involves how people spend, save, protect, and invest their financial resources.

You are fortunate to be reading this book as it provides prudent guidance for every step of the way. Careful study will enhance your 
financial literacy
, which is simply your knowledge of facts, concepts, principles, and technological tools that are fundamental to being smart about money. Financial literacy empowers you. It improves your ability to handle day-to-day financial matters, helps you avoid the consequences of poor financial decisions that could take years to overcome, helps you make informed and confident personal money decisions, and makes you more financially responsible.

financial literacy
Knowledge of facts, concepts, principles, and technological tools that are fundamental to being smart about money.

Financial responsibility

 means that you are accountable for your future financial well-being and that you strive to make good decisions in personal finance. The biggest example of not being financially responsible is to live like you are rich before you are. Being financially responsible means you will control your personal financial destiny and be successful. At the beginning of each chapter, we provide a short case vignette titled “What Do You Recommend?” Each story focuses on the financial challenges that can be experienced by someone who has not learned about the material in that chapter. You will be asked to think about what advice you might give the person as you study the chapter. Then at the end of each chapter, you will again be asked to provide more informed advice based on what you have learned. You will be much better informed then!

financial responsibility
Means that you are accountable for your future financial well-being and that you strive to make wise personal financial decisions.

1.1 ACHIEVING PERSONAL FINANCIAL SUCCESS

LEARNING OBJECTIVE 1

Recognize the keys to achieving financial success.

Today’s marketplace provides a constant barrage of messages suggesting that you can spend and borrow your way to financial success, security, and wealth. Well, they are wrong because you can’t. These messages are very enticing for those starting out in their financial lives. In truth, overspending and overuse of consumer credit seriously impede financial success.

Many people think that being wealthy is a function of how much you earn or inherit. In reality, it is much more closely related to your ability to make good decisions that generate wealth for you.

Consider accepting some advice from your grandparent’s generation: “Be responsible for yourself. Be frugal. Work hard. Keep a level head. Use common sense. And above all, never give up on what you love.”

DID YOU KNOW

 

In Life and Career We Must Learn to “Focus”

Daniel Goleman’s book Focus: The Hidden Ingredient in Excellence offers tips for getting more out of our lives and careers as well as our roles as parents and as partners. He argues that the secret to high performance and fulfillment is “attention.” Goleman says that we must learn to sharpen our focus if we are to contend with, let alone succeed in, a complex world. We are overwhelmed by so much stuff in life (e.g., e-mails, texts, smart phones, Facebook) that we hardly enjoy a relaxed conversation, listening, and even quietly enjoy our meals. Goleman’s research focuses on three types of listening: inner, other, and outer focus. Paying careful attention is a capability that can be learned because it will enhance one’s emotional intelligence and performance.

You have to do only a few things right in personal finance during your lifetime, as long as you don’t do too many things wrong. Personal finance is not rocket science. You can succeed very well in your personal finances by making appropriate plans and taking sensible actions to implement those plans.

1.1a Plan for Financial Success and Happiness

Financial success

 is the achievement of financial aspirations that are desired, planned, or attempted. Success is defined by the person who seeks it. Some define financial success as being able to actually live according to one’s standard of living. Many seek 
financial security
, which provides the comfortable feeling that your financial resources will be adequate to fulfill any needs you have as well as most of your wants. Others want to be wealthy and have an abundance of money, property, investments, and other resources.

financial success
The achievement of financial aspirations that are desired, planned, or attempted, as defined by the person who seeks it.

financial security
The comfortable feeling that your financial resources will be adequate to fulfill any needs you have as well as most of your wants.

Financial happiness

 encompasses a lot more than just making money. It is the experience you have when you are satisfied with your money matters. People who are happy about their finances are likely to be spending within a budget and taking steps to achieve their goals, and this happiness spills over in a positive way to feelings about their overall enjoyment of life. Financial happiness is in part a result of practicing good financial behaviors. Examples of such behaviors include paying bills on time, spending less than you earn, knowing where your money goes, and investing some money for the future. The more good financial behaviors you practice, the greater your financial happiness. In fact, simply setting financial goals contributes to financial happiness.

financial happiness
The experience you have when you are satisfied with your money matters, which is in part a result of practicing good financial behaviors.

DID YOU KNOW
 

Bias Toward Thinking Negatively

People engaged in the understanding personal finance have a bias toward certain behaviors that can be harmful, such as a tendency toward thinking negatively about their level of living. These people compare their personal finances to others a lot and care about the results.

And, they tend to feel better when others are doing poorly. What to do? Focus on your own goals and resist comparing your situation to others.

DID YOU KNOW
 

The Five Fundamental Steps in the Financial Planning Process

There are five fundamental steps to the personal financial planning process: (1) Evaluate your financial condition relative to your education and career choice; (2) define your financial goals; (3) develop a plan of action to achieve your goals; (4) implement your plan; and (5) review your financial progress and make changes as appropriate.

As indicated in step 5, this process is revisited periodically, ideally every year, and whenever your life takes a meaningful turn such as a new job, marriage, birth of a child, or even after a sad event such as a divorce or death of a family member.

1.1b Spend Less So You Can Save and Invest More

Financial objectives are rarely achieved without forgoing or sacrificing current consumption (spending on goods and services). This restraint is accomplished by putting money into 
savings
 (income not spent on current consumption) for use in achieving future goals. Some savings are actually 

investments

 (assets purchased with the goal of providing additional future income from the asset itself). By saving and investing, people are much more likely to have funds available for future consumption. If you save for tomorrow, you will be happier today and tomorrow.

savings
Income not spent on current consumption.

investments
Assets purchased with the goal of providing additional future income from the asset itself.

Effective financial management often separates the haves from the have-nots. The haves are those people who learn to live on less than they earn and are the savers and investors of society. The have-nots are the spenders who live paycheck to paycheck, usually with high consumer debt. They fail to manage money and as a result money manages them.

Being frugal is not about abstinence. It is about being smart in personal finance. Saving money does not make you cheap; it makes you smarter than those who just spend and spend. Spending less is about prioritizing your choices. You should think about making good choices in life when making every day spending decisions by asking yourself “What is most important to me?” This helps you get out of the habit of simply spending money and making choices that will enhance your life.

Figure 1-1

 Building Blocks to Achieving Financial Success

Figure 1-2

 How to Get Your Financial House in order by Age 30

Saving for future consumption represents a good illustration of the human desire to achieve a certain 

standard of living

. This standard is what an individual or group earnestly desires and seeks to attain, to maintain if attained, to preserve if threatened, and to regain if lost. Our standards include our wants and needs—our comforts and luxuries too. In contrast, individuals actually experience their level of living at any particular time. In essence, your standard of living is where you would like to be, and your level of living is where you actually are.

standard of living
Material well-being and peace of mind that individuals or groups earnestly desire and seek to attain, to maintain if attained, to preserve if threatened, and to regain if lost.

Figure 1-1
 shows the building blocks to achieving financial success and how they fit together. 
Figure 1-2
 shows how to get your financial house in order by age 30. Accomplish these steps and you will be financially successful.

FINANCIAL POWER POINT

 

Dreams Are Not Goals

Everybody has dreams about financial success. But only by setting clear financial goals with specific plans for their achievement will you achieve financial success in the future.

CONCEPT CHECK 1.1

1. Distinguish among financial success, financial security, and financial happiness.

2. Explain the five fundamental steps in the financial planning process.

3. What are the building blocks to achieving financial success?

1.2 THE ECONOMY AFFECTS YOUR PERSONAL FINANCIAL SUCCESS

LEARNING OBJECTIVE 2

Understand how the economy affects your personal financial success.

Your success in personal finance depends in part on how well you understand the economic environment; the current stage of the business cycle; and the future direction of the economy, inflation, and interest rates.

DID YOU KNOW
 

Your Worst Financial Blunders in Understanding Personal Finance

Based on other’s financial woes, you will make personal finance mistakes when you:

1. Only think about money matters when you have a financial problem

2. Spend more than you earn

3. Believe and act on financial advice from amateurs rather than trust professional sources

1.2a How to Tell Where We Are in the Business Cycle

An economy is a system of managing the productive and employment resources of a country, state, or community. The U.S. federal government attempts to regulate the country’s overall economy to maintain stable prices (low inflation) and stable levels of employment (low unemployment). In this way, the government seeks to achieve sustained 
economic growth
, which is a condition of increasing production (business activity) and consumption (consumer spending) in the economy— and hence increasing national income. Government policies also affect the economy. For example, tax cuts keep money in consumers’ pockets, money that they are then likely to spend. Tax increases, in contrast, depress consumer demand.

economic growth
A condition of increasing production (business spending) and consumption (consumer spending) in the economy and hence increasing national income.

1.2b The Business Cycle

Growth in the U.S. economy varies over time. The 

business cycle

 (also called the 

economic cycle

) is a process by which the economy grows and contracts over time. It can be depicted as a wavelike pattern of rising and falling economic activity in which the same pattern occurs again and again over time. As illustrated in 

Figure 1-3

, the phases of the business cycle are expansion (when the economy is increasing), peak (the end of an expansion and the beginning of a contraction), contraction (when the economy is falling), and trough (the end of a contraction and beginning of an expansion).

business cycle/economic cycle
Business cycles can be depicted as a wavelike pattern of rising and falling economic activity; the phases of the business cycle include expansion, peak contraction (which may turn into recession), and trough.

The preferred stage of the economic cycle is the expansion phase, where production is at high capacity, unemployment is low, retail sales are high, and prices and interest rates are low or falling. Under these conditions, consumers find it easier to buy homes, cars, and expensive goods on credit, and businesses are encouraged to borrow to expand production to meet the increased consumer demand. The stock market also rises because investors expect higher profits in the future.

As the demand for credit increases, short-term interest rates rise because more borrowers want money. Consumers and businesses purchase more goods, exerting upward pressure on prices. Eventually, prices and interest rates climb high enough to stifle consumer and business borrowing, send stock prices down, and choke off the expansion. One effect of such economic turmoil is 
deleveraging
, meaning that instead of normal economic times when credit usage grows, it shrinks because companies and individuals pay down their debts. When businesses and consumers use less debt, home and car sales decline as does employment. The result is a period of negligible economic growth or even a decline in economic activity.

deleveraging
A time period when credit use shrinks in an economy instead of expanding as during normal economic times.

In such situations, the economy often contracts and moves toward a 

recession

. During recessions, consumers become pessimistic about their future buying plans. The typical U.S. recession is marked by an average economic decline of 2 percent that lasts for ten months with an average unemployment rate exceeding 6 percent.

recession
A recurring period of decline in total output, income, employment, and trade, usually lasting from six months to a year and marked by widespread contractions in many sectors of the economy.

There have been five recessions since 1980. The federal government’s Business Cycle Dating Committee of the National Bureau of Economic Research officially defines a recession as “a period of falling economic activity spread across the economy, lasting more than a few months, normally visible in real gross domestic product, real income, employment, industrial production, and wholesale-retail sales.”

The Aftermath of the Great Recession The Great Recession began in December 2007 and ended in June 2009. The recession lasted 18 months, which makes it the longest of any recession since World War II.

The economy contracted 5.1 percent during the Great Recession, and it was of historic proportions. It was the worst economic contraction since the Great Depression of 1929–1941. During the Great Recession nine million people in the United States had their jobs disappear as unemployment surpassed 10 percent. Half of all American workers suffered job losses, pay cuts, or reduced hours at work, or they were forced into part-time employment.

Figure 1-3
 Business Cycle Phases

Many people of your parents’ ages saw the value of their homes shrink 25 to 65 percent while at the same time half of their retirement funds evaporated. The Great Recession destroyed 20 percent of American’s wealth in home values and investments. Surveys revealed that over 60 percent of those between age 50 and 61 have had to delay their retirements, and the average retirement age rose three years since 2008. Consumer confidence dropped to an all-time low.

Years later the U.S. economy is still dealing with the aftermath of the Great Recession. We continue to experience slow economic growth and relatively high unemployment. It took four years (until 2013) for stock prices to recover and to see home prices recover in most communities.

FINANCIAL POWER POINT
 

Double Dip Recession

Some people fear that continued downward pressure from relatively weak wages and demand may result in a double dip recession. This occurs when the economy has a recession and then, soon after emerging from the recession with a short period of growth, falls back into recession.

The Economic Future … Eventually … Will Be Expansion Despite the severity or length of any recession, eventually the economic contraction ends, and consumers and businesses become more optimistic. The economy then moves beyond the trough toward recovery and expansion, where levels of production, employment, and retail sales begin to improve, allowing the overall economy to experience some growth from its previously weakened state. The entire business cycle typically takes about six years.

Politicians and economic advisors struggle with which path to take to create economic growth. Most of the world has followed the Keynesian economic theory since the 1930s, which is to increase demand with stimulus spending even if it creates large temporary government deficits. The logic is that when consumers and businesses spend less, the economy will be depressed unless the government spends more. Such spending creates additional economic growth that results in increased tax revenues, thus resulting in budget surpluses that can be used to pay down the debts.

*

 Now, however, the deficits themselves are seen as the problem by some U.S. politicians and in other countries resulting in calls to slash public outlays. Others say such an austerity approach will lead to lower demand, lower growth, lower tax revenues, stock market declines, and an even higher national debt, as has occurred in Greece, Ireland, Portugal, Spain, and Great Britain.

FINANCIAL POWER POINT
 

You Can Be optimistic About Your Future

During slow or sluggish economic times people face uncertain financial futures. However, this does not mean that they should stop saving and investing for their futures. Every generation has faced similar uncertainties. You should be positive about the long-term economic future. Make sound, prudent decisions regarding spending, saving, and investing by putting in practice what you learn in this book.

No matter what path is chosen, the 2007 to 2009 contraction of the economy will have costly after effects in the United States for years to come, including the new normal of slower job growth, slimmer paychecks, less borrowing, lower consumer spending, and higher savings.

The Congressional Budget Office says that given the severity of the Great Recession, it could take until 2022 or 2023 for unemployment to get back to the more typical 5 or 5% percent and see the economy return to a healthy growth rate of 3+ percent annually. The U.S. economy has to grow around 2.5 percent a year just to keep up with rising productivity and population growth, and to keep unemployment from rising.

1.2c How to Tell the Future Direction of the Economy

To make sound financial decisions, you need to know where we are in the business cycle, how well the economy is doing, and where the economy might be headed. You can do this by paying attention to some economic statistics that are regularly reported in the news as well as on cable TV business shows. Your knowledge can help guide your long-term financial strategy. An 
economic indicator
 is any economic statistic, such as the unemployment rate, GDP, or the inflation rate (terms discussed in the next few paragraphs), that suggests how well the economy is doing and how well the economy might do in the future.

economic indicator
Any economic statistic, such as the unemployment rate, GDP, or the inflation rate, that suggests how well the economy is doing now and how well it might be doing in the future.

Look at Procyclic Indicators, like GDP and Jobs A procyclic (or procyclical) economic indicator is one that moves in the same direction as the economy. Thus if the economy is doing well, this number typically is increasing. If we are in a recession, this indicator is decreasing. Examples of procyclic indicators are retail sales, industrial production, new orders for durable goods (like household appliances), number of employees on nonagricultural payrolls, and the gross domestic product. Consumer spending accounts for about 70 percent of the total U.S. economy.

The best understood example of a procyclic economic indicator is the 
gross domestic product (GDP)
, which is the broadest measure of the economic health of the nation because it reports how much economic activity (all goods and services) has occurred within the U.S. borders. The government regularly announces the rate at which the GDP has grown during the previous three months (

www.bea.gov/newsreleases/rels.htm

). In the United States, an annual rate of 2 percent or less is considered very low growth (not even enough to create jobs for new entrants to the job market such as college graduates), and 3 percent is considered growth occurring at a safe speed that is not likely to induce excessive inflation. A sustained rate of 4 percent or higher starts to worry economists and investors. The United States needs a GDP growth rate of about 2.5 percent just to keep unemployment from rising and much faster economic growth, such as a growth rate of 4 or 5 percent, to bring the unemployment rate significantly down.

gross domestic product (GDP)
The nation’s broadest measure of economic health; it reports how much economic activity (all goods and services) has occurred within the U.S. borders during a given period.

Look at Countercyclic Indicators A countercyclic (or countercyclical) economic indicator is one that moves in the opposite direction from the economy. For example, the unemployment rate is countercyclic because it gets larger as the economy gets worse. Similarly, the price of gold rises as the economy gets worse since some people see gold as a safe haven in bad times (even though it is not).

Look at Leading Indicators Leading economic indicators are those that change before the economy changes; thus, they help predict how the economy will do in the future. The stock market is a leading economic indicator because it usually begins to decline shortly before the overall economy slows down. Then the stock market advances before the economy begins to pull out of a recession. Other examples of leading economic indicators are the number of new building permits, existing home sales, home prices, jobless claims (average number of weekly first-time filings for unemployment benefits), the Standard & Poor’s 500 Stock Index, and the consumer confidence index.

leading economic indicators
Statistics that change before the economy changes, thus helping predict how the economy will do in the future, such as the stock market, the number of new building permits, and the consumer confidence index.

The consumer confidence index is a widely watched leading economic indicator that gauges how consumers feel about the economy and their personal finances. It gives a sense of consumers’ willingness to spend (

www.conference-board.org

). Growing confidence suggests increased consumer spending. Consumers worried about the future postpone purchases, and the reduced spending acts as a drag on the economy.

The 
index of leading economic indicators (LEI)
 is a composite index, reported monthly by the Conference Board, that suggests the future direction of the U.S. economy (
www.conference-board.org
). The LEI averages ten components of growth from different segments of the economy, such as building permits, factory orders, and new private housing starts. Leading economic indicators are very important to investors as they help predict what the economy will be like in the future.

index of leading economic indicators (LEI)
A composite index reported monthly by the Conference Board that suggests the future direction of the U.S. economy.

1.2d The Future Direction of Inflation and Interest Rates

Prices and interest rates typically move in the same direction. A steady rise in the general level of prices is called 

inflation

. Inflation is measured by the changing cost over time of a “market basket” of goods and services that a typical household might purchase. Inflation often occurs when the supply of money (or credit) rises faster than the supply of goods and services available for purchases. It also may be attributed to excessive demand or sharply increasing costs of production.

inflation
A steady and sustained rise in general price levels across economic sectors; measured by the changing cost over time of a “market basket” of goods and services that a typical household might purchase.

Inflation Is the Typical Economic Condition Some level of inflation is the typical condition in any economy and can be beneficial in moderation as it encourages job creation and economic growth. But when there is high inflation in the United States, perhaps 5 or 6 percent workers begin to push for higher wages, thereby adding to the cost of production. In response to the increases in the costs of labor and raw materials, manufacturers will charge more for their products. Lenders, in turn, will require higher interest rates to offset the lost purchasing power of the loaned funds. Consumers will lessen their resistance to price increases because they fear even higher prices in the future. Thus, inflation can have a snowball effect. In times of moderate to high inflation, buying power declines rapidly, and people on fixed incomes suffer the most. A very negative complication of inflation that sometimes occurs is stagflation, which is the condition of stagnant economic growth and high unemployment accompanied by rising prices.

Here Is How Inflation Is Measured The U.S. Bureau of Labor Statistics measures inflation on a monthly basis using the 
consumer price index (CPI)
. The CPI is a broad measure of changes in the prices of all goods and services purchased for consumption by urban households. The prices of more than 400 goods and services (a “market basket”) sold across the country are tracked, recorded, weighted for importance in a hypothetical budget, and totaled. In essence, the CPI is a cost of living index. The index has a base time period—or starting reference point—from which to make comparisons. The 1982 to 1984 time period represents the base period of 100. For example, if the CPI were 234 on January 1, 2015, the cost of living would have risen 121 percent since the base period [(234 − 100) / 100 = 1.34 or 134%]
*
. Similarly, if the index rises from 234 to 242 on January 1, 2016, then the cost of living will have increased by 3.4 percent over the year [(242 − 234) / 234 = 0.034 or 3.4%].

consumer price index (CPI)
A broad measure of changes in the prices of all goods and services purchased for consumption by urban households.

Here Is How Inflation Affects Your Income From an income point of view, inflation has significant effects. Consider the case of Scott Wade of Chicago, a single man who took a job in retail management three years ago at a salary of $50,000 per year. Since that time, Scott has received annual raises of $1000, $1200, and $1500, but he still cannot make ends meet because of inflation. Although Scott received raises, his current income of $53,700 ($50,000 + $1000 + $1200 + $1500) did not keep pace with the annual inflation rate of 3.0 percent ($50,000 × 1.03 = $51,500; $51,500 × 1.03 = $53,045; $53,045 × 1.03 = $54,636). If Scott’s own cost of living rose at the same rate as the general price level, in the third year he would be $936 ($54,636 − $53,700) short of keeping up with inflation. He would need $936 more in the third year to maintain the same purchasing power that he enjoyed in the first year.

Personal incomes rarely keep up in times of high inflation. Your 

real income

 (income measured in constant prices relative to some base time period) is the more important number. It reflects the actual buying power of the 
nominal income
 (also called money income) that you have to spend as measured in current dollars. Rising nominal income during times of inflation creates the illusion that you are making more money, when in actuality that may not be true.

real income
Income measured in constant prices relative to some base time period. It reflects the actual buying power of the money you have as measured in constant dollars.

nominal income
Also called money income; income that has not been adjusted for inflation and decreasing purchasing power.

To compare your annual wage increase with the rate of inflation for the same time period, you first convert your dollar raise into a percentage, as follows:

For example, imagine that Javier Gomez, a single parent and assistant manager of a convenience store in Windermere, Florida, received a $1600 raise to push his $37,000 annual salary to $38,600. Using Equation (1.1), Javier calculated his percentage change in personal income as follows:

After a year during which inflation was 4.0 percent, Javier did better than the inflation rate because his raise amounted to 4.3 percent. Measured in real terms, his raise was 0.3 percent (4.3 − 4.0). In dollars, Javier’s real income after the raise can be calculated by dividing his new nominal income by 1.0 plus the previous year’s inflation rate (expressed as a decimal):

DO IT IN CLASS

ADVICE FROM A PROFESSIONAL

Seven Money Mantras for a Richer Life

1. It’s not an asset if you are wearing it!

2. Is this a need or is it a want?

3. Sweat the small stuff.

4. Cash is better than credit.

5. Keep it simple.

6. Priorities lead to prosperity.

7. Enough is enough!

Michelle Singletary

Nationally syndicated Washington Post columnist (““The Color of Money”) and author of The Power to Prosper: 21 Days to Financial Freedom.

Reprinted with permission of the author.

Clearly, a large part of the $1600 raise Javier received was eaten up by inflation. To Javier, only $115 ($37,115 − $37,000) represents real economic progress, while $1485 ($1600 − $115) was used to pay the inflated prices on goods and services. The $115 real raise is equivalent to 0.31 percent ($115 / $37,000, or less than 1 percent) of his previous income, reflecting the difference between Javier’s percentage raise in nominal dollars and the inflation rate.

Here Is How Inflation Affects Your Consumption When prices are rising, an individual’s income must rise at the same rate to maintain its 

purchasing power

, which is a measure of the goods and services that one’s income will buy. When prices rise, the purchasing power of the dollar declines, but not by the same percentage. Instead, it falls by the reciprocal amount of the price increase (the counterpart ratio quantity needed to produce unity).

purchasing power
Measure of the goods and services that one’s income will buy.

In the preceding illustration where prices increase between 2015 and 2016, prices rose 2.1 percent, whereas the purchasing power of the dollar declined 2.07 percent over the same period. [The previous year base of 237 divided by the index of 242 equals 0.9793; the reciprocal is 0.0207 (1 − 0.9793), or 2.07%.].

The 
Rule of 70
 can be used to determine how long it will take for the value of the dollar to go down by one-half. Simply divide 70 by the current inflation rate. In our example, a 2.1 percent inflation rate would reduce the value of a dollar by one-half in 33 years (70 / 2.1). As you can see, even a low inflation rate means that by the time a young worker retires, the purchasing power of their initial income will have dropped significantly.

Rule of 70
A formula to determine how long it will take for the value of a dollar to decline by one-half.

Inflation pushes up the costs of the products and services we consume. If automobile prices rose 20 percent over the past five years, for example, then it will take $28,800 now to buy a car that once sold for $24,000 ($24,000 × 1.20). If your market basket of goods and services differs from that used to calculate the CPI, you might have a very different personal inflation rate (the rate of increase in prices of items purchased by a particular person). Inflation pushes up the cost of borrowing, so monthly car payments and home mortgage rates increase when inflation rises.

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Deflation Can Be Bad, Too During a severe recession there is the possibility of 
deflation
, which is a broad, sustained decline in prices of goods and services. Deflation last occurred in the United States in 2009 as prices declined 0.34 percent during the year, and prices continued to decline during the early months of 2010. When faced with deflation, government policymakers often embark on massive spending programs to stimulate the economy. Such spending, of course, creates high national liabilities that ideally could be repaid when the economy is strong.

deflation
A broad, sustained decline in prices of goods and services that is hard to stop once it takes hold, causing less consumer spending, lower corporate profits, declining home values, rising unemployment, and lower incomes.

You Can Track the Federal Funds Rate to Forecast Interest Rates and Inflation One of the mandates of the Federal Reserve Board (an agency of the federal government commonly referred to as the “

Fed

”) is to “promote maximum employment and price stability.” You can forecast interest rates and inflation by paying attention to changes in the 
federal funds rate
, which is the short-term rate at which banks lend funds to other banks overnight so that the borrowing bank has sufficient reserves as mandated by the Fed. The federal funds rate is set by the Fed and is a benchmark for business and consumer loans and an indication of future Fed policy. The Fed lowers the federal funds rate to boost the economy in slow economic times and raises it to slow down an overheated economy. The Fed has kept the federal funds rate low for the past decade, but as the economy expands it will allow rates to go up. The Fed’s goals are inflation at 2 percent or a bit lower, interest rates at 3 percent or a bit lower, and unemployment at 5 percent or a bit higher.

fed
The Federal Reserve Board, an agency of the federal government.

federal funds rate
The short-term rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight.

Here Is How Inflation Affects Your Borrowing, Saving, and Investing 

Interest

 is the price of money. During times of high inflation, interest rates on new loans for cars, homes, and credit cards rise. Even though nominal interest rates for savers rise as well, the increases do not provide “real” gains if the inflation rate is higher than the interest rate on savings accounts or certificates of deposit.

interest
The price of borrowing money

The Fed meets regularly to discuss the economy and review federal interest rates.

Smart investors recognize that the degree of inflation risk is higher for long-term lending (5 to 20 years, for example) than for short-term lending (such as a year) because the likelihood of error when estimating inflation increases when lots of time is involved. Therefore, long-term interest rates are generally higher than short-term interest rates. Similarly, stock market investors are negatively affected when inflation causes businesses to pay more when they borrow, thereby reducing their profits and depressing stock prices. When inflation is at 5 percent annually, a dollar of profit that a company will earn a year from now will be worth only 95 cents in today’s prices. If instead inflation were only 2 percent, that dollar would be worth 98 cents today. Such differences add up to significant amounts over many years. Throughout your financial life, you will want to factor the impact of inflation into your financial decisions in an effort to reduce its negative effects.

In summary, to assess the economic outlook for the United States, watch these indicators: (1) GDP and jobs, including unemployment rate changes; (2) procyclic items like inflation and interest rates; (3) countercyclic items like unemployment and gold prices; (4) leading indicators like the consumer confidence index, LEI, and the stock market; (5) interest rates; and (6) the federal funds rate.

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DID YOU KNOW
 

Bias Toward Thinking Things Will Continue as They Have

People engaged in the understanding personal finance have a bias toward certain behaviors that can be harmful, such as a tendency toward thinking things will go on as they have recently. During a rising stock market people often will think that things will continue as they have for many more months. What to do? Watch for economic indicators that suggest that the economy and the stock market are reaching a peak and sell stocks that are likely to decline as the economy eventually slows.

CONCEPT CHECK 1.2

1. Summarize the phases of the business cycle.

2. Describe two statistics that help predict the future direction of the economy.

3. Give an example of how inflation affects income and consumption.

1.3 THINK LIKE AN ECONOMIST WHEN MAKING FINANCIAL DECISIONS

Understanding and applying basic economic principles will affect your financial success. The most important of these are opportunity costs, marginal utility and costs, and marginal income tax rate.

LEARNING OBJECTIVE 3

Apply basic economic principles when making financial decisions.

1.3a Consider Opportunity Costs When Making Decisions

The 

opportunity cost

 of a decision is the value of the next best alternative that must be forgone. A simple example of opportunity costs in personal finance is spending money on current living expenses, which, of course, reduces the amount you can save and invest and the opportunity to earn interest and dividends. Also, buying on credit results in monthly payments later, which reduces the opportunity to make desired purchases in the future. It is not just the payments and interest that is the cost of credit but other uses of those funds. If opportunity costs are underestimated, then decisions will be based on faulty information, and judgments may prove wrong. Properly valuing opportunity costs of alternatives represents a key step in rational decision making.

opportunity cost
The opportunity cost of any decision is the value of the next best alternative that must be forgone.

Using the concept of opportunity costs in your thinking allows you to address the personal consequences of choices because every decision inevitably involves trade-offs. A 

trade-off

 is giving up one thing for another. For example, it is wise to give up some current spending in order to enjoy a financially comfortable future. For example, suppose that instead of reading this book you could have gone to a movie or watched television, but mainly you wanted to sleep. The lost benefit of reading—the next best alternative—is the opportunity cost when you choose to sleep. Similarly, keeping the money in a savings account has the opportunity cost of the higher return on investment that a stock market mutual fund might pay. This opportunity to earn a higher rate of return is a primary opportunity cost when making low-risk investment decisions. Other challenging opportunity cost decisions are renting versus buying housing, buying a new or used car, working or borrowing to pay for college, and starting early or late to save and invest for retirement.

trade-off
Giving up one thing for another.

FINANCIAL POWER POINT
 

Save $4.66 for Every $1 Not Saved Earlier

If you want to retire at age 65, you will have to save about $4.66 beginning at age 42 to make up for every dollar you did not save at age 22.

1.3b Identify Marginal Utility and Costs in Your Decision Making

Utility is the ability of a good or service to satisfy a human want. A key task in personal finance is to determine how much utility you will gain from a particular decision. For example, if you decide to spend $90 on a ticket to a concert, you might begin by thinking about what you might gain from the expenditure. Perhaps you’ll enjoy a nice evening, good music, and so on.

Marginal utility

 is the extra satisfaction derived from having one more incremental unit of a product or service. 

Marginal cost

 is the additional (marginal) cost of one more incremental unit of some item. When known, this cost can be compared with the marginal utility received. Thinking about marginal utility and marginal cost can help in decision making because it reminds us to compare only the most important variables. It requires that we examine what we will really gain if we also experience a certain extra cost.

marginal utility
The extra satisfaction derived from gaining one more incremental unit of a product or service.

marginal cost
The additional (marginal) cost of one more incremental unit of some item.

To illustrate this idea, assume that you will consider spending $150 instead of $90 (an additional $60) for a ground floor seat at the concert. What marginal utility will you gain from that decision? Perhaps it is the ability to see and hear more or the satisfaction of having one of the best seats in the house. You would then ask yourself whether those extra benefits are worth 60 extra dollars. In practice, people are inclined to seek additional utility as long as the marginal utility exceeds the marginal cost.

In another example, imagine that two new automobiles are available on a dealership lot in Ferndale, Michigan, where chemical engineer Pamela Hicks is trying to make a purchase decision. The first, with a sticker price of $29,100, has a moderate number of options; the second, with a sticker price of $32,800, has numerous options. Marginal analysis suggests that Pamela does not need to consider all of the options when comparing the vehicles. Instead, the concept of marginal cost says to compare the benefits of the additional options with the additional costs—$3700 in this instance ($32,800 − $29,100). Pamela needs to decide if the additional options are worth $3700.

1.3c Factor Your Marginal Income Tax Rate When Making Financial Decisions

Financial decisions often have an impact on the income taxes one must pay. Of particular importance is your 

marginal tax rate

, which is the tax rate at which your last dollar earned (not all your income) is taxed. As income rises, taxpayers pay progressively higher marginal income tax rates. Financially successful people often pay U.S. federal income taxes at the 25 percent, or higher, marginal tax rate on the top segment of their income. For example, if Juanita Martinez, an unmarried office manager working in Atlanta, Georgia, has a taxable income of $66,000 and receives a $1000 bonus from her employer, she has to pay an extra $250 in taxes on the bonus income ($1000 × 0.25 = $250). Juanita also has to pay state federal income taxes of 6 percent, or $60 ($1000 × 0.06 = $60), local income taxes of 2 percent and Social Security and Medicare taxes of 7.65 percent, or $76.50 ($1000 × 0.0765 = $76.50). Therefore, Juanita pays an effective marginal tax rate of just over 40 percent (25% + 6% + 2% + 7.65% = 40.65%), or $406.50, on the extra $1000 of earned income.

marginal tax rate
The tax rate at which your last dollar earned is taxed.

tax-exempt income
Income that is totally and permanently free of taxes.

The Very Best Kind of Income Is Tax-Exempt Income The best kind of income, as this discussion implies, is 

tax-exempt income

, which is income that is totally and permanently free of taxes. People who pay high marginal tax rates often seek out tax-exempt investments, such as buying bonds issued by various agencies of states and municipalities. For example, Serena Miller, a married chiropractor with two children from Prescott, Arizona, currently earns $250 per year on $5000 in stocks and pays $62.50 in federal income tax on that income at her 25 percent marginal tax rate ($250 × 0.25). Alternatively, a tax-exempt $5000 state bond paying 4 percent will provide Serena with a better after-tax return, $200.00 instead of $187.50.

Figure 1-4

 Tax-Sheltered Returns Are Greater Than Taxable Returns
In the illustration, the annual return is 8 percent and the annual contribution is $2000.

The Second Best Kind of Income Is Tax-Sheltered Income The second best kind of income for individuals is 
tax-sheltered (or tax-deferred) income
—that is, income that is exempt from income taxes in the current year but that will be subject to taxation in a later tax year. 
Figure 1-4
 shows that tax-sheltered returns on savings and investments provide much greater returns than returns on which income taxes have to be paid because more money remains available to be invested. In addition, tax-sheltered funds grow more rapidly because compounding (the subject of the next section in this chapter) is enhanced when larger dollar amounts continue to grow especially during the latter years of an investment.

tax-sheltered (or tax-deferred) income
Income exempt from income taxes in the current year but that will be subject to taxation in a later tax year.

CONCEPT CHECK 1.3

1. Define opportunity cost and give an example of how opportunity costs might affect your financial decision making.

2. Explain and give an example of how marginal analysis makes some financial decisions easier.

3. Describe and give an example of how income taxes can affect financial decision making.

1.4 PERFORM TIME VALUE OF MONEY CALCULATIONS

A dollar in your pocket today is worth more than a dollar to be received five years from now. Why? Time is money.

LEARNING OBJECTIVE 4

Perform time value of money calculations in personal financial decision making.

The 

time value of money

 (TVM) is perhaps the single most important concept in personal finance. TVM is the cost of money that is borrowed or lent, and it commonly referred to as interest. TMV adjusts for the fact that dollars to be received or paid out in the future are not equivalent to those received or paid out today. It is easy to understand that a dollar received today is worth more than a dollar received five years from now because today’s dollar can be saved or invested and earn some kind of return, such as interest, so that in five years you expect it to be worth more than a dollar. The time value of money involves two components: future value and present value.

time value of money
A method by which one can compare cash flows across time, either as what a future cash flow is worth today (present value) or what an investment made today will be worth in the future (future value). Also, the cost of money that is borrowed or lent; it is commonly referred to as interest and adjusts for the fact that dollars to be received or paid out in the future are not equivalent to those received or paid out today.

1.4a There Are Only Two Common Questions About Money

To illustrate the time value of money, two questions in personal finance are commonly asked:

1. What will an investment (or a series of investments) be worth after a period of time? This question asks for a future value, which is referred to as compounding.

2. How much has to be put away today (or as a series of investments) to provide some dollar amount in the future? This question asks for a present value.

As you can see from these two questions, comparisons between time periods cannot be made without making adjustments to money values. Accordingly, time value of money calculations compare future and present values by taking into account the interest rate (or investment rate of return) and the time period involved.

FINANCIAL POWER POINT
 

To Succeed Financially, Do What Your Grandparents Did

To succeed in life financially, people today can do what their grandparents did. This includes a willingness to postpone gratification, invest for the future, work harder than the next person, and hold your kids to the highest expectations.

Simple Interest The calculation of interest involves (1) the dollar amount, called the 
principal
, (2) the rate of interest earned on the principal, and (3) the amount of time the principal is invested. One way of calculating interest is called simple interest and is illustrated by the simple interest formula

principal
The original amount invested.

If someone saved or invested $1000 at 8 percent for four years, he would receive $320 in interest ($1000 × 0.08 × 4) over the four years.

Compounding Is the Basis of All Time Value of Money Considerations But something is missing in the simple interest calculation. The simple interest formula assumes that the interest is withdrawn each year and only the $1000 stays on deposit for the entire four years, and thus interest is not added to the principal. Most people do not invest this way. Instead, they leave the interest earned in the account so that it will earn additional interest. This earning of interest on interest is referred to as 
compound interest
. It arises when interest is added to the principal, so that from that moment on the interest that has been added also itself earns interest. This addition of interest to the principal is called 

compounding

. The effect of compounding depends on the frequency with which interest is paid and the periodic interest rate that is applied. Compound interest is always assumed in time value of money calculations.

compound interest
Compound interest is earning of interest on interest and arises when interest is added to the principal so that, from that moment on, the interest that has been added also earns interest.

compounding
The addition of interest to principal; the effect of compounding depends on the frequency with which interest is compounded and the periodic interest rate that is applied.

Compounding is the best way to build investment values over time. Because of compounding, money grows much faster when the income from an investment is left in the account. In fact, the deposit of $1000 in our example would grow to $4,661 after 20 years (the calculation is described in the following paragraph). Many of the techniques for building wealth that we describe in this book are based on compounding. The way to build wealth is to make money on your money, not simply to put money away. Yes, you need to put money away first, but compounding over time is what really builds wealth.

Compounding serves as the basis of all time value of money considerations. To see how this works, let us look again at our example in which $1000 is invested at 8 percent for four years. Here is how the amount invested (or principal) would grow using compounding:

Due to the effects of compounding, this investor would have earned an additional $40.49 ($360.49 − $320). While this amount might not seem like much, realize that a $1000 investment for a longer period—say, 40 years—earning 8 percent interest would grow to $21,724.52, providing $20,724.52 in interest over that time period. Simple interest would have resulted in only $3200 in interest ($1000 × 0.08 × 40). The benefit of compounding over that time period is an additional $17,524.52 in interest ($20,724.52 − $3200).

The results are even more dramatic if $1000 is invested at the end of each year for 40 years. The total at the end of 40 years would be $259,056, with $219,056 representing the interest on the invested funds. This illustration suggests one of the cardinal rules of personal financial planning: Getting rich is not a function of investing a lot of money. It is the result of investing regularly for long periods of time. The greatest investment strategy of all is compounding. Only through compounding will you attain the serious growth of your wealth over time.

1.4b Calculating Future Values

Future value

 (FV) is the valuation of an asset projected to the end of a particular time period in the future. You can calculate the future value of a lump sum or the future value of a series of deposits.

future value
The valuation of an asset projected to the end of a particular time period in the future.

Future Value of a Lump Sum Equation (1.4) can be used to calculate the future value of a lump sum:

where i represents the interest rate and n represents the number of time periods. Applying this formula to our earlier example of investing $1000 at 8 percent for four years, we obtain

or

While mathematically correct, these calculations can be cumbersome when using long time periods. 

Table 1-1

 provides a quick and easy way to determine the future dollar value of an investment. For the preceding example, use the table in the following manner: Go across the top row to the 8 percent column. Read down the 8 percent column to the row for four years to locate the factor 1.3605 (at the intersection of the dark brown column and row). Multiply that factor by the present value of the cash asset ($1000) to arrive at the future value ($1360.50).

Appendix A.1 provides an even more complete table for calculating the future value of lump-sum amounts. 

Figure 1-5

 demonstrates the importance of higher yields and longer time horizons by showing the effects of various compounded returns on a $10,000 investment. The $10,000 will grow to $57,435 in 30 years with an interest rate of 6 percent. Compounding $10,000 at 10 percent yields $174,494 over the same time period; at 14 percent, it yields a whopping $509,502! For practice you might want to confirm these results using Appendix A.1.

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Table 1-1 Future Value of $1 After a Given Number of Periods

Figure 1-5
 The Importance of Higher Yields and More Time (Future Value of a Single Investment of $10,000)

DID YOU KNOW
 

Money Websites for Understanding Personal Finance

Informative websites for understanding personal finance, including present and future values are:

Bankrate.com (

www.bankrate.com/calculators.aspx

)

Bureau of Labor Statistics (

www.bls.gov/

)

CNNMoney (

www.cgi.money.cnn.com/ tools/

)

Department of Labor (

www.dol.gov/ebsa/

)

Federal Reserve Board (www.federalreserve .gov/)

Financial Calculators (

www.fincalc.com/

)

KJE (

www.dinkytown.net/

)

moneychimp (

www.moneychimp.com/calculator/compound_interest_calculator.htm

)

USA Today (

www.usatoday.com/money/perfi/calculators/calculator.htm

)

Future Value of a Stream of Payments (an Annuity) People often save for long-term goals by putting away a series of payments. Appendix A.3 provides a complete table for calculating the future value of a stream of deposited amounts, referred to as an 
annuity
. You can use it to determine the effects of various compounded returns on a $2000 annual investment made at the end of each year. The $2000 will grow to $91,524 in 20 years (read across the interest rate row in Appendix A.3 to 8 percent and then down the column to 20 years to obtain the factor of 45.762 to multiply by $2000) and to $226,566 in 30 years at an 8 percent rate. Compounding $2000 at 10 percent yields $114,550 in 20 years and $328,988 over 30 years; at 14 percent, it becomes $713,574 after 30 years! As you can see, time builds wealth.

annuity
A stream of payments to be received in the future.

1.4c Finding Present Values Is Called Discounting

Present value (or discounted value) is the current value of an asset (or stream of assets) that will be received in the future. Discounting is the process of reducing future values to present values. You can calculate the present value of a lump sum to be received in the future or the present value of a series of payments to be received in the future.

Present Value of a Single Lump Sum The present value of a lump sum is the current worth of an asset to be received in the future. Alternatively, it can be thought of as the amount you would need to set aside today at a given rate of interest for a given time period so as to have some desired amount in the future. Suppose you want to have $20,000 for the down payment on a new home in ten years. What would you need to set aside today to reach this goal if you could invest your money and receive a 7 percent return? Using Appendix A.2 you could look across the interest rate rows to 7 percent and then down to ten years to obtain the factor of 0.5083. Multiplying $20,000 by this factor reveals that $10,166 set aside today would allow you to reach your goal.

A simple formula for figuring the number of years it takes to double the principal using compound interest is the Rule of 72. Simply divide the interest rate that the money will earn into the number 72.

Present Value of a Stream of Payments (an Annuity) The present value of an annuity is the current worth of a stream of payments to be received in the future. Alternatively, it can be thought of as the amount you would need to set aside today at a given rate of interest for a given time period so as to receive that stream of payments. Suppose you want to have $30,000 per year for 20 years during your retirement. What amount would you need to have invested at retirement to reach this goal if you could invest your money and receive a 7 percent return? Using Appendix A.4 you could look across the interest rate rows to 7 percent and then down to 20 years to obtain the factor of 10.5940. Multiplying $30,000 by this factor reveals that $317,820 (10.5940 × $30,000) set aside at retirement would fund this stream of payments. Note the beauty of compound interest in this result. It takes only $317,820−not $600,000−to fund a $30,000 per year retirement for 20 years if you can earn 7 percent on your financial nest egg.
*

CONCEPT CHECK 1.4

1. Explain the difference between simple interest and compound interest, and describe why that difference is critical.

2. What are the two components used when figuring the time value of money?

3. Use 
Table 1-1
 to calculate the future value of (a) $2000 at 5 percent for four years, (b) $4500 at 9 percent for eight years, and (c) $10,000 at 6 percent for ten years.

1.5 MAKE SMART MONEY DECISIONS AT WORK

Smart decisions about your employee benefits can increase your actual income by 30 percent or more each year. An 

employee benefit

 is compensation for employment that does not take the form of wages, salaries, commissions, or other cash payments. Your benefits package might also include paid vacations and sick days, health insurance, a retirement plan, child care, and an educational assistance program.

employee benefit
Compensation for employment that does not take the form of wages, salaries, commissions, or other cash payments.

LEARNING OBJECTIVE 5

Make smart decisions about your employee benefits.

1.5a Choosing Tax-Free Cafeteria Plan Benefits

A 

cafeteria

 (or 

flexible benefits) plan

 is a type of employee benefit plan where employees choose their benefits from a “menu” of both taxable and one or more qualified nontaxable or tax-sheltered benefits, thereby providing a funding mechanism by which employees may pay for some of the benefits they choose on a pretax basis. For example, an employer might offer $4000 annually to each employee to spend on benefits. The plan might offer health insurance, life insurance, sick leave or disability benefits, medical expense reimbursement, vacation days, dependent care, adoption assistance, and orthodontia treatments. Employees choose the benefits they want and can design their own benefits package.

cafeteria plan (flexible benefits plan)
A type of employee benefit plan where employees choose their benefits from a “menu” of taxable and tax reducing benefits, thereby providing a funding mechanism by which employees may pay for some of the benefits they choose on a pretax basis.

1.5b Making Decisions About Employer’s Flexible Spending Accounts

Some employee benefits are tax-sheltered. A 
flexible spending account (FSA)
, also called a flexible spending arrangement, is an employer-sponsored account that allows employee-paid expenses related to health and dependent care to be paid with 
pretax dollars
 (money income that has not been taxed by the government) rather than after-tax income. Under a typical FSA, the employee agrees to have a certain amount deducted from each paycheck that is then deposited into a separate account. There are two types of flexible spending accounts; the medical and dental expense FSA and the dependent care FSA. FSA contributions are limited to $2500. Dependent care FSA contributions are limited to $5000 per year. As eligible expenses are incurred, the employee requests and receives reimbursements from the account.

flexible spending account (FSA)
An employer-sponsored account that allows employee-paid expenses for medical or dependent care to be paid with an employee’s pretax dollars rather than after-tax income.

pretax dollars
Money income that has not been taxed by the government.

Because many workers pay combined effective marginal income tax rates (discussed earlier) of about 40 percent, that same percentage can be saved by not giving it to the government in taxes. The worker who contributes $5000, for example, to a flexible spending account (FSA) saves approximately $2000 ($5000 × 0.40) in taxes, further reducing his or her overall expenses.

Funds in a dependent care FSA account may be used to pay for the care of a dependent younger than age 13 or the care of another dependent who is physically or mentally incapable of caring for himself or herself and who resides in the taxpayer’s home. Funds in a medical care FSA account may be used to pay for qualified, unreimbursed out-of-pocket expenses for health care, but they may not be used for over-the-counter medicines unless specifically prescribed by a doctor.

Before enrolling in an FSA, you need to estimate your expenses carefully so that the amount in the FSA does not exceed anticipated expenses. According to Internal Revenue Service (IRS) regulations, unused amounts are forfeited and are not returned to the employee—a condition called the “use it or lose it” rule. However, employers may choose to offer a 2½-month grace period during which time you can continue to spend up to $500 of the previous year’s FSA money. Many employers offer debit cards that withdraw money directly from an employee’s FSA. Only about 20 percent of eligible employees participate in flexible spending accounts, even though doing so saves money.

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DID YOU KNOW
 

A Baker’s Dozen of Good Financial Behaviors

Good financial behaviors to follow include these:

1. Develop a plan for your financial future.

2. Saving regularly and increase savings as income grows.

3. Follow a budget or spending plan to control and/or reduce living expenses.

4. Keep personal debts to a minimum.

5. Pay credit card bills in full each month.

6. Sign up to participate in employer’s retirement plan.

7. Calculate how much money is needed for retirement and then save for it through your employer’s plan and/ or an individual retirement account (IRA).

8. Comparison shop for purchases.

9. Use a credit/budget counselor if debt becomes unmanageable.

10. Contemplate how economic events will affect personal financial decision making.

11. Consult a financial planner when faced with complicated financial questions.

12. Set aside an emergency fund sufficient to live on for three to six months.

13. Contribute to a flexible spending account at work.

1.5c Making Decisions About Employer-Sponsored Health Care Plans

Many employers offer employees a choice of 
health care plans
 to assist employees with their health care expenses. The premium for an employee’s individual or family plan could be as high as $10,000 annually depending upon the amount of coverage selected. The premiums for employees are often either paid for entirely or partially by the employer. For example, some employers pay the first $3000 of annual premiums for employee health care coverage and require that employees pay the remainder. Employees usually can make a decision to change health plans once a year as well as when one’s family situation changes, such as getting married.

health care plans
An employee benefit designed to pay all or part of the employee’s medical expenses.

Employers often offer multiple options for health care plans. These may include an expensive traditional health plan, perhaps with a high annual premium that offers comprehensive coverage requiring little out-of-pocket health care spending by the employee. Also frequently available is a less expensive 
high-deductible health plan (HDHP)
, which has lower premiums and higher deductibles than a traditional health plan. The 

deductible

 is the amount paid to cover health care expenses before benefits begin. A policy with perhaps a $3500 premium might require larger out-of-pocket health care spending by the employee.

high-deductible health plan (HDHP)
A plan that requires individuals to pay a higher deductible to cover medical expenses before insurance plan payments begin; chosen to save money on premiums.

deductible
An initial portion of any loss that must be paid before collecting insurance benefits.

Younger employees, particularly those who are typically healthy, often select high-deductible plans to save on the cost of premiums. For example, if an employer pays only the first $3000 in health care premiums for employees, an employee selecting the high-cost plan described previously has to pay $6000 ($9000 premium — $3000 employer contribution) annually, or $500 a month in premiums. This contrasts with only a $500 total annual premium for employees who select the high-deductible plan ($3500 premium — $3000 employer contribution). The maximum out-of-pocket limit for HDHPs is $6250 for self-only coverage and $12,500 for self-and-family coverage, after which the policy is supposed to pay for all health expenses.

Some employers also offer 
health savings accounts (HSAs)
. This special savings account is intended for people who have a high-deductible health care plan. Employees make tax-deductible contributions to a savings account to be used for eligible expenses. Employers may also contribute. The employee invests HSA funds, and the money in the account grows tax free. Withdrawals are made to pay for medical expenses. The limits on contributions to an HSA are $3300 per year for individuals and $6550 for families. The money in the account remains there even if you don’t spend it within a certain time period.

health savings accounts (HSAs)
Special savings account intended for people who have a high-deductible health care plan (with annual deductibles of at least $1000 for individuals and $2000 for families).

1.5d Making Decisions About Participating in Employer Insurance Plans

Life, disability, and long-term care insurance coverages are often available through employers. While the premiums charged for the group of employees for life insurance are rarely as low as those available in the general marketplace, some employers pay for part or all of employees’ premiums. Coverage is typically one or two times the employee’s salary. So, always sign up for free or subsidized life insurance at work. The premiums for disability and long-term care insurance are often less expensive when purchased through one’s employer rather than in the general marketplace. See 

Chapters 10

, 

11

, and 

12

 to begin to purchase any needed insurance coverage.

1.5e Making Decisions About Participating in Your Employer’s Retirement Plan

More than half of all workers are covered by an employer-sponsored, defined-contribution retirement plan, also called a 
tax-sheltered retirement plan
. These include 401(k) plans and similar 403(b) and 457 plans, as discussed in 

Chapter 17

, “Retirement and Estate Planning.” Employer-sponsored retirement plans provide four distinct advantages.

tax-sheltered retirement plan
Employer-sponsored, defined-contribution retirement plans including 401(k) plans and similar 403(b) and 457 plans.

DID YOU KNOW
 

Turn Bad Habits into Good Ones

Do You Do This?

Ignore news about the economy

Buy lots of extra features on products

Focus only on take-home pay

Don’t know how much to save for retirement

Have not yet started to invest for retirement

Pay out-of-pocket expenses for health care

Get financial advice from friends

Do This Instead!

Watch business news on cable television

Use marginal costs in buying decisions

Sign up for employer tax-advantaged saving plans

Calculate future values

Begin investing as soon as possible

Use employer’s cafeteria benefits plan for expenses

Seek advice of fee-only financial planner

First Advantage: Tax-Deductible Contributions Tax-sheltered retirement plans provide tremendous tax benefits compared with ordinary savings and investment plans. Because pretax contributions to qualified plans reduce taxable income, the current year’s tax liability is lowered. The money saved in taxes can then be used to partially fund a larger contribution, which creates even greater returns. The 401(k) plan lets the IRS help employees finance their retirement plans because of the income taxes saved.

As 

Table 1-2

 illustrates, you can save substantial sums for retirement with minimal effects on your monthly take-home pay. For example, a married man like Hongbok Lee of Macomb, Illinois, with a monthly taxable income of $4000 paying taxes at the 25 percent marginal tax rate who forgoes some spending and places $500 into a tax-sheltered retirement plan every month reduces monthly take-home pay from $3345 to $2970, or $375—that is certainly not an enormous amount.

The net effect is that it costs Hongbok only $375 to put away that $500 per month into a retirement plan. The immediate “return on investment” equals a fantastic 25 percent ($125 / $500). In essence, the taxpayer puts $375 into his or her retirement plan and the government contributes $125. (Without the plan, the taxpayer would pay the $125 directly to the government.) A taxpayer paying a higher marginal tax rate realizes even greater gains. Because a substantial part of your contributions to a tax-sheltered retirement plan comes from money that you would have paid in income taxes, it costs you less to save more. In addition, the Social Security Administration credits Hongbok with an earned income of $4000 a month rather than $3500.

Table 1-2 It Costs Only $375 a Month (or $4500) to Save $6000 a Year for Retirement

Second Advantage: Employer’s Matching Contributions To retain employees and encourage saving for retirement, many employers also offer employer-paid matching contributions in addition to amounts contributed by the employee. Employers may match all or part of their employees’ contributions. An employee who saves $250 might receive an additional $250 a month from his/ her employer. That’s a 100 percent return on the employee’s $250! More typically, employer’s match fifty percent of an employee’s contributions up to a certain maximum—still, a nice 50 percent return.

Third Advantage: Employer’s Contributions Are Not Income You will pay income taxes on any employer’s contributions to your 401(k) retirement plan only when you withdraw from the account. That may not be until you retire and perhaps are in a lower tax bracket than you were in when the contributions were made.

Careful planning can result in a much more comfortable life when you retire.

Fourth Advantage: Tax-Deferred Growth Because interest, dividends, and capital gains from qualified plans are taxed only after funds are withdrawn from the plan, investments in tax-sheltered retirement plans grow tax-deferred. The benefits of tax deferral can be substantial.

For example, if a person in the 25 percent tax bracket invests $2000 at the end of every year for 30 years and the investment earns an 8 percent taxable return compounded annually, the fund will grow to $158,116 at the end of the 30-year period. As shown in 
Figure 1-5
 on page 20, if the same $2000 invested annually were instead compounded at 8 percent within a tax-deferred program, it would grow to $226,566! The higher amount results from compounding at the full 8 percent and not paying any income taxes on investment income over the years. When the funds are finally taxed upon their withdrawal some years later, the taxpayer may be in a lower marginal tax bracket.

Fifth Advantage: Borrowing Lets You Tap Your Funds Without Income Taxes If you have an immediate need for cash, you can get it quickly by borrowing from your own 401(k) account. Your credit score doesn’t matter and interest rates are low. All you need to do is ask your plan administrator for a loan and you do not have to explain why you need the money.

The most you can borrow is 50% of your account balance or $50,000, whichever is less. You have to repay the loan in level amounts over no more than five years (longer if the funds are used to buy a home), but you can pay it off more quickly with no penalty. If you’re married, you must obtain your spouse’s consent to the loan.

Sixth Advantage: Starting Early Really Pays Off Big Recall the rule of 72, which can be used to calculate the number of years it would take for a lump-sum investment to double. An 8 percent rate of return doubles an investment every nine years. Waiting eight years to begin saving (starting at age 31 instead of 22) results in the loss of one doubling. Unfortunately, it is the last doubling that is lost, as illustrated in 

Table 1-3

. In the example, $48,000 ($96,000 − $48,000) is lost due to a hesitancy to invest $3000. That is a tremendously negative opportunity cost for waiting nine years to start. The financial gains in a 401(k) or other tax-sheltered retirement account will work best for you only if you begin to invest early in life. You cannot wait until your 40s to begin to save because the compounding boat will have sailed and you will have missed it.

Table 1-3 Starting to Save Early Versus Starting Late

The gains are awesome when you start early and make regular, continuing investments instead of delaying. The amounts invested do not have to be large to have a big impact. For example, a worker who starts saving $50 per week in a qualified retirement plan starting at age 22 will have a million dollars ($1,052,740) by age 66, assuming an annual rate of return of 8 percent. Waiting until age 30 to start saving, instead of beginning at age 23, results in a retirement fund of only about $540,950; about one-half of the larger amount. The benefit of starting to invest early is about $512,000 yet the total extra dollars invested over the ten years was only about $21,000! This effect occurs because most of the power of compounding appears in the last years of growth.

CONCEPT CHECK 1.5

1. Summarize the benefits of participating in a high-deductible health care plan at work.

2. Create a math example of why many employees participate in a tax-sheltered employee benefit plan, such as an HSA or 401(k) plan.

3. List two ways you can maximize the benefits from a tax-sheltered retirement program.

DID YOU KNOW
 

Sean’s Success Story

Sean appears in every chapter of this book. Sean always makes good decisions in personal finance, and he aims to be financially successful and happy. Following graduation during his first year of work as a public relations analyst earning $60,000, Sean signed up for his employer’s low-premium, high-deductible health care plan. Within his employer cafeteria benefits plan, he chose the tax-free options of excellent vacation days, maximum sick leave and disability benefits, and a dollar limit of medical expense reimbursements. Sean did some future value calculations on the cost of his eventual retirement and then filled out the forms to contribute the maximum possible to his 401(k) retirement plan ($3000), and since he is in the 25 percent tax bracket, he saved $750 ($3000 × 0.25) in income taxes. His $3000 was fully matched by his employer, thus giving him $6000 to invest within his retirement plan. Since he expects the economy to expand in the coming years, Sean concluded this was an excellent time to invest in stocks as values will probably rise, so he put the full $6000 into those kinds of investments. Sean decided that when his retirement account reaches $50,000 (probably in about five years with continuing contributions and values growing at 8 percent), he will contact a fee-only financial planner for investment advice.

1.6 WHERE TO SEEK EXPERT FINANCIAL ADVICE

At various points in their lives, many people rely on the advice of a professional to make comprehensive financial plans and decisions. Most often financial planning advice is focused on a narrow area of one’s finances. Professional advisers, such as lawyers, tax preparers, insurance agents, credit counselors, or stockbrokers, are often relied upon for advice. Much too often, however, these people are salespeople for specific financial services and receive compensation if they make a sale and as a result may not have your best interests at heart.

LEARNING OBJECTIVE 6

Identify the professional certifications of providers of financial advice.

People often find it helpful to obtain the services of more broadly qualified financial experts. A 

financial planner

 is an investment professional who evaluates the personal finances of an individual or family and recommends strategies to set and achieve long-term financial goals. The most recognized professional designation for financial planners is the

Certified Financial Planner (CFP®)

.

financial planner
An investment professional who evaluates the personal finances of an individual or family and recommends strategies to set and achieve long-term financial goals.

A good financial planner should be able to analyze a family’s total needs in such areas as investments, taxes, insurance, education goals, and retirement and pull all of the information together into a cohesive plan. The planner may help a client select and prioritize goals and then rearrange assets and liabilities to fit the client’s lifestyle, stage in the life cycle, and financial goals. Where appropriate, planners should make referrals to outside advisers, such as attorneys, accountants, trust officers, real estate brokers, stockbrokers, and insurance agents. Effective financial advice helps you make better day-to-day financial decisions so you have more to spend, save, invest, and donate. About half of large employers offer discounted visits to a financial planner.

The shape of the relationship between you and your financial advisor should be clear from the beginning. It should be spelled out in writing, and both you and the advisor should have a copy of the document. When the nature of the advice includes investments an 
investment policy statement
 is a must. Such a statement details your investment philosophy, your financial situation, and the risks you are willing to take, as well as what the advisor will do for you. It provides a road map of how he/she will guide the investing of your money.

investment policy statement
A written document that spells out the relationship between an investor and his or her financial advisor and guides how the advisor will invest the person’s money; it should detail the person’s investment philosophy, financial situation, and the risks he or she is willing to take, as well as what tasks the advisor will perform.

Always ask if a financial advisor adheres to a 
fiduciary standard
 meaning that they must always act in the best interest of the client regardless of how it might affect the advisor. If the advisor says that such a standard is unnecessary be very wary of the advice given especially if it involves buying financial products through the advisor.

fiduciary standard
A financial advisor must always act in the best interest of the client regardless of how it might affect the advisor.

You can check the background of the planner you are considering. Self-regulatory organizations and government agencies are available to help.

• The Certified Financial Planner Board of Standards (CFP Board) assists those searching for a CFP as well as accepts complaints. Contact 

www.cfp.net

 or (800)487–1497.

• The National Association of Insurance Commissioners (NAIC) directs inquiries to the appropriate state agency where you can check on planners who also sell insurance products. Contact 

www.naic.org

 or (816)842–3600.

• The Financial Industry Regulatory Authority (FINRA) regulates U.S. security firms. Contact 

www.finra.org

 or (301)590–6500.

• The National Association of Personal Financial Advisors (NAPFA) assists those searching for a fee-only financial planner and sets standards for CFPs who are NAPFA Registered Financial Planners. Contact 

www.napfa.org

 or (847)483–5400.

• The Securities and Exchange Commission (SEC) regulates investment advisers and all securities dealers. Contact 

www.sec.gov

 or (800)732–0330.

1.6a How Financial Planners Are Compensated

One way or another, you will pay to get financial advice—commissions, fees, or lousy financial decisions—so assess the total costs up front as well as the opportunity costs. Financial planners earn their income in one of four ways:

1. Commission-only financial planners and brokers live solely on the commissions they receive on the financial products (such as investments or insurance) they sell to their clients. In this case, the plan will be “free,” but a commission will be paid to the adviser by the source of the financial product, such as an insurance company or mutual fund. Advantage: Save money if you make only a few transactions.

2. Fee-based financial planners charge an up-front fee for providing services and charge a commission on any securities trades or insurance purchases that they conduct on your behalf. Advantage: Unlimited consultations with broker.

3. Fee-offset financial planners charge an annual or hourly fee. That fee will be reduced by any commissions earned off the purchase of financial products sold to the client. Advantage: Fee will be reduced as you trade investments.

4. Fee-only financial planners earn no commissions and work solely on a fee-for-service basis—that is, they charge a specified fee (typically $50 to $200 per hour or 1 percent of the client’s assets annually) for the services provided. They usually need five or more one-hour appointments to analyze a client’s financial situation and to present a thorough plan. Fee-only planners do not sell financial products, such as stocks or insurance. As a result and unlike other financial planners/ brokers, they do not recommend products that earn them a commission at the lowest cost. Using a true fee-only financial planner has one big advantage; unbiased advice.

ADVICE FROM A PROFESSIONAL

Questions to Ask a Financial Planner

Financial planners will influence your life and your future, so be sure to ask them these questions:

1. What experience do you have, such as work history and companies with which you have been associated?

2. Am I permitted a no-cost, initial consultation, and how much time is allowed?

3. What are your qualifications to practice financial planning, such as education, formal training, licenses, and credentials, and who can vouch for your professional reputation including some of your long-term clients?

4. Will you be the only person working with me or will an associate be involved in evaluating and updating the plan you suggest, and how often are formal reviews held with the client?

5. How do you evaluate my investment performance, and how often?

6. What process do you follow to identify a client’s financial goals and may I see representative examples of financial plans, monitoring reports, and portfolios or actual case studies of your clients?

7. How much do you charge, what is your fee structure, how are you personally compensated, and if you earn commissions, how are they earned and from whom?

8. To whom would I take a complaint, if I had one?

9. Do you adhere to a fiduciary standard when working with your clients? Why or why not?

10. May I have a written agreement that details the points above and the services to be provided?

Joan Koonce

University of Georgia

DID YOU KNOW
 

A Baker’s Dozen of Bad Financial Behaviors

Poor financial behaviors to avoid include the following:

1. Purchasing things in order to feel good or important

2. Reaching the maximum limit on a credit card

3. Spending more money than you make

4. Making a credit purchase after running out of money

5. Obtaining a cash advance on a credit card after running out of money or to pay on another credit card

6. Ignoring an overdue notice from a creditor

7. Paying a credit card, utility, or any other bill late

8. Borrowing money from a coworker or employer

9. Borrowing from 401(k) retirement plan at work

10. Taking an old employer’s 401(k) money in cash when changing jobs

11. Using a debit card (or writing a check) with insufficient funds, incurring hefty overdraft fees

12. Lending to or borrowing money from friends or family

13. Following the financial advice of family or friends rather than qualified financial advisors

Table 1-4 Financial Planner Professional Certifications

Many financial planners have voluntarily undergone training and satisfied various qualifications for particular professional certifications. Related work experience is often required.

Accredited Estate Planner

Estate planning

(866) 226–2224
www.naepc.org

(888) 263–7265
www.theamericancollege.edu

(888) 777–7077
www.aicpa.org

Certification	Description	Contact Information
	Accredited Estate Planner		Estate planning		(866) 226–2224 www.naepc.org
Certified Financial Planner (CFP®)	Best-known financial planning certification	(800) 487–1497 www.cfp.net
NAPFA Registered Financial Advisor (NRFA)	Source for fee-only financial advisors	(847) 483–5400 www.napfa.org
Chartered Financial Consultant (ChFC®)	Financial planning in insurance		(888) 263–7265 www.theamericancollege.edu
Chartered Life Underwriter (CLU®)	Life insurance
Certified Public Accountant (CPA)	Income tax and estate planning		(888) 777–7077 www.aicpa.org
Personal Financial Specialist (PFS)	Personal finance credential for CPAs
Certified Trust and Financial Advisor (CTFA)	Trusts and taxes	(800) 226–5377 www.aba.com
Accredited Financial Counselor (AFC)	Financial counseling and money management	(614) 485–9650 www.afcpe.org
Chartered Mutual Fund Counselor (CMF®)	Mutual funds	(800) 237–9990 www.cffpinfo.com/cmfc.xhtml
Registered Investment Adviser (RIA)	Investment adviser	(202) 551–6999 www.sec.gov

Remember, it’s your money and your financial future. So when you use the services of a financial planner, don’t be intimidated. Ask the hardest questions and don’t leave the planner’s office until you understand the answers.

DO IT NOW!

You know more about personal finance after reading this chapter, so get started right now by:

1. Searching the Internet to identify the current stage in the business cycle;

2. Visiting 

www.bls.gov

 to determine the current inflation rate;

3. Going to 

www.conference-board.org

 to assess expectations for economic growth for the next 12 months.

CONCEPT CHECK 1.6

1. What are the four ways financial planners may be compensated?

2. Describe two professional certification programs for financial planners.

WHAT DO YOU RECOMMEND NOW?

Now that you have read the chapter on the importance of personal finance, what do you recommend to Na Yeon in the case at the beginning of the chapter regarding:

1. Participating in her employer’s 401 (k) retirement plan?

2. Understanding the effects of her marginal tax rate on her financial decisions?
3. Considering the current state of the economy in her personal financial planning?
4. Using time value of money considerations to project what her IRA might be worth at age 63?

5. Using time value of money considerations to project what her 401 (k) plan might be worth at age 63 if she were to participate fully?

BIG PICTURE SUMMARY OF LEARNING OBJECTIYES

LO1 Recognize the keys to achieving financial success.

Financial success and happiness come from spending less and saving and investing more. The goal is to achieve a level of living that is very close to your standard level of living. You can do so by applying the five fundamental steps in the financial planning process.

LO2 Understand how the economy affects your personal financial success.

Using your knowledge of where we are in the business cycle and tracking a few economic statistics will guide you to make appropriate adjustments in your long-term financial strategy. Also recognize how inflation and deflation will affect your finances.

LO3 Apply economic principles when making financial decisions.

Understanding and applying the basic economic principles of opportunity cost, marginal utility and cost, and marginal income tax rate will affect your financial success. The opportunity cost of a decision is the value of the next best alternative that must be forgone. Marginal cost is the additional (marginal) cost of one more incremental unit of some item. When known, this cost can be compared with the marginal utility received. One’s marginal tax rate is the tax rate at which your last dollar is taxed.

LO4 Perform time value of money calculations in personal financial decision making.

Dollars to be received or paid out in the future are not equivalent to those received or paid out today. A dollar received today is worth more than a dollar received a year from now because today’s dollar can be saved or invested; by next year, you expect it to be worth more than a dollar. The time value of money involves two components: future value and present value.

LO5 Make smart decisions about your employee benefits.

Smart decisions can increase your actual income by thousands of dollars each year. You need to select wisely among choices within employer-sponsored cafeteria plans; health care; flexible spending accounts; life, disability, and long-term care insurance; and retirement. These decisions often require you to calculate the tax-sheltered aspects of the employee benefits.

LO6 Identify the professional certifications of providers of financial advice.

When choosing a financial planner, know that many professional designations are meaningful in this field, such as CFP and ChFC. Costs may be charged on a fee-only, commission-only, fee-based, or feeoffset basis.

LET’S TALK ABOUT IT

1. Economic Growth. How might some of the federal government’s recent efforts to help stimulate economic growth affect consumers?

2. The Business Cycle. Where is the United States in the economic cycle now, and where does it seem to be heading? List some indicators that suggest in which direction it may move.

3. Personal Finance Mistakes. What are some common mistakes that people make in personal finance? Which three might be the worst, and why?

4. Federal Reserve. Describe some economic circumstances that might persuade the Federal Reserve to lower short-term interest rates.

5. Opportunity Costs. People regularly make decisions in personal finance that have opportunity costs. List three financial decisions you have made recently, and identify the opportunity cost for each.

DO IT IN CLASS
PAGE 14

DO THE MATH

1. Real Income. Joshua Vermier of Sacramento, California, received a raise after his first year on the job to $43,800 from his initial salary of $42,000. What was Joshua’s raise stated as a percentage? Inflation averaged 2.8 percent for the year. What was his real income after the raise? What was his real raise stated as a percentage?

DO IT IN CLASS
PAGE 12

2. Future Value. As a graduating senior, Chun Kumora of Manhattan, Kansas, is eager to enter the job market at an anticipated annual salary of $54,000. Assuming an average inflation rate of 3 percent and an equal cost-of-living raise, what will his salary be in ten years? In 20 years? (Hint: Use Appendix A.1.) To make real economic progress, how much of a raise (in dollars) does Chun need to receive next year and the year after?

DO IT IN CLASS
PAGE 19

3. Present and Future Values. Megan Berry, a freshman horticulture major at the University of Minnesota, has some financial questions for the next three years of school and beyond. Answers to these questions can be obtained by using Appendix A or the Garman/Forgue companion website.

(a) If Megan’s tuition, fees, and expenditures for books this year total $12,000, what will they be during her senior year (three years from now), assuming costs rise 4 percent annually? (Hint: Use Appendix A.1 or the Garman/Forgue companion website.)

(b) Megan is applying for a scholarship currently valued at $5000. If she is awarded it at the end of next year, how much is the scholarship worth in today’s dollars, assuming inflation of 3 percent? (Hint: Use Appendix A.2 or the Garman/Forgue companion website.)

(c) Megan is already looking ahead to graduation and a job, and she wants to buy a new car not long after her graduation. If after graduation she begins an investment program of $2400 per year in an investment yielding 6 percent, what will be the value of the fund after three years? (Hint: Use Appendix A.3 or the Garman/Forgue companion website.)

(d) Megan’s Aunt Karroll told her that she would give Megan $1000 at the end of each year for the next three years to help with her college expenses. Assuming an annual interest rate of 2 percent, what is the present value of that stream of payments? (Hint: Use Appendix A.4 or the Garman/Forgue companion website.)

4. Future Values. Using 
Table 1-1
 on page 19, calculate the following:

(a) The future value of lump-sum investment of $4000 in four years that earns 5 percent.

(b) The future value of $1500 saved each year for three years that earns 6 percent.

(c) A person who invests $1200 each year finds one choice that is expected to pay 3 percent per year and another choice that may pay 5 percent. What is the difference in return if the investment is made for four years?

(d) The amount a person would need to deposit today with a 5 percent interest rate to have $2000 in three years.

DO IT IN CLASS
PAGE 19

5. Using the present and future value tables in Appendix A, the appropriate calculations on the Garman/Forgue companion website, or a financial calculator, calculate the following:

(a) The amount a person would need to deposit today to be able to withdraw $6000 each year for ten years from an account earning 6 percent.

(b) A person is offered a gift of $5000 now or $8000 five years from now. If such funds could be expected to earn 8 percent over the next five years, which is the better choice?

(c) A person wants to have $3000 available to spend on an overseas trip four years from now. If such funds could be expected to earn 7 percent, how much should be invested in a lump sum to realize the $3000 when needed?

(d) A person invests $50,000 in an investment that earns 6 percent. If $6000 is withdrawn each year, how many years will it take for the fund to run out?

6. Inflation. Lauren Simpson’s salary a year ago was $42,000. If inflation during the year was 3.5 percent, how much of a decline in her purchasing power occurred? Also, what would be her purchasing power if deflation of 1 percent occurred?

DO IT IN CLASS
PAGE 13

7. Employee Benefits Decision. Ramon Alvarez signed up for his employer’s cafeteria plan primarily because he can use the money to pay for unreimbursed medical expenses for himself and his disabled son. Ramon is in the 15 percent marginal tax bracket, pays Social Security payroll taxes and pays a 4 percent state income tax rate. How much will he save in income taxes by participating in the program this year in the amount of $3000? How much would Ramon save if he was in the 25 percent federal marginal tax bracket?

DO IT IN CLASS
PAGE 22

8. Use the Rule of 72. Using the rule of 72, calculate how quickly $1000 will double to $2000 at interest rates of 2 percent, 4 percent, 6 percent, 8 percent, and 10 percent.

9. Use the Rule of 72. Based on the Rule of 72 determine how long it would take to double an investment of $5000 if you could invest it at 7 percent. How long would it take to triple the investment?

DO IT IN CLASS
PAGE 21

FINANCIAL PLANNING CASES

CASE 1

Reasons to Study Personal Finance

Samantha Beliveau of DeKalb, Illinois, is a senior in college, majoring in sociology. She anticipates getting married a year or so after graduation. Samantha has only one elective course remaining and is going to choose between an advanced class in sociology and one in personal finance. As Samantha’s friend, you want to persuade her to take personal finance, a course you enjoyed. Give some examples of how Samantha might benefit from the study of personal finance.

CASE 2

A Closer Look at Financial Success

You have been asked to give a brief speech on how to achieve financial success and financial security. Use the five steps in the financial planning process and the building blocks to achieving financial success in your speech.

CASE 3

Julia Price Thinks About the Economy

Throughout this book, we will present a continuing case about Julia Price. Following is a brief description about her. Six years ago, Julia graduated with a degree in aeronautical engineering and went to work as an engineer in Alabama. Last year she moved to Seattle, Washington, to start a job as a mid-level systems engineer on jet aircraft, and some of her design and coordination responsibilities include Department of Defense projects. Julia thinks that the economy is going to get worse in the next 12 to 24 months, perhaps with prices declining (deflation). Offer your opinions about her thinking.

BE YOUR OWN PERSONAL FINANCIAL MANAGER

1. Practice Employment Decisions. Assume you earn $50,000 annually and your employer offers (a) a flexible spending account to which you can contribute a maximum of $3000 this year, and (b) a 401(k) retirement account to which you may also contribute up to $3000. Your 401(k) contribution will be matched 50 percent by your employer. Assuming you can only afford to contribute $3000 to these benefits, explain what you would do with your $3000. Write an explanation of your decision and a table similar to 
Table 1-2
 (on page 24) to support your thinking.

2. Track the Economy. Complete Worksheet 1: Tracking the Economy from “My Personal Financial Planner” to write up your findings on current data as well as your projections one and two years in the future.

3. Future Values of a Lump Sum. Complete Worksheet 2: Calculating the Future Value of a Lump Sum from “My Personal Financial Planner” for the following three questions: (a) $10,000, 2 years, 6%; (b) $22,500, 20 years, 8%; (c) $5000, 10 years, 7%. Fill out the worksheet including the last two columns.

4. Future Value of an Annuity. Complete Worksheet 3: Calculating the Future Value of an Annuity from “My Personal Financial Planner” for the following three questions: (a) $3000 annually, 5 years, 6%; (b) $1000 annually, 20 years, 8%; (c) $5000 annually, 30 years, 7%. Fill out the worksheet including the last two columns.

5. Present Value of a Lump Sum. Complete Worksheet 4: Calculating the Present Value of a Lump Sum from “My Personal Financial Planner” for the following three questions: (a) lump sum needed $10,000, 5 years, 6%; (b) lump sum needed $250,000, 30 years, 8%; (c) lump sum needed $30,000, 10 years, 7%. Fill out the worksheet including the last two columns.

6. Present Value of an Annuity. Complete Worksheet 5: Calculating the Present Value of an Annuity from “My Personal Financial Planner” for the following three questions: (a) withdraw $12,000 annually for 5 years at 6%; (b) withdraw $2000 annually for 15 years at 8%; (c) withdraw $3000 annually for 10 years at 7%. Fill out the worksheet including the last two columns.

ON THE NET

Go to the Web pages indicated to complete these exercises.

1. Inflation. Visit the Bureau of Labor Statistics Consumer Price Index homepage at 

www.bls.gov/cpi/

 and link to information for various areas of the country and metropolitan areas of various sizes. Describe how prices have been changing for your area and community during the past year.

2. Future Direction of the Economy. Visit the Conference Board website, 
www.conference-board.org
 and click on “U.S. Indicators” for the latest information on the consumer confidence index and the index of leading economic indicators. What do the indexes suggest about the direction of the economy over the next six months to one year?

3. Economic Trends. Scan the top four economic trends at the Economic Policy Institute (

www.epi.org/

) for insights on the future of the economy.

4. NAPFA Financial Planners’ Code of Ethics. Visit the website of the National Association of Personal Financial Advisors at 

www.napfa.org/about/FiduciaryOath.asp

. Read through the code of ethics for members of the organization. What does the code tell you about the members?

5. Financial Planning Careers. Visit the website of the Certified Financial Planner Board of Standards at 
www.cfp.net
 and read about “Become a CFPTM Professional.” Summarize your findings.

ACTION INVOLVEMENT PROJECTS

1. Interview a Financial Planner. Use the Internet and/or Yellow Pages to find a fee-only or fee-based financial planner in your community and telephone that person to ask if he/she would agree to an interview. Take the list of questions in the box “Advice from a Professional … Questions to Ask a Financial Planner” on page 28, and use it as an outline for your interview. Ask the professional to pick the three questions that he/she considers the most important. Write a summary of your findings.

2. Smart Money Decisions at Work. Survey three employed relatives or friends to determine whether or not they take advantage of certain employee benefits at work, such as a cafeteria plan, health care plan, high-deductible health care plan, health savings account, flexible spending account, life insurance, and tax-sheltered retirement plan. Make a written summary of your findings.

3. Opportunity and Marginal Costs. Survey three relatives or friends and ask about their decision-making process when they most recently bought a vehicle. Find out if they thought about the opportunity costs when making the purchase. Also ask if they used marginal costs in their thinking. Make a written summary of your findings.

4. Research Future Direction of the Economy. Survey five people to determine their opinions on the direction of the economy over the next 12 months. Even though they may not know the meaning of these exact terms, ask about their perceptions on such indicators as the (a) gross domestic product, (b) consumer confidence, (c) inflation and deflation, (d) interest rates, and (e) federal fund rate. Make a table that summarizes your findings.

Visit the Garman/Forgue companion website at 

www.cengagebrain.com

.

*
 The last budget surpluses in the United States were during the last two years of the Clinton presidency (1999 and 2000). Every year since 1970, Congress has authorized more spending than projected revenue.

*
 This equation shows how the percentage change is calculated for any difference between two measurements. Divide the difference between measurement 1 and measurement 2 by the value of measurement 1. For example, a stock selling for $65 per share on January 1 and for $76 on December 31 of the same year would have risen 16.92 percent during the year: [($76 − $65) ÷ $65 = 0.1692 or 16.92%.]

*
 If you are using a financial calculator for time value of money calculations, see “How to Use a Financial Calculator” on the Gorman/Forgue companion website, or you can use the present and future value calculators also found on the Garman/ Forgue companion website, 
www.cengagebrain.com
.

3 Financial Statements, Tools, and Budgets

YOU MUST BE KIDDING, RIGHT?

The w

or

ld of personal finances is getting more complicated and challenging each year. Recent economic times have been tough with some negative impacts on people’s personal finances. Which one of the following statements is false?

A. Half of Americans have less than one month’s income saved for a rainy day.

B. Half of adults say they do not budget.

C. Sixty percent of Americans say they live paycheck-to-paycheck.

D. Forty percent of Americans say they find it difficult to meet monthly expenses.

The answer is “none of the above” because all the statements are true. Clearly, many Americans are experiencing trouble with their personal finances. You can get smart about personal finances so these statements do not apply to you!

LEARNING OBJECTIVES

After reading this chapter, you should be able to:

 

Identify your financial values, goals, and strategies.

 Use balance sheets and cash-flow statements to measure your financial health and progress.

 

Collect and organize the financial records necessary for managing your personal finances.

 

Achieve your financial goals through budgeting.

WHAT DO YOU RECOMMEND?

Austin and Rachel Patterson, both age 26, have been married for four years and have no children. Austin is a licensed electrician earning $4

6,000

per year, and Rachel earns $4

1,000

annually as a middle-school teacher. Austin would like to go to half time on his job and return to school on a part-time basis; he is one year short of finishing his bachelor’s degree in engineering. His education expenses would be about $20,000 for the year, which could be partially covered by student loans. He has not yet discussed his plans with Rachel.

Austin and Rachel have recently started saving for retirement through their employment and have set aside some savings for emergencies. They have substantial credit card debt and are still paying off their student loans. The couple rents a two-bedroom apartment. Austin always thought it smart to save all of their receipts, bank statements, and other financial documents. His system for organizing their records is very simple; each month he puts everything in a manila envelope and then puts the 12 envelopes into a box at the end of the year.

Austin knows that his educational plans will have financial implications for the couple. He wants to factor these financial issues into his discussion with Rachel about his plans. To this point, they have never developed financial statements or explicit financial goals.

What do you recommend to Austin for his talk with Rachel on the subject of financial planning regarding:

1. Setting financial goals?

2. Determining what they own and owe?

3. Using the information in Austin’s newly prepared financial statements to summarize the family’s financial situation?

4. Evaluating their financial progress?

5. Setting up a record-keeping system to better serve their needs?

6. Starting a budgeting process to guide saving and spending?

Sixty percent of all adults say they do not budget. Four in ten say they are living beyond their means and rate themselves as fair or poor in managing money. A similar percentage say they find it difficult to meet monthly expenses. They live paycheck-to-paycheck, and they often turn to credit cards. They are incompetent in money matters, and their choices will forever make them the “have nots” in society rather than the “haves.” Living above your means can lead to financial ruin at a young age. If you always live below your means, you will always have means. That’s the secret.

To not mess up your financial life you must avoid living paycheck-to-paycheck because this lets your spending dictate your savings. Save first so you can spend later. To succeed you need to follow a spending plan that includes savings, take appropriate actions to achieve results, and regularly measure your financial strength and progress. No matter what your previous financial background, applying the knowledge within this chapter will help you enjoy financial decision making and be successful in managing your money.

What is important is not how much money you have. It is how well you spend your money. At its essence wealth is not measured by how much you make, rather it is how much you hang onto.

3.1 FINANCIAL VALUES, GOALS, AND STRATEGIES

LEARNING OBJECTIVE 1

Identify your financial values, goals, and strategies.

Identifying your financial values and goals sets the stage for financial success. Values and goals help you keep a balance between spending and saving and make you stay committed to your financial plans. Once goals are set, you can develop the strategies necessary for their achievement. Financial planning, which is the process of developing and implementing a coordinated series of financial plans, can help you achieve financial success. By planning your personal finances, you seek to manage your income and wealth so that you reach your financial goals throughout your lifetime.

Figure 3-1

 provides an overview of effective personal financial planning. 

Table 3-1

 illustrates one couple’s (Harry and Belinda Johnson) overall financial plan.

Figure 3-1
 How to Achieve Financial Goals

Table 3-1 Financial Plans, Goals, and Objectives for Harry (Age 23) and Belinda (Age 22) Johnson, Prepared in February 2015

Financial Plan Areas

Long-Term Goals and Objectives

Short-Term Goals and Objectives

FOR SPENDING

Evaluate and plan major purchases

Purchase a new car in two years.

Begin saving $

200

a month for a downpayment for a new car.

Manage debt

Keep installment debt under 10 percent of take-home pay.

Pay off charge cards at the end of each month and do not finance any purchases of appliances or other similar products.

FOR RISK MANAGEMENT

Medical costs

Avoid large medical costs.

Maintain employer-subsidized medical insurance policy by paying $135 monthly premium.

Property and casualty losses

Always have renter’s or homeowner’s insurance.

Always have maximum automobile insurance coverage.

Make semiannual premium payment of $

220

on renter’s insurance policy. Make premium payments of $440 on automobile insurance policy.

Liability losses

Eventually buy $1 million liability insurance.

Rely on $100,000 policy purchased from same source as automobile insurance policy.

Premature death

Have adequate life insurance coverage for both as well as lots of financial investments so the survivor would not have any financial worries.

Maintain employer-subsidized life insurance on Belinda.

Buy some life insurance for Harry.

Start some investments.

Income loss from disability

Buy sufficient disability insurance.

Rely on sick days and seek disability insurance through private insurers.

FOR CAPITAL ACCUMULATION

Tax fund

Have enough money for taxes (but not too much) withheld from monthly salaries by both employers to cover eventual tax liabilities.

Confirm that employer withholding of taxes is sufficient. Have extra money withheld to cover additional tax liability because of income on trust from Harry’s deceased father.

Revolving savings fund

Always have sufficient cash in local accounts to meet monthly and annual anticipated budget expense needs.

Develop cash-flow calendar to ascertain needs. Put money into revolving savings fund to build it up quickly to the proper balance. Keep all funds in interest-earning accounts.

Emergency fund

Build up monetary assets equivalent to three months’ take-home pay.

Put $150 per month into an emergency fund until it totals one month’s take-home pay.

Education

Maintain educational skills and credentials to remain competitive.

Have employer assist in paying for Belinda to earn a master of business administration (MBA).

Have Harry complete a master of fine arts (MFA), possibly a PhD in interior design.

Both take one graduate class per term.

Savings

Always have a nice-size savings balance.

Regularly save to achieve goals.

Save a portion of any extra income or gifts.

Save $26,000 for a down payment on a home to be bought within five years.

Save enough to pay cash for the newest smart phone.

Pay off

Visa credit card

balance of $

3

90

soon.

Begin saving $

400

per month for a down payment on a new home.

Investment

Own substantial shares of a conservative mutual fund that will pay dividends equivalent to about 10 percent of family income at age

45

.

Start investing in a mutual fund before next year.

Retirement

Own some real estate and common stocks. Retire at age 60 or earlier on income that is the same as the take-home pay earned just before retirement.

Establish individual retirement accounts (IRAs) for Harry and Belinda before next year.

Contribute the maximum possible amount to employer-sponsored retirement accounts.

Estate planning

Provide for surviving spouse.

Each spouse makes a will.

YOUR NEXT FIVE YEARS

In the next five years, you can start achieving financial success by doing the following related to financial statements, tools, and budgets:

1. Develop financial goals and update them annually.

2. Develop a cash-flow statement and spending plan every month to ensure that you spend less than you make.

3. Track your net worth and financial ratios annually to assess your financial progress.

4. Use an uncomplicated but effective personal financial record-keeping system.

5. Openly and honestly communicate about money matters with key loved ones on a regular basis.

Such excellent managerial efforts help push them toward achieving financial success. The couple has made plans in 15 specific areas spread across three broad categories: (1) spending, (2) risk management, and (3) capital accumulation. Some people choose not to make a financial plan. The fact is that not having a financial plan is still a plan, it is just a really bad plan.

3.1a

 

Values Define Your Financial Success

Your 

values

 provide the underlying support and rationale for your financial and lifestyle goals. Your values are your fundamental beliefs about what is important, desirable, and worthwhile. They serve as the basis for your goals. All of us differ in the ways we value education, spiritual life, health, employment, credit use, family life, and many other factors. Personal financial goals grow out of these values because we inevitably consider some things more important or desirable than others. We express our values, in part, by the ways we spend, save, invest, and donate our money.

values
Fundamental beliefs about what is important, desirable, and worthwhile.

3.1b

 

“Sacrifice Now or Suffer Later” Is a Key Value

One major benefit of financial planning is using money wisely. People who are smart about personal finance typically value saving some of their income. They adhere to the personal finance philosophy of “Pay myself first.” If you earn money, shouldn’t you be “paid” first? Successful money managers do this instead of spending it all or, even worse, spending even more than they earn by using credit. They establish a current spending level based on the necessities of life. They set aside money for future spending, such as for a vehicle purchase, home, child’s education, vacation home, and living expenses during the years of retirement. They live well while preparing for the future. If you do not save early in life, you definitely will have a lower level of living later.

3.1c

 

Financial Goals Follow from Your Values

Successful financial planning evolves from your financial goals. 

Financial goals

 are the specific long-, intermediate-, and short-term objectives to be attained through financial planning and management efforts. Financial and lifestyle goals should be consistent with your values. To serve as a rational basis for financial actions, they must be stated explicitly in terms of purpose, dollar amounts, and the projected dates by which they are to be achieved.

financial goals
Specific objectives addressed by planning and managing finances.

Set Specific Goals Setting goals helps you visualize the gap between your current financial status and where you want to be in the future. Make a list of your goals. Examples of general financial goals include finishing a college education, paying off credit card debts, repaying education loans, meeting financial emergencies, taking a vacation, owning a home, accumulating funds to send children through college, owning your own business, creating peace of mind, ensuring family harmony, and having financial independence at retirement.

The path toward turning a wish into reality begins with writing it down. If buying a condo is your goal, tape a photograph of a beautiful one onto your refrigerator. Then tell others about your financial goal. The public affirmations and constant reminders will help you make it into a reality.

Put Target Dates on Your Financial Goals Setting target dates for financial goals is important for success. Consider the example of Stephanie Vogel, a dance instructor from Champaign, Illinois. Stephanie has just made the last $347 payment on her four-year car loan. She does not like being in debt, so she does not want to take out such a large loan again. Stephanie would like to put at least part of the money she has been paying monthly for the loan into a savings account, which would allow her to replace her current vehicle in four or five years. Stephanie figures that it would take about $22,

500

to buy a similar inexpensive high-mileage used vehicle in five years. She assumes she could earn a 2 percent return on her savings and, using 

Appendix A.3

, has determined that she would need to save $4323 per year ($22,500 ÷ 5.2040 for five years at 2 percent interest), or roughly $

360

per month.

Stephanie’s thinking offers a good example of how proper financial goal setting works. She recognized the value she put on staying out of debt and proceeded to the general goal of trying to pay cash for her next car. After determining an overall dollar amount needed, she broke that amount down into first annual and then monthly amounts. For only $13 more per month than she has been paying on her loan ($360−$347), Stephanie will be able to pay cash for her next car. This is the sacrifice she is willing to make to avoid using credit to buy a vehicle in the future.

Prioritize Your Goals Once your financial goals are clearly identified, you can decide which are the most important. You simply prioritize the list by making trade-off decisions on what you can do with your finances in the near term as well as in the more distant future.

3.1d

 

Financial Goals Require Wealth-Building Principles

Following are several wealth-building principles that may help you achieve your financial goals:

1. Set clear financial goals both in the short and long term.

2. Save by paying yourself first out of your paycheck.

3. Pay credit card balances in full each month.

4. Spend less than you earn.

5. Participate in the retirement plan at work.

6. Take full advantage of your employer’s match on retirement savings.

7. Buy a home for the tax advantages.

8. Pay off your home before retirement.

9. Be patient when investing for the long term.

10. Live every day knowing that your financial future is under control.

3.1e

 

Financial Strategies Guide Your Financial Success

Financial strategies

 are pre-established plans of action to be implemented in specific situations. Stephanie Vogel implemented an effective strategy in the preceding example. That is, when a loan has been repaid, start a savings program with the same monthly payment amount. Saving may be easier for Stephanie if she arranges for the amount she would like to save to be automatically deposited from her paycheck into her savings account. Another useful savings strategy is to arrange for as much as 75 percent of any raises or bonuses to go into savings before you become accustomed to the additional income.

financial strategies
Pre-established action plans implemented in specific situations.

 CONCEPT CHECK 3.1

1. Summarize the financial planning process.

2. Explain the relationships among financial values, goals, and strategies.

3.2 FINANCIAL STATEMENTS MEASURE YOUR FINANCIAL HEALTH AND PROGRESS

LEARNING OBJECTIVE 2

Use balance sheets and cashflow statements to measure your financial health and progress.

Financial statements

 are compilations of personal financial data that describe an individual’s or family’s current financial condition. They present a summary of assets and liabilities as well as income and spending of an individual or family. The two most useful statements are the balance sheet and the cash-flow statement.

financial statements
Snapshots that describe an individual’s or family’s current financial condition.

DID YOU KNOW

 

Money Topics to Discuss with Your Partner

When you find the right partner, it is smart to do the following:

• Change beneficiaries. Life insurance policies, mutual fund accounts, and retirement accounts all have beneficiaries (the people who will receive the funds at your death) named when you set them up. (See chapters 12, 15, and 17.)

• Coordinate employee benefits. Couples often have two incomes today, so each has a menu of employee benefits from which to choose. As a result, one spouse may drop a benefit that is being received via the other’s plan. (See chapter 1.)

• Update life insurance coverage. Focus on term life insurance for the bulk of your needs. (See chapter 12.)

• Review auto and homeowner’s insurance coverages. Also inventory your personal property. (See chapter 10.)

• Update names with government agencies. If one or both partners’ names are changed as a result of your new status, you need to notify the Social Security Administration and driver’s licensing office of that change. You will need to show your marriage certificate as proof of the change.

• Close redundant bank accounts. Reducing the number of accounts that each partner brings into the marriage can save money on account fees. Decide which accounts are “yours, mine, or ours.” (See chapters 5 and 6 for more on managing accounts.)

• Get out of debt. One or both of you may bring debts into the new family. Because a couple can live together a little more cheaply than two individuals who live apart, funds can be freed up to pay off credit cards, student loans, and other borrowing. (See chapters 6, 7, and 9.)

• Decide on how to manage money. Decide on who pays what bills and makes investment decisions. Decide on whether or not each person will have individual control over certain money. Decide on who pays for the debt that precedes the relationship. Decide on who pays for gift giving. Decide on what money tasks you will do together, such as establishing annual financial goals, making purchases with debt, and agreeing on which expenditures require joint agreement, like an expense over $

300

. (See chapter 5 for how to effectively discuss money matters.)

• Save for retirement separately. Day-to-day living expenses will go down somewhat when you team up as a couple. use some of that money to allocate additional amounts to your individual retirement plans. (See chapter 17.)

• Update estate transfer plans. With a new “number one” in your life, you should change (or set up) your will, durable power of attorney, living will, and health care proxy. (See chapter 11.)

A 

balance sheet

 (or 

net worth statement

) describes an individual’s or family’s financial condition on a specified date (often January 1) by showing assets, liabilities, and net worth. It provides a current status report and includes information on what you own, what you owe, and what the net result would be if you paid off all of your debts. It answers the question, “Where are you financially right now?”

balance sheet or net worth statement
Snapshot of assets, liabilities, and net worth on a particular date.

A 

cash-flow statement

 (or 

income and expense statement

) lists and summarizes income and expense transactions that have taken place over a specific period of time, such as a month or a year. It tells you where your money came from and where it went. It answers the question, “Where did your money go?”

cash-flow statement or income and expense statement
Summary of all income and expense transactions over a specific time period.

3.2a

 

The Balance Sheet Is a Snapshot of Your Financial Status Right Now

To benchmark where you are on the wealth-building scale, determine your net worth. If you are indeed serious about your financial success, then you will sit down soon with pencil and paper or at your computer to see exactly where you stand. You do so by preparing your balance sheet, which summarizes the value of what you own minus what you owe. Your balance sheet should be updated at least once each year and compared to previous ones, so save all your old financial statements. Then you can assess your progress over the years. Net worth grows slowly, but it definitely increases over time. If you are successful in your career and follow the basic principles outlined in this book, there is no reason why you cannot have a net worth of $1 million, or $2 million or more, later in your life. Net worth typically peaks for people in their 50s or 60s (see 

Figure 3-2

 on page 73) and declines thereafter as one lives off their financial nest egg in retirement.

Components of the Balance Sheet A balance sheet consists of three parts: assets, liabilities, and net worth. Your 

assets

 include everything you own that has monetary value. Your 

liabilities

 are your debts—amounts you owe to others. Your 

net worth

 is the dollar amount left when what is owed is subtracted from the dollar value of what is owned—that is, if all the assets were sold at the listed values and all debts were paid in full. Your net worth is the true measure of your financial wealth.

assets
Everything you own that has monetary value.

liabilities
What you owe.

net worth
What’s left when you subtract liabilities from assets.

What Is Owned—Assets Are “The Things You Own.” The assets section of the balance sheet lists items valued at their fair market value—what a willing buyer would pay a willing seller, not the amount originally paid or what it might be worth a year from now. It is useful to classify assets as monetary, tangible, or investment assets.

Monetary assets

 (also known as 

liquid assets

 or 

cash equivalents

) include cash and low-risk near-cash items that can be readily converted to cash with little or no loss in value such as checking and savings accounts. They are primarily used for maintenance of living expenses, emergencies, savings, and payment of bills.

monetary assets/liquid assets/cash equivalents
Assets that can be used as cash.

Tangible

 (or 

use

 or 

lifestyle

) assets are personal property whose primary purpose is to provide maintenance of one’s everyday lifestyle. Tangible assets, such as furniture and vehicles, generally depreciate in value over time.

tangible/use/lifestyle assets

Personal property

used to maintain your everyday lifestyle.

Investment assets

 (also known as 

capital assets

) include tangible and intangible items that have a relatively long life and high cost and that are acquired for the monetary benefits they provide, such as generating additional income and appreciation (or increasing in value). Examples include stocks and bonds. Investment assets generally appreciate and are dedicated to the maintenance of one’s future level of living.

investment/capital assets
Tangible and intangible items acquired for their monetary benefits.

Following are some examples of each kind of asset.

Monetary Assets

• Cash (including

cash on hand

, checking accounts, savings accounts, savings bonds, certificates of deposit, and money market accounts)

• 

Tax refunds

due

• Money owed to you by others

Tangible Assets

• 

Automobile

s, motorcycles, boats, bicycles

• House, condominium, mobile home

• Household furnishings and appliances

• Personal property (jewelry, furs, tools, clothing)

• Other “big ticket” items

Investment Assets

• Stocks, bonds, mutual funds, gold, partnerships, art, IRAs

• Life insurance and annuities (cash values only)

• Real property (and anything fixed to it)

• Personal and employer-provided retirement accounts

What Is Owed—Liabilities Are “The Money You Owe”The liabilities section of the balance sheet summarizes debts owed, including both personal and business-related debts. The debt could be either a 

short-term

 (or 

current

) 

liability

, an obligation to be paid off within one year, or a 

long-term

 (or 

noncurrent

) liability, debts that do not have to be paid in full until more than a year from now. To be accurate, record debt obligations at their current payoff amounts (excluding future interest payments). Following are some examples of items to include in the liabilities section of a balance sheet, with some suggested subheadings.

short-term (current) liability
Obligation paid off within one year.

long-term (noncurrent) liability
Debt that comes due in more than one year.

Short-Term (or Current) Liabilities

• Personal loans owed to other people

• 

Credit

card and charge account balances

• Other open-end credit obligations

• Professional services unpaid (doctors, dentists, chiropractors, lawyers)

• 

Taxes

unpaid

• Past-due rent, utility bills, and insurance premiums

Long-Term Liabilities

• Automobile loans

• Real estate mortgages

• Home equity (second mortgage) loan

• Consumer installment loans and leases (although a lease is technically not a debt)

• Education loans

• Margin loans on securities

DO IT IN CLASS

Net Worth

—What Is Left Is “A Measure of Your Financial Worth” Net worth is determined by subtracting liabilities from assets, as indicated in (Equation 3.1) the net worth formula:

or

This formula assumes that if you converted all assets to cash and paid off all liabilities, the remaining cash would be your net worth. For example, if your items of value had a fair market value of $8000 and the amount you owe to others is $

450

0, your net worth, or wealth, is $

350

0($8000-$4500). 
Figure 3-2
 shows household net worth figures by age group. College students typically have more debts than assets; thus they are technically 
insolvent
 because they have a negative net worth. When students graduate and take on full-time jobs, typically their balance sheets change dramatically after a few years.

insolvent
When a person owes more than he or she owns and the person has a negative net worth.

Sample Balance Sheet The total assets on a balance sheet must equal the total liabilities plus the net worth. Both sides must balance, which is the source of the name “balance sheet.” You decide how much detail to include to show your financial condition accurately on a given date. The balance sheet shown in 

Table 3-2

 (page 74) reflects the degree of detail and complexity that might be included for a couple with two children (Victor and Maria Hernandez).

3.2b

 

Strategies to Increase Your Net Worth

You can increase your net worth by increasing assets, decreasing liabilities, or doing both. One way to increase assets and net worth is to cut back on spending. Perhaps consider forgoing the cup of coffee or soda you buy each day as you head to class, as any decrease in spending leaves money in the bank as an asset ($5 day × 200 days = $1000). Reducing expenses on high-cost items, such as housing and transportation, will have an even greater effect on assets. A second way to increase net worth is to increase income to build assets or pay down debts. For example, as you earn more money, perhaps consider saving half or more of the difference between your new income and your old income rather than using the added money for more spending. Third, paying off debt, especially high-interest credit card balances, can quickly increase net worth.

Figure 3-2
 Median Net Worth by Age

3.2c

 

The Cash-Flow Statement Tracks Where Your Money Came From and Went

The cash-flow (or income and expense) statement summarizes the total amounts that have been received and spent over a period of time, usually one month or one year. It shows whether you were able to live within your income during that time period. It reflects the flow of funds in and out.

A cash-flow statement includes three sections: income (total income received); 

expenses

 (total expenditures made); and 

surplus

 (or 

net gain

 or 

net income

), when total income exceeds total expenses, or deficit (or net loss), when expenses exceed income. Such statements are usually prepared on a 
cash basis
,

*

 meaning the only transactions recorded are those involving actual cash received or cash that was spent.

expenses
Total expenditures made in a specified time such as reported on a cash-flow statement.

surplus (or net gain or net income)
When total income exceeds total expenses such as reported on a cashflow statement.

cash basis
Only transactions involving actual cash received or cash spent are recorded.

Income/Cash Coming In: Where Your Money Comes From You may think of income as simply what is earned from salaries or wages, but there are other types of income that you should include on a cash-flow statement, such as the following:

• 

Bonus

es and commissions

• Child support and alimony

• Public assistance

• Social Security benefits

FINANCIAL POWER POINT

 

Income Does Not Create Wealth,

Investments

Do

People do not get wealthy by earning an income. Real wealth comes from increases in the value of assets over time such as the growth of investments within a 401(k) retirement program.

Table 3-2 Balance Sheet for a Couple with Two Children—Victor and Maria Hernandez, January 1, 2015

DO IT IN CLASS

• Pension and profit-sharing income

• Scholarships and grants

• 

Interest and dividends

received (from savings accounts, investments, bonds, or loans to others)

• Income from the sale of assets

• Other income (gifts, tax refunds, rent, royalties, capital gains)

Expenses/Cash Going Out: Where Your Money Goes All expenditures made during the period covered by the cash-flow statement should be included in the expenses section. The number and type of expenses shown will vary for each individual and family. Many people categorize expenses according to whether they are fixed or variable.

Fixed expenses

 are usually paid in the same amount during each time period; they are typically inflexible and often contractual. Examples of such expenses include rent payments and automobile installment loans. It usually takes quite an effort to reduce a fixed expense.

fixed expenses
Expenses that recur at fixed intervals.

Variable expenses

 (or 

flexible expenses

) are expenditures over which an individual has considerable control.

Food

, entertainment, and clothing are variable expenses, for example. Some categories, such as savings, can be listed twice, as both fixed and variable expenses. The following are examples of fixed and variable expenses that you might include in a cash-flow statement:

variable expenses (or flexible expenses)
Expenses over which you have substantial control.

Fixed Expenses

• Savings and investments

• Retirement contributions (employer’s plan, IRA)

• Housing (rent, mortgage, loan payment)

• Automobile (installment payment, lease)

• 

Insurance

(health, life, liability, disability, renter’s, homeowner’s, automobile)

• Installment loan payments (appliances, furniture)

• Internet service

• Taxes (federal income, state income, local income, real estate, Social Security, Medicare, personal property)

Variable Expenses

• Meals (at home and away)

• 

Utilities

(cell phone, electricity, water, gas)

• Transportation (gasoline and maintenance, licenses, registration, public transportation, tolls)

• 

Medical expenses

• 

Child care

(nursery, baby-sitting)

• Clothing and accessories (jewelry, shoes, handbags)

• Snacks (candy, soft drinks, other beverages)

• Education (tuition, fees, books, supplies)

• Household furnishings (furniture, appliances, curtains)

• 

Cable

television (beyond basic services)

• 

Personal care

(beauty shop, barbershop, cosmetics, dry cleaner)

• 

Entertainment

and recreation (hobbies, socializing, health club, downloads/tapes/CDs, movie rentals, movies)

• Charitable contributions (gifts, church, school, charities)

• Magazine subscriptions

• Vacations and long weekends

• Credit card payments

• Savings and investments

• 

Miscellaneous

(postage, books, magazines, newspapers, personal allowances, domestic help, membership fees)

There is no rigid list of categories to be used in the expenses section, but you do need to classify all of your expenditures in some way that suits your needs. Rather than just use fixed and variable expenses categories, you might also separate expenditures into savings/investments, debts, insurance, taxes, and household expenses. The more specific your categories, the deeper your understanding of your outlays.

When reducing variable expenses, cut back or eliminate overpriced items like café’ lattes and make bigger budget cuts elsewhere.

DID YOU KNOW
 

Money Websites for Financial Statements, Tools, and Budgets

Informative websites for financial statements, tools, and budgets, including managing your spending are:

Buxfer (

www.buxfer.com/

)

CNNMoney (

money.cnn.com/pf/

)

HelloWalle (

www.hellowallet.com

)

LearnVest (

www.learnvest.com

)

Manilla (

www.manilla.com

)

Mint (

www.mint.com

)

Mvelopes (

www.mvelopes

)

Pageonce (

check.me/

)

Cash Surplus (or Cash Deficit) The surplus (deficit) section shows the amount of cash remaining after you have itemized income and subtracted expenditures from income, as illustrated by the following calculations using Equation (3.2), the surplus/deficit formula. A business would call this amount its net profit or net loss.

A surplus demonstrates that you are managing your financial resources successfully and do not have to use savings or borrow money to make financial ends meet. When the calculation shows a surplus, that amount is then available (in your checking and savings accounts) to spend, save, invest, or donate. A surplus is not really cash lying around on the kitchen table; it is the cash value reflected in the accounts on your balance sheet. 

Figure 3-3

 shows the typical personal financial situation over the life cycle in present value dollars, from the wealth accumulation years through retirement.

Sample Cash-Flow Statements 

Table 3-3

 shows the cash-flow statement for a couple with two children (Victor and Maria Hernandez). It vividly highlights the additional income needed to rear children and shows the increased variety of expenditures that characterize a family’s (rather than an individual’s) lifestyle. As a person earns more income, the cash-flow statement usually becomes more involved and detailed.

DO IT IN CLASS

Figure 3-3
 Personal Finance over the Life Cycle

Table 3-3 Cash Flow Statement for a Couple with Two Children—Victor and Maria Hernandez, January 1-December 31, 2015

1,200

1.35%

2,400

2.70%

Revolving savings fund

1,800

2.02%

2,400

2.70%

2,400

2.70%

100.00%

		Dollars			Percent
	INCOME
Victor’s gross salary	63,180	70.99%
Maria’s gross salary	15,500	17.42%
Interest and dividends			1,800		2.02%
Bonus			600	0.67%
Tax refunds	200	0.22%
Net rental income	7, 720	8.67%
	Total Income	89,000					10 0.00%
	EXPENDITURES
	Fixed Expenses
Mortgage loan payments	1 4,400	16.18%
Real estate taxes				2,400				2.70%
Homeowner’s insurance							1,200		1.35%
	Automobile loan payments	4,400	4.94%
Automobile insurance and registration	2,190	2.46%
Life insurance premiums
Medical insurance (employee portion)		2,980	3.35%
Emergency fund savings
Federal income taxes	1 1,300	12.70%
State income taxes	4,200	4.72%
City income taxes		1,600	1.80%
Social Security taxes	6,020	6.76%
Personal property taxes	950	1.07%
Retirement IRAs	6,000	6.74%
	Total Fixed Expenses	$63,040	70.83%
	Variable Expenses
	Food	4,900	5.51%
		Utilities	2,100	2.36%
	Gasoline and maintenance	3,100	3.48%
Medical expenses	3,400	3.82%
	Medicines	1, 750	1.97%
	Clothing and upkeep	1,950	2.19%
Church
		Gifts	1,400	1.57%
	Personal allowances
Children’s allowances	2,080	2.34%
		Miscellaneous			480	0.54%
	Total Variable Expenses	$25, 960	29.17%
	Total Expenses	$89,000
	SURPLUS (DEFICIT)	$0	0.00%

 CONCEPT CHECK 3.2

1. Distinguish between the balance sheet and cash-flow statement.

2. How should assets and liabilities be valued for the balance sheet?

3. Distinguish between fixed and variable expenses.

DID YOU KNOW
 

Ratios for Evaluating One’s Financial Progress

Financial ratios

 are numerical calculations designed to simplify the process of evaluating your financial strength and the progress of your financial condition. Ratios serve as tools or yardsticks to develop saving, spending, and credit-use patterns consistent with your goals. They are illustrated below using data from the Hernandez family shown in 
Table 3-2
 and 
Table 3-3
. calculators for these ratios can be found on the 
Garman/Forgue
 companion website.

financial ratios
Calculations designed to simplify evaluation of financial strength and progress.

DO IT IN CLASS

3.3 COLLECT AND ORGANIZE YOUR FINANCIAL RECORDS TO SAVE TIME AND MONEY

LEARNING OBJECTIVE 3

Collect and organize the financial records necessary for managing your personal finances.

Financial records

 are documents that evidence financial transactions, such as bills, receipts, credit card receipts and statements, bank records, tax returns, brokerage statements, and paycheck stubs. Your financial records will help determine where you are, where you have been, and where you are going financially. They also help you save money as well as make money. Good records enable you to review the results of financial transactions as well as permit other family members to find them in an emergency. Organized records help you take advantage of all available tax deductions when filing income taxes and provide you with more dollars to spend, save, invest, or donate.

financial records
Documents that evidence financial transactions.

Table 3-4

 shows categories of financial records and the contents that might be included in each. Many people keep duplicates of important records in an envelope at their workplace or with relatives because the likelihood of records at both locations being stolen or destroyed simultaneously is very small. You can purge or shred some of your records when you no longer need them, such as non-tax-related checks and credit card receipts more than a year old, out-of-date warranties, expired insurance policies for which there will be no claims, records from automobiles you no longer own, and financial reports when replaced with updated reports.

Some records may be safely stored at home in a fire-resistant file cabinet or a safe. Other records should be kept in a safe-deposit box. Safe-deposit boxes are secured lock boxes available for rent ($25 to $250 per year) in banks. Two keys are used to open such a box. The customer keeps one key, and the bank holds the other.

FINANCIAL POWER POINT
 

Before You Buy, Ask Yourself These Questions

If you want to save $1,000 this year, ask yourself these questions before you buy!

ADVICE FROM A PROFESSIONAL

Get-Tough Ways to Cut Spending

If you always run out of money before the month is over, you may need to take some drastic steps to get your finances under control. Consider the following:

1. Stop paying bank fees by maintaining minimum balances and eliminating overdrafts.

2. Stop making ATM withdrawals that assess fees.

3. Stop getting cash back from debit or credit card purchases to use for pocket money.

4. Spend only cash or money that you have, and leave debit and credit cards at home.

5. Stop using credit cards.

6. Refinance credit card debt at a credit union.

7. Do not eat out.

8. Cut back on telephone use if it costs money.

9. Avoid paying for entertainment; rather do activities that are free.

10. Reduce or stop spending on luxuries such as clothing, movies, entertainment, memberships, hobbies, CDs, DVDs, phones, and expanded cable channels.

11. Drop landline telephone service and use only a cell phone.

12. Find cheaper auto insurance.

13. Increase your 401(k) retirement contribution as it reduces income taxes.

14. Change income tax withholding to increase take-home pay.

15. Take a list when shopping, and stick to it.

16. Avoid shopping malls and discount stores.

17. Sell an asset, especially one that requires additional expenses, such as a boat or second car.

18. Build up an emergency fund of savings even if it means temporarily decreasing retirement-plan contributions.

19. Only buy used items.

20. Consider making Christmas a “nonspend” holiday.

21.ve to lower-cost housing.

22. Increase income by working overtime or finding a second job.

Alena C. Johnson

Utah State University

Table 3-4 Financial Records: What to Keep and Where

Contents
Category	In Home Files and Fireproof Home Safe	In Safe-Deposit Box
Financial plans/ budgeting	Financial plans Balance sheets and cash-flow statements Current budget List of safe-deposit box contents Names and contact information for financial advisers	Names and contact information for financial advisers copy of written financial plans, goals, and budgets
Career and employment	Current resume College transcripts Letters of recommendation Employee benefits descriptions Written career plans	Employer retirement plan correspondence
Banking and financial services	Checkbook, unused checks, and canceled checks List of locations and account numbers for all bank accounts Checking and savings account statements Locations and access numbers for safe-deposit boxes Account transaction receipts	List of financial institutions and account numbers for all financial services accounts Certificates of deposit
	Taxes	Copies of all income tax returns, both state and federal, for the past three years, including all supporting documentation Receipts for all donations of cash or property Log of volunteer expenses Receipts for property taxes paid	Copies of all income tax filings, both state and federal, for the past three years Records of securities purchased and sold
Credit	Utility and telephone bills Monthly credit card statements Receipts of credit payments List of credit accounts and telephone numbers to report lost/stolen cards Unused credit cards Credit reports and scores	List of credit accounts and telephone numbers to report lost/stolen cards Loan discharge notice when it is paid off Credit card bills for seven years if they support tax deductions
Housing, vehicles, and consumer purchases	Copies of legal documents (leases, mortgage, deeds, titles) Property appraisals and inspection reports Home repair/home improvement receipts Warranties Owner’s manuals for purchases Auto registration records Vehicle service and repair receipts Receipts for important purchases	Original legal documents (leases, mortgage, deeds, titles) Copies of property appraisals Vehicle purchase contracts (until vehicle is sold) Photographs or videos of valuable possessions
Insurance	Original insurance policies List of insurance policies with premium amounts and due dates Premium payment receipts Calculation of life insurance needs Insurance claims forms and reports Medical records for family, including immunization records and list of prescription drugs	List of all insurance policies with company and agent names and addresses and policy numbers Listing with photographs or videotape of personal property
Investments	Records of stock, bond, and mutual fund transactions and certificate numbers Mutual fund statements Statements from brokers Reports from financial planner Company annual reports Retirement plan quarterly and annual reports Documents on business interests Written investment philosophy Written investment strategies	Contact information for all investment needs Stock and bond certificates Rare coins, stamps, and other collectibles
Retirement and Estate Planning	Pension and retirement plan information Retirement statements Copies of all retirement plan transactions Copy of Social Security card Trust agreements Information on Social Security Copy of current will Copies of advance directives (wills, living wills, medical powers of attorney, durable powers of attorney with originals with physician/attorney) Copies of trust documents (originals with executor, trustees/attorney)	Extra copy of all retirement plan transactions and statements Social Security statements (newest one) Copy of will (original of all estate planning documents should be placed in attorney’s office)
Personal information	Copy of birth certificate and marriage license Religious documents Copy of divorce decree, property settlement, and custody agreement Receipts for alimony and child support payments Custodial information for your children, relatives, and/or elderly parent	Passports while not being used Military and adoption papers Originals of birth, marriage, death certificates Originals of Social Security cards Originals of divorce decrees, property settlements, and custody agreements Master list of all important documents and their location Flash drive or cD containing soft copies of many financial records (update once a year)

 CONCEPT CHECK 3.3

1. List some advantages of keeping good financial records.

2. Name three financial records that might be best kept in a safe-deposit box.

3.4 REACHING YOUR GOALS THROUGH BUDGETING: YOUR SPENDING/SAVINGS ACTION PLAN

LEARNING OBJECTIVE 4

Achieve your financial goals through budgeting.

Your financial success is largely a matter of choice, not a matter of chance. Your budget is where you make and implement those choices. Your budget is your plan for spending and saving. Budgeting forces you to consider what is important in your life, what things you want to own, how you want to live, what it will take to do that, and, more generally, what you want to achieve in life. The budgeting process gives you control over your finances, and it empowers you to achieve your financial goals while simultaneously (and successfully) confronting any unforeseen events. In short, budgeting answers the question, “What is my spending/savings action plan?” Another advantage of budgeting is that it reduces stress because making and following a budget helps you get more of what you want.

Some people do all their budgeting mentally—and do so successfully. Good for them! Many of us, however, need to see the actual numbers on paper or on a computer screen. A 

budget

 is a paper or electronic document used to record both planned and actual income and expenditures over a period of time. Your budget represents the major mechanism through which your financial plans are carried out and goals are achieved.

budget
Paper or electronic document used to record both planned and actual income and expenditures over a period of time.

Figure 3-4

 illustrates how to think about financial statements and budgeting. The cash-flow statement focuses on 
where you have been
 financially, the balance sheet shows 
where you are
 financially at the current time, and the budget indicates 
where you want to go
 in the future. Creating and following a spending plan has three stages: before, during, and after.

3.4a Action Before: Set Financial Goals

Before establishing your budget, take action to set financial goals. 

Long-term goals

 are financial targets or ends that an individual or family wants to achieve perhaps more than five years in the future. Such goals provide direction for overall financial planning as well as shorter-term budgeting. An example of a long-term goal is to create a $1 million retirement fund by age 60. Goals must be specific. They should contain dollar-amount targets and specific dates for achievement.

long-term goals
Financial targets to achieve more than five years in the future.

If you have a small income or large debts, it may be unrealistic to think of long-term goals until any current financial difficulties are resolved. You may be unable to do much more than take care of immediate necessities, such as housing and vehicle expenses, food, and utility bills. In such instances, you need to focus on short-term efforts to improve your financial situation. You may need to focus on paying down debt, not adding to it.

Figure 3-4
 About Financial Statements and Budgets

FINANCIAL POWER POINT
 

Savings Is The Secret to Success in Personal Finance

If you have some money in emergency savings, perhaps $500 or $2000, depending upon your income, you probably will always have enough money to pay for vehicle repairs and unexpected travel. Thus, you may not have to pay with plastic for things that are not in your budget. Only one-fourth of people have six months or more of savings; another one-fourth have zero, and fully one-half have less than one month’s income saved for a rainy day.

Establishing unrealistic short-term goals sets up a high likelihood of failure. Instead, set financial targets that are almost too easy to meet. For example, you may want to save $350 per month to use as a down payment on a home in five years. That may seem like a lot. Start perhaps painlessly by saving $100 per month for a few months. Then put away $150 for two months, $200 for two months, then $250, then $300, and finally $350 so that by the end of the first year you are on target.

Intermediate-term goals

 are financial targets that can be achieved between one year and perhaps three to five years. Examples of intermediate -term goals are creating an emergency fund amounting to three months of income within four years, saving $22,500 within three years for a down payment on a home, taking a $4000 vacation to Asia in two years, paying off $8000 in credit card debt in one-and-a-half years, and paying off a

$12,000

college loan in five years. 

Short-term goals

 are financial targets or ends that can be achieved in less than a year, such as finishing college, paying off an auto loan, increasing savings, purchasing assets (i.e., vehicle, furniture, television, stereo, clothes), reducing high-interest debt, taking an annual vacation, attending a wedding, buying life insurance, and making plans for retirement.

intermediate-term goals
Financial targets that can be achieved within one to five years.

short-term goals
Financial targets or ends that can be achieved in less than a year.

You need to be as clear as possible about what your financial goals are. The goals worksheet in 

Figure 3-5

 provides examples of how much to save to reach long-, intermediate-, and short-term goals. People can view such savings as a fixed expenditure (such as withholding from a paycheck to contribute to an employer’s retirement plan or to transfer to a savings account). Additional savings, such as saving what is left over after all expenditures are made, will be a variable expense.

Prioritizing your goals makes sense. But what are your most important goals? One certain priority should be to pay off high-interest credit cards as soon as possible because paying 18 percent interest is foolish. Another is to contribute as much as you can afford to a retirement plan at least up until you receive the employer’s full matching contribution. Many college graduates buy a new car soon after getting their first job to celebrate having “made it.” Before you’re lured into following suit, give careful consideration to your priorities and remember that every action carries not only the dollar cost of the action taken but also the opportunity cost of the alternatives forgone. To achieve your long-term goals, you may have to sacrifice by deferring some of your short-term desires. Thus, you might consider buying a used car or a lower-cost new one.

3.4b Action Before: Make and Reconcile Budget Estimates

Before the month begins, you identify how you are spending money now in the process of making and reconciling budget estimates of income and expenditures. Here you resolve conflicting needs and wants by revising estimates as necessary. You can’t have everything in life—especially this month—even though you might want it.

Budget Estimates Gets You from Gross Income to What’s Available for Variable Expenses 

Budget estimates

 are the projected dollar amounts in a budget that one plans to receive or spend during the period covered by the budget. Begin by estimating total gross income from all sources. For example, Jonathan Depp’s annual gross income is $60,000. Typical withholdings from your paycheck and noted as percentages of gross income are: federal income taxes (12%), Social Security taxes (7%), state income taxes (6%), employer retirement plan (6%), health insurance premiums (10%), and Roth IRA (5%). This totals 46% leaving Jonathan with 54% in 

take-home pay

 (also called 

disposable income

). This is the pay received after employer withholdings for such things as taxes, insurance, and union dues, and it is available for budgeting for spending, saving, investing, and donating.

budget estimates
Projected dollar amounts to receive or spend in a budgeting period.

take-home pay/disposable income
Pay received after employer with-holdings for such things as taxes, insurance, and union dues, and it is available for budgeting for spending, saving, investing, and donating.

Figure 3-5
 Goals Worksheet for Harry and Belinda Johnson

Now Jonathan subtracts money for fixed expenses, such as rent (4%), emergency savings (2%), student loans (2%), auto loan (1%), and auto insurance (1%). This totals (10%) for 

discretionary

 or controllable expenses, which make up the bulk of money available to pay for one’s various expenses. After paying his fixed expenses Jonathan has 44% of his pay left to spend (100%−46%−10%) for such variable items as food, electricity, Internet, cable television, phone, gasoline and maintenance, church and charity, entertainment, and miscellaneous.

discretionary income
Money left over after necessities such as housing and food are paid for.

Table 3-5

 presents budget estimates for a college student, a single working person, a young married couple, a married couple with two young children, and a married couple with two college-age children. The college student’s budget requires monthly withdrawals of previously deposited savings to make ends meet. The single working person’s budget allows for an automobile loan, but not much else. The young married couple’s budget permits one automobile loan, an investment program, contributions to retirement accounts, and significant spending on food and entertainment. The budget of the married couple with two young children allows for only an inexpensive automobile loan payment even though one spouse has a part-time job to help with the finances.

Table 3-5 Sample Monthly Budgets for Various Family Units

DID YOU KNOW
 

Bias Toward Putting Off Decisions

People engaged in financial statements, tools, and budgets have a bias toward certain behaviors that can be harmful, such as a tendency toward putting off difficult decisions. People often delay reducing their spending even to save for worthy causes like vacations, putting money into a college fund, or contributing to a retirement account. What to do? Reject this tendency and take timely action to save and achieve what is important to you.

The budget of the married couple with two college-age children permits a home mortgage payment, ownership of two paid-for automobiles, savings and investment programs, and a substantial contribution for future college expenses.

It is essential to make reasonable budget estimates. If you have seven holiday gifts to buy and expect to spend $50 for each, it’s easy to make an estimate of $350. If you want to go out to dinner once each week with a friend at $60 per meal, estimate an expense of $

24

0 per month. Avoid using unrealistically low figures by simply being fair and honest in your estimates. Then add up your totals.

Revise Budget Estimates to Create a “Balanced Budget” When trying to make your spending conform to your budget goals, sometimes you will find the math is alarming! When initial expense estimates exceed income estimates, three choices are available: (1) earn more income, (2) cut back on expenses, or (3) try a combination of more income and fewer expenses. The process of reconciling needs and wants is a healthy exercise. It helps identify your priorities by telling you what is important in your life at the current time, and it identifies areas of sacrifice that you might make. Revising your short-term financial goals may also be required.

FINANCIAL POWER POINT
 

Cut the Dollars and the Pennies

If you are often spending $5 per day (rather than $1.50) on fancy coffee, you end up spending $

700

more per year ($5 − $1.50 = $3.50 × 200 workdays). So, when reducing variable expenses, cut back or eliminate things like café lattes, overpriced vitamin water, and energy drinks, and make bigger budget cuts elsewhere, like housing, care, preschool, health care, and frequent treats.

You must reconcile conflicting wants to revise your budget until total expenses do not exceed income. You have no choice! Perhaps you can change some “must have” items to “maybe next year” purchases. Perhaps you can keep some quality items but reduce their quantity. For example, instead of $240 for four meals for you and a friend at restaurants each month, consider dining out twice each month at $70 per evening out. You’ll save $100 a month and still have two really nice meals. Your actions on money matters override your words, so act accordingly. Eventually you will finalize your “balanced budget” by making sure planned income equals or exceeds projected expenses.

Unfinished Budget Estimates for Harry and Belinda 

Table 3-6

 presents the projected annual budget for Harry and Belinda Johnson and reflects their efforts to reconcile their budget estimates. Wisely Harry and Belinda are “paying themselves first.” They plan to save $100 a month in a savings/emergency fund, put away $300 per month to save to buy their own home, and contribute to both their retirement plans at work. However, the Johnsons have failed to complete their budget because their total planned expenses are $1310 more than their total planned income. The Johnsons have a little ways to go to fully reconcile their annual budget estimates.

3.4c Action Before Budgeting Period: Plan Cash Flows

Before the month begins, you plan your cash flows or where the money will go. Income usually remains somewhat constant month after month, but expenses do rise and fall, sometimes sharply. As a result, people occasionally complain that they are “broke, out of money, and sick of budgeting.” This challenge can be anticipated by using a cash-flow calendar and eliminated by using a revolving savings fund.

Cash Flow Calendar for Harry and Belinda Johnson The budget estimates for monthly income and expenses in 
Table 3-6
 have been recast in summary form in 

Table 3-7

, providing a 

cash-flow calendar

 for the Johnsons. Annual estimated income and expenses are recorded in this calendar for each budgeting time period in an effort to identify surplus or deficit situations. In the Johnsons’ case, planned annual expenses still exceed income. The couple starts out the year with five months of income meeting expenses, and then they face planned monthly deficits for the remainder of the year.

cash-flow calendar
Budget estimates for monthly income and expenses.

Table 3-6 2015 Unfinished Annual Budget Estimates for Harry and Belinda Johnson
Table 3-7 Cash-Flow Calendar for Harry and Belinda Johnson

Effective management of cash flow can involve curtailing expenses during months with financial deficits, increasing income, using savings, or borrowing. If you borrow money and pay finance charges, the credit costs will further increase your monthly expenses.

Revolving Savings Fund for Harry and Belinda Johnson For this reason alone, it is smart to “borrow from yourself” by using a 

revolving savings fund

. This is a variable expense classification budgeting tool into which funds are allocated in an effort to create savings that can be used to balance the budget later so as to avoid running out of money. Establishing such a fund involves planning ahead—much like a college student does when saving money all summer (creating a revolving savings fund) to draw on during the school months.

revolving savings fund
Variable budgeting tool that places funds in savings to cover emergency or higher-than-usual expenses.

You establish a revolving savings fund for two purposes: (1) to accumulate funds for large nonmonthly irregular expenses, such as automobile insurance premiums, medical costs, holiday gifts, and vacations; and (2) to meet occasional deficits due to income fluctuations.

Table 3-8

 shows the Johnsons’ revolving savings fund. When preparing their budget, the Johnsons realized that in June, November, and December they were going to have significant deficits. Thus they decided to begin setting aside $250 per month to cover the June deficit, so by June they had $1250 in their revolving savings fund to cover that amount. Continued use of the revolving savings fund helped them meet the November deficit as well.

Harry and Belinda Argue About Budgeting Alternatives The Johnsons will still be $1530 short in December. Lacking that much money, the couple has a number of alternatives: (1) reduce some planned spending throughout the year to create sufficient surpluses, (2) use some of

Harry’s trust fund

interest income to cover the deficit, (3) dip into their emergency savings in December, and/or (4) utilize credit cards to get through the end-of-year expenses. Ideally, the Johnsons want to have sufficient emergency funds by the end of the year to establish their revolving savings fund for the following 12 months.

Table 3-8 Revolving Savings Fund for Harry and Belinda Johnson

The Johnsons disagree about their budget priorities. Belinda wants to spend less on food out and to open a credit card account to pay for the deficits later in the year, while Harry wants to spend less on clothing and entertainment and to skip their planned anniversary dinner party. They both wonder how they can earn so much money and still have such challenging budgeting problems. The Johnsons might benefit by considering the suggestions in 

Chapter 5

 (see pages 159–163) on how to talk with a significant other about financial matters. The Johnsons need to discuss their spending priorities and make decisions so they can reconcile their budget estimates for the year.

3.4d

 

Action During the Budgeting Period: Control Spending

Budget controls are techniques to maintain control over personal spending so that planned amounts are not exceeded. They give feedback on whether spending is on target and provide information on overspending, errors, emergencies, and exceptions or omissions. Following are several examples of budget controls:

Budget for Shopping Trips Set a budget for every shopping trip, and don’t spend a penny more.

Record the Purpose of Expenditures Checks contains a space to record the purpose of expenditures. The check stub or register also provides a place to record explanations of expenditures. If you use automatic teller machines (ATMs) to withdraw cash or use debit cards to pay for day-to-day expenditures, record these withdrawals in the check register immediately. Retain the paperwork, and write the purpose of each expense on the back of each. Deposit all checks received to your checking account without receiving a portion in cash; if you need cash, write a check or make an ATM withdrawal. If you get cash back when using a credit card, be sure to record why on the receipt.

Keep Track of Credit Transactions People often do not record their credit transactions until they receive a statement. Then it is easy to continue buying on credit without recognizing the amount of indebtedness until the statement arrives. Instead you should record each credit transaction when it occurs. If you spend $40 on clothing using a credit card, record the expenditure as clothing expenditure and reduce the amount you have remaining to spend for the month in that category.

ADVICE FROM A PROFESSIONAL

Secrets of Super Savers

How do some people enjoy the good comfortable life and still find ways to save 20 to 30 percent or more of their incomes? Like most many people, such super savers have home mortgages, pay tuition bills, and take vacations. And they tend to have peace of mind about their finances because they have built up a sizeable cushion of savings and investments. Some of their secrets include:

• Be goal-oriented about savings and investments to achieve results.

• Ignore impulses to spending (ask “Do I really need it?”) and choose to postpone buying anything expensive for a few months to see if the “need” is still strong.

• Avoid debt (auto loans and installment loans for computers, TVs, cell phones, and furniture) and using credit cards so you will not spend money you do not have.

• Cut back on spending on expensive items such as homes (not the largest in the neighborhood) and cars (drive older ones), and enjoy creative vacations that are not too pricey.

• Choose to spend wisely on everyday expenses by comparison shopping, clipping and using coupons, buying cheaper discounted goods and services, and being careful and mindful about entertainment expenses.

• Track spending by writing down every purchase, perhaps on a small tablet, so you know where money goes.

• Make savings automatic by diverting the maximum contribution to your employer’s retirement plan, and sign up for automatic transfers from a checking to a savings account as well as to a brokerage account, a 529 plan, a Roth IRA, and/or a high-yield savings account. Save more as income rises.

Dorothy B. Durband

Kansas State University

To help keep to a budget, write checks as often as possible instead of using cash. Also record the purpose of the expenditure on the lower left of the check.

Monitor Unexpended Balances to Control

Overspend

ing the Number One method to control overspending is to monitor unexpended balances in each of your budget classifications. You can accomplish this task by using a budget design that keeps a declining balance, as illustrated by parts (a) and (b) of 

Figure 3-6

. Other budget designs, such as those shown in parts (c) and (d) of 
Figure 3-6
, need to be monitored differently. As illustrated in parts (c) and (d) of the figure, simply calculate subtotals every week or so, as needed, during a monthly budgeting period. You can also track your spending using Quicken software or an online program.

DO IT IN CLASS

Justify Exceptions to Avoid Lying to Yourself 

Budget exceptions

 occur when budget estimates in various classifications differ from actual expenditures. Exceptions usually take the form of overexpenditures but can also occur in the over-or underreceipt of earnings. Simply spending extra income instead of recording it is not being honest with yourself. Recording the truth—by writing a few words to explain the exception—gives you the information to control your finances. If the exception is an expenditure, then immediately determine how to make up for the overexpenditure by trying to reduce other expenses in your spending plan.

budget exceptions
When budget estimates differ from actual expenditures.

Use a Subordinate Budget A 
subordinate budget
 is a detailed listing of planned expenses within a single budgeting classification. For example, an estimate of $1200 for a vacation could be supported by a subordinate budget as follows: motels, $700; restaurants, $300; and entertainment, $200.

subordinate budget
Detailed listing of planned expenses within a single budgeting classification.

Use the Envelope System for the Strongest Control The 
envelope system
 of budgeting entails placing exact amounts of money into envelopes for purposes of strict budgetary control. Here you place money equal to the budget estimate for the various expenditure classifications in envelopes at the start of a budgeting period and write the classification name and the budget amount on the outside of each envelope. As expenditures are made, record them on the appropriate envelope and remove the proper amounts of cash. When an envelope is empty, funds are exhausted for that classification. Of course, you must safeguard your cash.

envelope system
Placing exact amounts into envelopes for each budgetary purpose.

3.4e Action After: Evaluate Budgeting Progress to Make Needed Changes

Evaluation occurs at the end of each budgeting cycle. The purpose is to determine whether the earlier steps in your budgeting efforts have worked, and it gives you feedback to use for the next budget cycle. You review by comparing actual amounts with budgeted amounts, evaluating whether your objectives were met, and assessing the success of the overall process as well as your progress toward your short- and long-term goals. The evaluation process helps you to make any needed changes.

In some budget expenditure classifications, the budget estimates rarely agree with the actual expenditures—particularly in variable expenses. A 
budget variance
 is the difference between the amount budgeted and the actual amount spent or received. The remarks column, as illustrated in parts (c) and (d) of 
Figure 3-6
, can help clarify why variances occurred. Overages on a few expenditures may cause little concern. If large variances have prevented you from achieving your objectives or making the budget balance, then take some action. Serious budget controls might have to be instituted or current controls tightened.

budget variance
Difference between amount budgeted and actual amount spent or received.

DID YOU KNOW
 

Your Worst Financial Blunders in Financial Statements, Tools, and Budgets

Based on others’ financial woes, you will make mistakes in personal finance when you:

1. Fail to plan for non-monthly irregular expenditures.

2. Underestimate how much you plan to spend each month.

3. Use credit card purchases to “balance” your budget.

Whatever your goals, it feels good when you make progress toward them, and it is thrilling to achieve them. If you did not achieve some of your objectives, you can determine why and then adjust your budget and objectives accordingly. It is okay to revise your plans. Suppose at the end of the month Robert Chen finds that he is unable to set aside a planned amount of $250 in monthly savings. By evaluating his budget, perhaps Robert will find that unexpected emergency car repairs led him to spend more than budgeted for the month. Because Robert understands why the objective was not achieved, he can set his sights on reaching the goal during the next budgeting time period.

Figure 3-6
 Record-keeping Formats

DID YOU KNOW
 

Turn Bad Habits into Good Ones

Do You Do This?

Spend all your income

Overspend

Can’t find financial records

Do not know how much you owe

Can’t pay for auto insurance premium or vacation

Run out of money every few months

Do This Instead!

Save 10 percent or more

Utilize budget controls to reduce spending

Create a record-keeping system

Make a balance sheet

Save for large irregular expenses

Create a cash-flow calendar

Record Keeping In the process of budgeting, 
record keeping
 is the process of recording the sources and amounts of dollars earned and spent. Recording the estimated and actual amounts for both income and expenditures helps you monitor your money flow. Keeping track of income and expenses is the only way to collect sufficient information to evaluate how close you are to achieving your financial objectives. For those who keep records on paper, 
Figure 3-6
 shows four samples of self-prepared recordkeeping formats that vary in complexity. Most people record earnings and expenditures when they occur. When writing in the “activity” and “remarks” columns in your record, be descriptive because you may need the information later.

record keeping
Recording sources and amounts of dollars earned and spent.

Adding Up Actual Income and Expenditures After the budgeting period has ended—usually at the beginning of a new month—you need to add up the actual income received and expenditures made during that period. You can perform this calculation on a form for each budget classification, as shown in parts (a) and (b) of 
Figure 3-6
 or on a form with all income and expenditure classifications, as in parts (c) and (d) of 
Figure 3-6
. Such calculations indicate where you may have overspent within your budget categories. If you are new at budgeting, do not be too concerned about overspending.

It occurs in some classifications almost always, only to be balanced by underspending in other categories. Use such information to refine your budget estimates in the future. In three or four months, you will be able to estimate your expenses much more accurately. The 
Garman/Forgue
 companion website provides budgeting software as well as numerous other templates, calculators, and worksheets that you can use in your own personal financial planning.

What to Do with Budgeted Money Left Over at the End of the Month At the end of the budgeting time period, some budget classifications may still have a positive balance. For example, perhaps you estimated the electric bill at $100, but it was only $80. You may then ask, “What do I do with the $20 surplus?” You also may ask, “What happens to budget classifications that were overspent?”

People handle the 
net surplus
 (the amount remaining after all budget classification deficits are subtracted from those with surpluses) in any of the following ways:

net surplus
Amount remaining after all budget classification deficits are subtracted from those with surpluses.

• Put the money into savings (and this allows the budget to total out to zero)

• Carry the surpluses forward to the following month

• Pay toward credit card debt

• Put surpluses toward a mortgage or other loan

• Put the money into a retirement account

• Spend surpluses like “mad money” on anything you want

DID YOU KNOW
 

Save Money When Shopping by Using Coupons

You can save hundreds of dollars every year by taking advantage of coupons and discounts. It’s fun getting a “$25-off coupon at Ruby Tuesdays,” a “$5-off coupon for Pepsi or Coke at Walgreens,” or “$50 off a phone.” Try the following:

• Take advantage of Facebook or Twitter to sign up for coupons and discounts by liking your favorite brands.

• Receive daily coupon notices on local deals at BuyWithMe, groupon.com, and livingsocial.com.

• Use your phone to check out ShopSawy’s app that scans an item barcode, sees who has it for less, and locates those sellers.

• In addition, it can send price alerts when items drop below the prices you’ve already seen.

• Utilize the Google Shopper app, which uses your phone’s camera to recognize products by cover art, barcode scanning, voice, and text, and then provides reviews and specs. Also try Coupon Sherpa, Shopkick, and Scoutmob for your phone.

• Search for air, car rental, and hotel coupon codes at 

promotional/codes.com

 or 

couponwinner.com

.

• Try out “price comparison” programs such as 

bizrate.com

, InvisibleHand, 

nextag.com

, price-grabber.com, and RedLaser.

• Redeem Sunday newspaper coupons that provide discounts for hundreds of products.

• Stop by the U.S. Post Office for an envelope of coupons if you are moving from one address to another or if you think you might move.

• Take grocery store coupons attached to products, on tear pads, and on bottlenecks as well as from cashiers upon checkout.

• Go online to obtain coupons and do so by setting up a separate e-mail account for coupons and then registering at the sites. Examples are 

restaurant.com

, 

coupons.com

, 

coolsavings.com

, 

smartsource.com

, 

grocerycoupons.com

, 

couponmom.com

, 

retailmenot.com

, and 

grocerysmarts.com

.

• Go to the websites for local radio stations, where they may have downloadable coupons for local restaurants and entertainment venues.

• Purchase valid coupons on eBay for only 10 to 25 cents on the dollar.

DID YOU KNOW
 

Sean’s Success Story

Sean has done well financially since he started working for his current employer three years ago. In addition to earning better-than-average raises, he has received an annual bonus of $3000 each year. One of Sean’s major life goals is to enjoy an early retirement, perhaps beginning at age 55. He creates financial statements every year to track his progress. Sean now has a net worth of over $20,000 because he saved the after-tax amount of each bonus ($2500) and contributed the maximum amount to his employer’s 401(k) retirement plan ($3000), which includes a 100 percent match ($3000 a year). Sean uses Quicken software to manage his personal finances. He lives below his income and is saving about $300 a month for emergencies, irregular expenses, and occasional splurges.

The budgeting form in part (d) of 
Figure 3-6
 (page 92) allows for carrying balances forward to the next period. Some people carry forward deficits, with the hope that having less available in a budgeted classification the following month will motivate them to keep expenditures low. Because variable expense estimates are usually averages, it is best not to change the estimate based on a variation that occurs over just one or two months. If estimates are too high or low for a longer period, you will want to make adjustments.

Using financial software for budgeting, like Quicken, takes the drudgery out of making and using a spending plan. And it gets to be easy after a few months.

DO IT NOW!

You know more about personal finance after reading this chapter, so get started right now by:

1. Putting a notepad in your pocket to record every single expense of $1 or more for one month.

2. Preparing a cash-flow statement at the end of the month.

3. Setting up a spending plan for next month that provides for savings for at least one of your goals.

3.4f

 

Some Final Suggestions

Here are some final suggestions for successful budgeting: (1) Keep it simple, (2) make it personal, (3) keep it flexible, and (4) keep a positive attitude. A smart thing to do is to list the benefits to yourself that will occur when you reach a particular financial goal. You are likely to achieve a financial goal when you are convinced that it is your own goal, when you make an emotional commitment to the goal, when your short-term goals lead to your long-term goals, and when you can visualize receiving the benefits of your goals.

 CONCEPT CHECK 3.4

1. Identify two actions that should be performed before establishing a budget.

2. What are budget estimates? Offer some suggestions on how to go about making budget estimates for various types of expenses.

3. Distinguish between a cash-flow calendar and a revolving savings fund, and tell why each is important.

4. Offer three suggestions for effective budget controls.

DID YOU KNOW
 

Income Inequality Continues

Rising income inequality worries many Americans. continuing a three-decade trend, the wealthiest Americans—the richest 1 percent who have a pre-tax family income above $39

4,000

—earned more than 23 percent of the country’s household income in a recent year. And they earned 95 percent of the increase in income in the post-crisis recovery. The top 10 percent of earners—those with pre-tax income exceeding $114,000—captured 48 percent of total earnings. Reasonable people can be fairly certain that there is a problem here.

WHAT DO YOU RECOMMEND NOW?

Now that you have read the chapter on financial planning, what do you recommend to Austin for his talk with Rachel on the subject of financial planning regarding:

1. Setting financial goals?
2. Determining what they own and owe?
3. Using the information in Austin’s newly prepared financial statements to summarize the family’s financial situation?
4. Evaluating their financial progress?
5. Setting up a record-keeping system to better serve their needs?
6. Starting a budgeting process to guide saving and spending?

BIG PICTURE SUMMARY OF LEARNING OBJECTIVES

LO1 Identify your financial values, goals, and strategies.

By identifying your financial values, goals, and strategies, you can always keep a balance between spending and saving and stay committed to your financial success. You may create financial plans in three broad areas: plans for spending, plans for risk management, and plans for capital accumulation.

LO2 Use balance sheets and cash-flow statements to measure your financial health and progress.

Financial statements are compilations of personal financial data designed to furnish information on money matters. The balance sheet provides information on what you own, what you owe, and what the net result would be if you paid off all your debts. The cash-flow statement lists income and expenditures over a specific period of time, such as the previous month or year.

LO3 Collect and organize the financial records necessary for managing your personal finances.

Your financial records will help determine where you are, where you have been, and where you are going financially. They also help you make money.

LO4 Achieve your financial goals through budgeting.

Budgeting is all about logical thinking about your finances. Budgeting forces you to consider what is important in your life, what things you want to own, how you want to live, what it will take to do that, and, more generally, what you want to achieve in life. A budget is a process used to record both projected and actual income and expenditures over a period of time, and it represents the major mechanism through which your financial plans are carried out and goals are achieved.

LET’S TALK ABOUT IT

1. Families. During sluggish economic times, the federal government’s budgeting priority is to borrow so it can spend much more money than it takes in. What happens to families that try that, and why?

2. Your Values. What are your three most important personal values? Give an example of how each of those values might influence your financial plans.

3. Cash Flow. College students often have little income and many expenses. Does this reduce or increase the importance of completing a cash-flow statement on a monthly basis? Why?

4. Financial Ratios. Of the financial ratios described in this chapter, which two might be most revealing for the typical college student? Which two might be the most revealing for a retiree?

5. Why Budget. Do you have a budget? Why or why not? What do you think are the major reasons why people do not make formal written budgets?

6. Control Spending. What can a person do to control spending to better achieve financial success?

7. Budgeting Mistake. What is the biggest budget-related mistake that you have made? What would you do differently now?

8. Personal Finances over the Life Cycle. Areas of financial decision making change over one’s life-cycle. Based on the information provided in 
Figure 3-3
 on page 76 contrast your own areas of concern with those of your parents.

DO IT IN CLASS PAGE 76

DO THE MATH

1. Ratio Analyses for Victor and Maria. Review the financial statements of Victor and Maria Hernandez (
Table 3-2
 and 
Table 3-3
) and respond to the following questions:

(a) Using the data in the Hernandezes’ balance sheet, calculate an investment assets-to-net worth ratio. How would you interpret the ratio? The Hernandez family appears to have too few monetary assets compared with tangible and investment assets. How would you suggest that they remedy that situation over the next few years?

(b) Comment on the couple’s diversification of their investment assets.

(c) Calculate the asset-to-debt ratio for Victor and Maria. How does this information help you understand their financial situation? How do their total assets compare with their total liabilities?

(d) The Hernandezes seem to receive most of their income from employment rather than investments. What actions would you recommend for them to remedy that imbalance over the next few years?

(e) The Hernandezes want to take a two-week vacation next summer, and they have only eight months to save the necessary $2400. What reasonable changes in expenses might they consider to increase net surplus and make the needed $300 per month?

2. Calculating Net Worth and Net Surplus. Jennifer Pontesso wants to better understand her financial situation. Use the following balance sheet and cashflow statement information to determine her net worth and her net surplus for a recent month. Liquid assets: $10,000; home value: $210,000; monthly mortgage payment: $1300 on $170,000 mortgage; investment assets: $90,000; personal property: $20,000; total assets: $330,000; short-term debt: $5500 ($250 a month); total debt: $175,500; monthly gross income: $9000; monthly disposable income: $

680

0; monthly expenses: $6000.

DO IT IN CLASS PAGE 72

3. Ratio Analyses. Now that Jennifer better understands her situation she wants to do some analysis of what she has found. Given her balance sheet and cash-flow statements calculate the following ratios:

(a) Liquidity ratio

(b) Asset-to-debt ratio

(c) Debt-to-income ratio

(d) Debt payments-to-disposable income ratio

(e) Investment assets-to-total assets ratio

DO IT IN CLASS PAGE 76

4. Cash Flow Surplus/Deficit. Cody Sebastion earns $40,000 a year. He pays 30 percent of his gross income in federal, state, and local taxes. He has fixed expenses in addition to taxes of $1200 per month and variable expenses that average $900 per month. What is his net cash flow (surplus or deficit) for the year?

5. Construct Financial Statements. Thomas Green has been a retail salesclerk for six years. At age 35, he is divorced with one child, Amanda, age 7. Thomas’s salary is $36,000 per year. He regularly receives $400 per month for child support from Amanda’s mother. Thomas invests $100 each month ($50 in his mutual fund and $50 in

U.S. savings bonds

). Using the following information, construct a balance sheet and a cash-flow statement for Thomas.

DO IT IN CLASS
PAGE 78

5,000

3,000

	ASSETS			Amount
Vested retirement benefits (no employee contribution)	$ 3,000
Money market account (includes $150 of interest earned last year)		5,000
Mutual fund (includes $200 of reinvested dividend income from last year)	4,000
Checking account		1,000
	Personal property
Automobile				3,000
U.S. savings bonds

	LIABILITIES	Outstanding Balance
Dental bill (pays $25 per month and is included in uninsured medical/dental)	$ 450
Visa (pays $100 per month)	1,500
Student loan (pays $100 per month)	7,500

Amount

Utilities

1,200

Food

3,000

1,000

	ANNUAL EXPENSES
Auto insurance	$ 780
	Rent	9,100
Phone	680
Cable	360
Uninsured medical/dental

ANNUAL EXPENSES

Amount

480

Gifts

Miscellaneous

Taxes

Dry cleaning
Personal care		420
Gas, maintenance, license	2,120
Clothes	500
	Entertainment		1,700
Vacations/visitation travel	1,300
Child care	3,820
	400
	300
	4,600
Health insurance	2,440

6. Budgeting and Income Projections. Leyia and Aldolfo DeVaney of Monument, Colorado, have decided to start a family next year, so they are looking over their budget (illustrated in 
Table 3-5
 as the “young married couple”). Leyia thinks that she can go on half-salary ($1050 instead of $2100 per month) in her job as a graduate assistant for about 18 months after the baby’s birth; she will then return to full-time work.

(a) Looking at the DeVaneys’ current monthly budget, identify categories and amounts in their $4315 budget where they realistically might cut back $1050. (Hint: Federal and state taxes should drop about $290 as their income drops.)

(b) Assume that Leyia and Aldolfo could be persuaded not to begin a family for another two to three years until Leyia finishes graduate school. What specific budgeting recommendations would you give them for handling (i) their fixed expenses and (ii) their variable expenses to prepare financially for an anticipated $1050 loss of income for 18 months as well as the expenses for the new baby?

(c) If the DeVaneys’ gross income of $4315 rises 3 percent per year in the future, what will their income be after five years? (Hint: See 

Appendix A.1

 or the 
Garman/Forgue
 companion website.)

FINANCIAL PLANNING CASES

CASE 1

The Financial Statements of Harry and Belinda Johnson Suggest Budgeting Problems

Harry graduated with a bachelor’s degree in interior design last spring from a large Midwestern university near his hometown. Belinda has a degree in information technology from a university on the West Coast and is employed in a medium-size public relations firm. Harry and Belinda both worked on their schools’ student newspapers and met at a conference during their junior year in college. They were married last June and live in an apartment in Kansas City. They will face many financial challenges over the next 20 years, as they buy their first home, decide on life insurance needs, begin a family, change jobs, and invest for retirement.

Harry works at a medium-size interior design firm and, during the last half of last year, earned a gross salary of $3100 per month. He also receives $3000 in interest income per year from a trust fund set up by his deceased father’s estate; the trust fund will continue to pay that amount until 2028. He anticipates a raise of $150 a month in his salary by next January. Belinda works as a salesperson for a regional stock brokerage firm.

She earned a salary of $4750 per month last year. Belinda has many job-related benefits, including life insurance, health insurance, a retirement plan, and a credit union. Since she is a new employee Belinda does not expect a raise at the end of the year. The Johnsons live in an apartment located approximately halfway between their places of employment; however, their rent will increase by $100 a month next July. Harry drives about ten minutes to his job, and Belinda travels about 15 minutes via public transportation to reach her downtown job. Harry and Belinda’s apartment is very nice, but small, and it is furnished primarily with furniture given to them by their families. Soon after starting their first jobs, Harry and Belinda decided to begin their financial planning. Fortunately each had taken a college course in personal finance. After initial discussion, they worked together for two evenings to develop the two financial statements presented below.

(a) Briefly describe how Harry and Belinda probably determined the fair market prices for each of their tangible and investment assets.

(b) Using the data from the cash-flow statement developed by Harry and Belinda, calculate a liquidity ratio, asset-to-debt ratio, debt-to-income ratio, debt payments-to-disposable income ratio, and investment assets-to-total assets ratio. What do these ratios tell you about the Johnsons’ financial situation? Should Harry and Belinda incur more debt, such as credit cards or a new car loan?

(c) The Johnsons enjoy a high income because both work at well-paying jobs. They have spent parts of three evenings over the past several days discussing their financial values and goals together. As shown in the upper portion of 
Figure 3-5
, they have established three long-term goals: $3000 for a European vacation to be taken in 2018, $5000 needed in October 2019 for a down payment on a new automobile, and $18,900 for a down payment on a home to be purchased in December 2020. As shown in the lower portion of the figure, the Johnsons did some calculations to determine how much they had to save for each goal—over the near term—to stay on schedule to reach their long-term goals as well as pay for two vacations and an anniversary party. After developing their balance sheet and cash-flow statement (shown below), the Johnsons made a budget for the year (shown in 
Table 3-6
 on page 87). They then reconciled various conflicting needs and wants until they found that total annual income was close to the total of planned expenses. Next, they created a revolving savings fund (
Table 3-8
 on page 89) in which they were careful to include enough money each month to meet all of their short-term goals. When developing their cash-flow calendar for the year (
Table 3-7
 on page 88), they noticed a problem: substantial cash deficits toward the end of the year. In fact, despite their projected high income, they anticipate a deficit of $1530 for the year. To solve this problem, they do not anticipate increasing their income, using savings, or borrowing. Instead, they are considering modifying their needs and wants to reduce their budget estimates to the point where they would have a positive balance for the year. Make specific recommendations to the Johnsons on how they could make reductions in their budget estimates. Do not offer suggestions that would alter their new lifestyle drastically, as the couple would reject these ideas.

Balance Sheet for Harry and Belinda Johnson

January 1, 2015

ASSETS

Personal property

1,700

100.00%

Monetary Assets
cash on hand	1,178	5.48%
Savings (First Federal Bank)	890	4.14%
Savings (Far West Savings Bank)	560	2.60%
Savings (Homestead credit Union)	160	0.74%
Checking (First Federal Bank)	752	3.50%
Total monetary assets	$3,540	16.45%
Tangible Assets
Automobile (3-year-old Toyota)	11,000	51.13%
2,300	10.69%
Furniture	7.90%
Total tangible assets	$15,000	69.72%
Investment Assets
Harry’s retirement account	1,425	6.62%
Belinda’s retirement account	1,550	7.20%
Total investment assets	$ 2,975	13.83%
Total Assets		$21,515

LIABILITIES

400

$21,515

100.00%

Short-Term Liabilities
Visa credit card	390	1.81%
Target credit card	45	0.21%
Dental bill	1.86%
Total short-term liabilities	$ 835	3.88%
Long-Term Liabilities
Vehicle loan (First Federal Bank)	3,800	17.66%
Student loan (Belinda)	8,200	38.11%
January 1, 2015
Total long-term liabilities	$12,000	55.78%
Total Liabilities	$12,835	59.66%
Net Worth	$ 8,680	40.34%
Total Liabilities and Net Worth

Cash-Flow Statement for Harry and Belinda Johnson July 1-December 31, 2014 (First Six Months of Marriage)

Dollars

Percent

INCOME

3,000

Total Income

100.00%

	Cash Flow
Harry’s gross income ($3100×6)	18,600	37.11%
Belinda’s gross income ($4750×6)	28,500	56.86%
Interest on savings account	24	0.05%
Harry’s trust fund	5.99%
$50,124

EXPENDITURES

Fixed Expenses

Rent

Automobile loan payments

2,980

1,200

420

600

4,600

1,600

3,600

7.18%

300

Total Fixed Expenses

Variable Expenses

1,800

Utilities

6,600	13.17%
Renter’s insurance	220	0.44%
5.95%
Automobile insurance	850	1.70%
Health insurance (withheld from salary)				2.39%
Student loan payments		3,600		7.18%
Life insurance (withheld from salary)	90	0.18%
Cable TV and Internet		720		1.44%
Health club	0.84%
Savings/emergencies		1.20%
Harry’s retirement plan (6% of salary)	1,115	2.22%
Belinda’s retirement plan (4% of salary)	1,140	2.27%
Federal income tax (withheld from salary)	9.18%
State income tax (withheld from salary)	3.19%
Social Security (withheld from salary)
Automobile registration	0.60%
$29,635	59.12%
Food (groceries)	2,600	5.19%
Food (out)	3.59%
750	1.50%

Cash Flow

Dollars

Percent

Gasoline and maintenance

Medicines

Clothing and upkeep

1,200

2.39%

1,200

2.39%

Gifts

720

1.44%

Personal allowances

Entertainment

600

1.20%

1,200

2.39%

Miscellaneous

480

Total Variable Expenses

Total Expenses

SURPLUS (DEFICIT)

Cell phones	450	0.90%
700	1.40%
Doctor’s and dentist’s bills	710	1.42%
350	0.70%
Church and charity
1,070	2.13%
Public transportation
4,160	8.30%
960	1.92%
Vacation (holiday)
Vacation (summer)
0.96%
$18,950	37.81%
$48,585	96.93%
$1,539	3.07%

CASE 2

Victor and Maria Hernandez

Victor and Maria, both in their late 30s, have two children: John, age 13, and Joseph, age 15. Victor has had a long sales career with a major retail appliance store. Maria works part-time as a medical records assistant. The Hernandezes own two vehicles and their home, on which they have a mortgage. They will face many financial challenges over the next 20 years, as their children drive, go to college, and leave home and go out in the world on their own. Victor and Maria also recognize the need to further prepare for their retirement and the challenges of aging.

Victor and Maria spent some time making up their first balance sheet, which is shown in 
Table 3-2
. Victor and Maria are a bit confused about how various financial activities can affect their net worth.

(a) Assume that their home is now appraised at $192,000 and the value of their automobile has dropped to $9500. Calculate and characterize the effects of these changes on their net worth and on their asset-to-debt ratio.

(b) If Victor and Maria take out a bank loan for $1545 and pay off their credit card debts totaling $1545, what effects would these changes have on their net worth?

(c) If Victor and Maria sell their New York 2028 bond and put the cash into the savings account, what effects would this have on their net worth and liquidity ratio?

CASE 3

Julia Price Thinks About Financial Statements, Tools, and Budgets

Julia graduated six years ago in aeronautical engineering and changed job once. Her income is more than sufficient for her needs. Julia contributes the maximum into her employer’s retirement account and additionally saves about $400 a month. She has only about $1000 in credit card debt and makes a monthly car payment of $520. With such a strong financial position, she thinks it would be a waste of time to prepare financial statements and create a budget. Offer your opinions about her thinking.

CASE 4

Budget Control for a Recent Graduate

Seo-yeon, a political scientist from Lubbock, Texas, graduated from college eight months ago and is having a terrible time with his budget. Seo-yeon has a regular monthly income from her job and no really large bills, but she likes to spend. She exceeds her budget every month, and her credit card balances are increasing. Choose three budget control methods that you could recommend to Seo-yeon, and explain how each one could help her gain control of her finances.

DO IT IN CLASS PAGES 89–91

CASE 5

A Couple Creates an Educational Savings Plan

Stanley Marsh and Wendy Testaburger of South Park, Colorado, have two young children and have been living on a tight budget. Their monthly budget is illustrated in 
Table 3-5
 on page 85 as the “married couple with two young children.” Wendy and Stanley are nervous about not having started an educational savings plan for their children. Wendy has just begun working on a part-time basis at a local accounting firm and earns about $860 per month; this income is reflected in the Marsh-Testaburgers’ budget. They have decided that they want to save $200 per month for the children’s education, but Wendy does not want to work more hours away from home.

(a) Review the family’s budget and make suggestions about how to modify various budget estimates so that they could save $200 per month for the education fund.

(b) Briefly describe the effect of your recommended changes on the Marsh-Testaburgers’ lifestyle.

BE YOUR OWN PERSONAL FINANCIAL MANAGER

1. Financial Plan. Use 
Table 3-1
 on page 67 as a guide to making your financial plans, goals, and objectives for spending, risk management, and capital accumulation. Write up your findings.

2. Balance Sheet. Use 
Table 3-2
 on page 74 as a guide to create a balance sheet or complete Worksheet 10: My Balance Sheet from “My Personal Financial Planner” to create your own detailed annual balance sheet. Write up your findings.

3. Cash-Flow Statement. Use 
Table 3-3
 on page 77 as a guide to create a cash-flow statement or complete Worksheet 11: My Cash-Flow Statement from “My Personal Financial Planner” to create your own cash-flow statement. Write up your findings.

4. Evaluate Your Financial Ratios. Use the financial ratios on pages 78 to help evaluate your personal financial condition or complete Worksheet 12: My Financial Ratios from “My Personal Financial Planner” to record your financial ratios.

5. Categorize Your Financial Records. Review 
Table 3-4
 “Financial Records: What to Keep and Where” on pages 80–81 to develop a system for your own records or complete Worksheet 13: My Financial Records from “My Personal Financial Planner” to record what records will be placed in your home file, safe-deposit box, or another place.

6. Monthly Saving to Reach Your Goals. Use 
Figure 3-5
 “Goals Worksheet for Harry and Belinda Johnson” on page 84 as a guide to develop your own personal savings goals or complete Worksheet 14: Monthly Savings to Reach My Financial Goals from “My Personal Financial Planner” to record the dollar amount, time, and interim short-term goals.

7. Nonmonthly Expenses. Complete Worksheet 15: Determining Monthly Budget Amounts for My Nonmonthly Expenses from “My Personal Financial Planner” to carefully plan for your nonmonthly expenses over the year.

8. Revolving Savings Fund. Review 
Table 3-8
 “Revolving Savings Fund for Harry and Belinda Johnson” on page 89 to develop a plan for yourself or complete Worksheet 16: My Revolving Savings Fund from “My Personal Financial Planner” to record how you can save to pay for irregular expenses throughout the year.

9. Create Your Budget. Use 
Table 3-6
 on page 87 as a guide to create a 12-month budget or complete Worksheet 17: My Budget from “My Personal Financial Planner” to do so.

10. Control Spending with Budget Worksheets. Complete Worksheet 18: My Budget Category Ledger Worksheets from “My Personal Financial Planner” to create a system to monitor and control spending.

11. Organize Your Financial Records. Use 
Table 3-4
 on pages 80–81 as a guide to helping you get your financial records in order. Write down some notes about your thinking on what documents you will need and where to keep them.

ON THE NET

Go to the Web pages indicated to complete these exercises.

1. Online Calculators. Visit MoneyChimp’s website (

www.moneychimp.com/

). There you will find an assortment of calculators that can be used in various present and future value calculations. Select three that you believe would be particularly useful in the aspects of personal financial planning that were discussed in this chapter.

2. More Online Calculators. Visit CNNMoney’s website (

cgi.money.cnn.com/tools/

). Select three calculators to try out that you think would be useful in personal finance.

3. Input Your Budget and Compare to Your Projected Expenditures. Visit the website 

www.kiplinger.com/tool/spending/T007-S001-budgeting-worksheet-a-household-budget-for-today-a/index.php

 and use the budgeting worksheet and input your projected monthly living costs in various categories. It will compare your projections to what you actually spent.

4. Can You Make It Through the Month? ”Spent” is an online game that simulates the struggles of homelessness. Accept the challenge and take 10 minutes to play Spent (

playspent.org/

).

ACTION INVOLVEMENT PROJECTS

1. Money Discussion Topics. Use the list in the box “Did You Know? Money Topics to Discuss with Your Partner” as a guide to interview three married couples. Ask them which of the topics they discussed with their partners within the first year of marriage. Make a table that summarizes your findings.

2. Financial Mistakes. Survey five people to learn about their financial mistakes in life. Ask each person to cite two financial mistakes he/she has made. Make a table that summarizes your findings.

3. Short-Term Financial Goals. Survey five people to ascertain their financial goals. Ask each person, “What are your top two short-term financial goals?” Make a table that summarizes your findings.

4. Long-Term Financial Goals. Survey five people to ascertain their financial goals. Ask each person, “What are your top three long-term financial goals?” Make a table that summarizes your findings.

Visit the Garman/Forgue companion website at 

www.cengagebrain.com

.

*
 An alternative method is accrual-basis budgeting that recognizes earnings and expenditures when money is earned and expenditures are incurred, regardless of when money is actually received or paid.

2 Career Planning

YOU MUST BE KIDDING, RIGHT?

Alberto Duarte is contemplating going to graduate school at night for a master’s degree so he can advance his career and earn more than his current $64,000 salary income. He is a sales account manager for a health care organization, and he has a small business maintaining aquariums for medical offices and other small offices. How much more income can Alberto expect over an anticipated 40-year career if he obtains the advanced degree?

A. 

$100,000

B. $300,000

C. $600,000

D. $900,000

The answer is C, $600,000. Over a 40-year working career, a person with a postgraduate degree can expect to earn more than $3 million, and this is about $600,000 more than a person with a bachelor’s degree will earn. Getting an advanced degree is no guarantee of additional income, but the likelihood of such a reality is high!

LEARNING OBJECTIVES

After reading this chapter, you should be able to:

 

Identify the key steps in successful career planning.

 

Analyze the financial and legal aspects of employment.

 

Practice effective employment search strategies.

WHAT DO YOU RECOMMEND?

Nicole Linkletter, age 21, expects to graduate next spring with a bachelor’s degree in business administration. Nicole’s grades are mostly As and Bs, and she has worked part time throughout her college career. Nicole is vice president of the Student Marketing Association on her campus. She would like to work in management or marketing for a medium- to large-size employer. Because she loves the outdoors, Nicole thinks she would prefer a job in the Northwest, perhaps in northern California, Oregon, or Washington.

What would you recommend to Nicole on the importance of career planning regarding:

1. Clarifying her values and lifestyle trade-offs?

2. Enhancing her career-related experiences before graduation?

3. Creating career plans and goals?

4. Understanding her work-style personality?

5. Identifying job opportunities?

You can control much of your financial future with effective career planning. A 

career

 is the lifework chosen by a person using his or her personal talent, education, and training. 

Career planning

 can help you identify an employment pathway that aligns your interests and abilities with the tasks and responsibilities expected by employers. Career planning has always been important, but with today’s level of unemployment and slow economy, it is absolutely crucial. You must plan your career because failure awaits those who do not.

career
The lifework chosen by a person to use personal talent, education, and training.

career planning
Can help you identify an employment pathway that aligns your interests and abilities with the tasks and responsibilities expected by employers over your lifetime.

Your focus should not be simply a “job” but a career. The general progression of one’s career will include a number of related jobs. Indeed, the average tenure at a job for U.S. workers is about three years. A career translates into a base of income, employee benefits, additional educational experiences, advancement opportunities, and a secure financial future. Career planning is a high-priority, do-it-yourself project, allowing you to take control of where you are going and how you are going to get there.

2.1 DEVELOPING YOUR CAREER PLAN

LEARNING OBJECTIVE 1

Identify the key steps in successful career planning.

Your 

career plan

 provides a strategic guide for your career through short-, medium-, longer-, and long-term goals as well as future education and work-related experiences. You can’t advance very far in planning your financial life without also planning a career that will earn you an adequate income. A career that suits you will give you opportunities to display your abilities in jobs you find satisfying while providing balance between work and your personal life.

career plan
A strategic guide for your career through short-, medium-, longer-, and long-term goals as well as future education and work-related experiences.

In many parts of the country a slow job market may mean that neither the pay nor the geographic location opportunities for employment are quite what you expect. Realize, too, that the rest of your life will not be determined by your first professional job. No matter what job you choose, consider it a chance to do the required tasks effectively and learn more about yourself and your career field.

Career planning is a continuous process that lasts throughout your life. Every time your life circumstances change, you will likely reconsider your career plan. 

Figure 2-1

 provides an illustration of the steps in career planning.

2.1a Clarify Your Values and Interests

Thinking about and discovering what you want out of life gives you guidance for what to do to lead a satisfying life. Understanding yourself enables you to select a career path that best suits you. This requires understanding your values and interests.

Values

 are the principles, standards, or qualities considered worthwhile or desirable. Values provide a basis for decisions about how to live, serving as guides we can use to direct our actions. For something to be a value, it must be prized, publicly affirmed, chosen from alternatives, and acted upon repeatedly and consistently. Values are not right or wrong, or true or false; they are personal preferences.

values
The principles, standards, or qualities that you consider desirable.

People may place value on family, friends, helping others, religious commitment, honesty, pleasure, good health, material possessions, financial security, and a satisfying career. Examples of conflicting values are family versus satisfying career, privacy versus social networking, and material possessions versus financial security. When you make important decisions, you might be wise to think carefully to clarify your values before taking action. Consider making a list of your ten most important values.

Figure 2-1
 Steps in Career Planning

YOUR NEXT FIVE YEARS

In the next five years, you can start achieving financial success by doing the following related to career planning:

1. Continue to enhance your education and professional training.

2. Seek out mentors and sponsors on the job and in other professional settings.

3. Join and be active in the professional associations relevant to your career.

4. Identify your career planning values and live them in your selection of jobs and in your performance at work.

5. Map out your career plan by setting benchmarks as you move up the career ladder.

Your 
professional interests
 are topics and activities about which you have feelings of curiosity or concern. Interests engage or arouse your attention. They reflect what you like to do. Interests, including occupational interests, are likely to vary over time.

professional interests

Long-standing topics and activities that engage your attention.

You might consider making a list of your top ten interests. On that list will probably be some things you enjoy but have not done recently. Because of conflicting interests and alternative claims on your time, you cannot pursue all your interests. It is important in career planning to evaluate your interests; if you plan your career with your interests in mind, you will increase the likelihood of career satisfaction.

Interest inventories

 are measures that assist people in assessing and profiling the interests and activities that give them satisfaction. They compare how your interests are similar or dissimilar to the interests of people successfully employed in various occupations. The theory behind these interest inventories is that individuals with similar interests are often attracted to the same kind of work. These inventories can help you identify possible career goals that match your strongest personal interests.

interest inventories
Scaled surveys that assess career interests and activities.

The Strong Interest Inventory assessment is considered by many to be the gold standard of career exploration tools. The opportunity to take one or more interest inventory assessments, usually for free or at a nominal cost, is available at most colleges and state-supported career counseling facilities. These assessments can also be completed online for a fee. (See, for example, 

www.cpp.com/products/strong/index.aspx

.)

2.1b Identify One or More Desired Career Fields

People used to take a single job and remain at the same company until they retired. Now, people often change jobs five to ten times during their working years, about 4.4 years on average. Surveys show that 35 percent of employees change jobs at least every 5 years, 18 percent change between 6 and 10 years, and nearly half stay more than 10 years. In contrast, young adults average six jobs before age 26.

Thinking about a career goal helps you focus on what you want to do for a living. A 

career goal

 can be a specific job (e.g., cost accountant, teacher, human resources manager) or a particular field of work (e.g., health care, communications, green engineering). It helps guide you to do the kind of work you want in life rather than drift from job to job. You should focus on a series of jobs that form a career ladder. A 

career ladder

 typically describes the progression from entry-level positions to higher levels of pay, skill, responsibility, or authority. Formulating a career goal requires thinking about your interests, skills, and experiences and learning about different careers and employment trends. The process of establishing a career goal motivates you to consider career possibilities that you may not have thought of otherwise.

career goal
Identifying what you want to do for a living, whether a specific job or field of employment.

career ladder
Describes the progression from entry-level positions to higher levels of pay, skill, responsibility, or authority.

To create a career goal, explore the jobs, careers, and trends in the employment marketplace that fit your interests and skills. Ask people you trust about their careers. Search websites such as those for the Occupational Outlook Handbook (

www.bls.gov/ooh/

) and the Occupational Outlook Quarterly (

www.bls.gov/opub/ooq/home.htm

). Research the occupational groups that interest you, median pay, education, and projected growth.

Benefits and Costs When making career choices, you must weigh the benefits against the costs. The benefits could include a big salary, likelihood of personal growth and job advancements, and high job satisfaction. For some, the pluses might include the psychic benefit of a prestigious job with a high income. The costs might include living in a less desirable geographic area and climate, being far from friends and family, sitting at a desk all day, working long hours, and/or doing too much traveling.

Lifestyle Trade-offs A 

lifestyle trade-off

 is weighing the demands of particular jobs with your social and cultural preferences. When you consider a career, think about what lifestyle trade-offs are important to you. For example, if access to big-name live entertainment, museums, and artistic activities is important, then working and living in a rural area may not be appropriate. If you like to visit new places, you may choose a career that involves frequent travel or the chance to work overseas.

lifestyle trade-offs
Weighing the demands of particular jobs with your social and cultural preferences.

Consider the following lifestyle options in your decision making:

• Urban/rural setting

• Close/far from work

• Own/rent housing

• City/suburban life

• Warm/cold climate

• Constant/variable climate

• Near/far from relatives

DO IT IN CLASS

The Price of Career Coaching Privately available career coaching experts are available. For $600 you can buy 5 hours of basic services including identifying career goals, targeting companies, and practicing interviewing skills. For $3000 you can get customized preparation before each job interview. For $8000 you get 24/7-access to coaching, mock interviews, and one-on-one advice on salary and benefits.

2.1c Review Your Abilities, Experiences, and Education

Reviewing your abilities, aptitudes, experiences, education, and work style are key steps in career planning. The purpose is to see how well they match up with your career-related interests.

DECISION-MAKING WORKSHEET

 

Your Career Field Research

Selecting a career field should be based on solid research. It helps to have a set of questions prepared in advance. Use this worksheet to gather data about one or more career fields and use the results to compare fields against your values and interests. Various sources of data for your research are located throughout this chapter.

Career field	Comments on research results
General nature of work performed
Working conditions such as typical hours, degree of travel required, physical activities, and work locations and surroundings
Educational level, certifications, and training required for an entry-level position
Typical employee benefits provided
Typical career ladder including any geographical relocations that are likely to be required as one advances up the ladder
Educational level, certifications, and training required for career advancement
Earnings initially and as career progresses
Career field outlook in terms of employment growth and likely technological advances

Abilities and Aptitudes Your 
professional abilities
 are the qualities that allow you to perform job-related tasks physically, mentally, artistically, mechanically, or financially. Most of us think of ability as a word describing how well we do something, a proficiency, dexterity, or technique, particularly one requiring use of the mind, hands, or body. Other examples of abilities include being skilled in working with people, being able to easily meet the public, and being good at persuading people.

professional abilities

Job-related activities that you can perform physically, mentally, artistically, mechanically, and financially.

Employer surveys indicate that the single most important ability needed for career success in the twenty-first century is computer skills. Also very highly ranked are communication skills and honesty/integrity. Consider making a list of your top ten professional abilities.

Aptitudes

 are the natural abilities and talents that people possess. Aptitudes suggest that you have a tendency or inclination to learn and develop certain skills or abilities. Are you good with numbers? Do you find public speaking easy to do? Do you enjoy solving problems? What are your natural talents? Consider making a list of your top ten aptitudes.

aptitudes
The natural abilities and talents that individuals possess.

Experiences Most college graduates have much more going for them than a degree and a string of part-time job experiences. Reviewing your experiences is a step in career planning. Evaluate what you have been doing in your life, including jobs, participation in student organizations and community and church groups, leadership on school projects, volunteer activities, and internships. Hiring managers say college grads need two internships to be competitive.

Those still in college can enhance their job opportunities by learning as much as possible in school, participating in clubs and other student organizations (including volunteering for committees and campus projects), getting involved in a faculty research project, and attending off-campus professional meetings related to their major. Academic advisers can provide suggestions.

Education and Professional Training Going to college is excellent preparation for your career and your life. But college may not have provided you with all the skills and abilities to be successfully employed. A review of your abilities, experiences, and education may suggest you need to seek additional education and professional training.

Know Your Preferred Work-Style Personality Every job requires the worker to function in relation to data, people, and things in differing work environments and corporate cultures. Your 

work-style personality

 is a unique set of ways of working with and responding to your job requirements, surroundings, and associates. When making a career selection, you must balance your work-style personality against the demands of the work environment.

work-style personality
Your own ways of working with and responding to job requirements, surroundings, and associates.

You can begin by rating each work value as shown in the Decision-Making Worksheet “What Is Your Work-Style Personality?” Put a check mark in the appropriate column in terms of importance in your career. Armed with this information, you can now more clearly decide on careers that are most suitable for you.

Career planning should reflect your lifestyle preferences.

ADVICE FROM A PROFESSIONAL

Competencies of Successful People

People who are successful in their chosen careers, with their finances, and/or in life in general often possess and exhibit certain competencies.

1. Set goals in the various aspects of life and track progress toward attaining goals.

2. Use organizational tools such as making lists as well as using time management techniques.

3. Exhibit integrity.

4. Understand personal motives and behave ethically.

5. Make a quality effort every time.

6. Accept accountability for their decisions and actions.

7. Exhibit good written and oral communication skills.

8. Demonstrate strong computer skills.

9. Remain open to new ideas.

10. Adapt easily to change.

11. Share knowledge to assist and mentor others.

12. Acquire advanced education and technical training.

13. Be a life-long learner.

14. Willingly take on new assignments and capitalize on the new skills learned.

15. Anticipate problems and work proactively to implement solutions.

16. Work well in teams and know when to lead and when to follow.

17. Project an image consistent with organizational values.

18. Understand the operations, structure, and culture of the organization.

19. Are loyal to and supportive of the company and boss.

Caroline S. Fulmer

The University of Alabama

2.1d Take Advantage of Professional and Social Networking

Professional networking

 is the process of making and using contacts, such as individuals, groups, or institutions, to obtain and exchange information in career planning. Also use social-networking sites, including Facebook, LinkedIn, and Twitter. Spend a few minutes on the site each day making new connections, and keeping your profile up to date. Always send a personal message with all connection requests. Every person you know or meet is a possible useful contact. Don’t forget that a single crude quote or photo on a social-networking site could eliminate you from a job interview, therefore, be thoroughly professional at all times.

professional networking
Making and using contacts with individuals, groups, and other firms to exchange career information.

Job referrals are critical in professional networking. A 
job referral
 is the act of recommending someone to another for possible employment. This helps your résumé get a close look from a hiring manager. When you’re referred for a position, and you mention it in your cover letter, you’ve got a built in recommendation for the job in the first paragraph of your cover letter. It’s even better when the person referring you can take a couple of minutes to personally refer you for the job. A referral generally does not include a letter of recommendation. Companies find one-third of new hires through referrals. Thus you must make a conscious effort to use people you know and meet to maximize your job search process. Networking involves utilizing your social contacts, taking advantage of casual meetings, and asking for personal referrals. Most of your contacts will not be able to hire you, but they could refer you to the people who can, or they may be able to give you useful information about a potential employer.

job referral

The act recommending someone to another by sending a reference for employment.

Maintain a continually growing list of people who are family, neighbors, friends, college associates, coworkers, previous supervisors, teachers, professors, alumni, business contacts, and others you know through civic and community organizations such as churches and business and social groups. Take note of where your contacts work and what types of jobs they have. Ask these people for 10 to 20 minutes of their time so you can share a copy of your résumé and in an effort to seek information and suggestions from them. Perhaps meet at their workplaces (where you might meet other potential networking contacts), and afterward send them thank-you notes.

DECISION-MAKING WORKSHEET
 

What Is Your Work-Style Personality?

It would be useful for you to consider a number of work values critical to the process of career selection, particularly in the areas of work conditions, work purposes, and work relationships. Rate how you value the following work values as either very important in your choice of career, somewhat important, or unimportant.

As many as three-quarters of all job openings may never be listed in want ads, so the people in your network become a vital source of information about employment opportunities. For this reason, expanding the number of people in your network is advantageous; some of the people you know will also likely share their networking contacts. Don’t forget to keep them informed of your progress and eventual success in obtaining employment.

2.1e Align Yourself with Tomorrow’s Employment Trends

What are the trends in employment? The aging U.S. population will create jobs in the service industries of finance, insurance, health care, recreation, and travel. Jobs are gravitating to existing population centers, particularly in warmer climates that have superior transportation systems. Jobs in manufacturing continue to go overseas to Mexico, Asia, Europe, and other countries, with the U.S. job market primarily demanding highly skilled workers in the service industries.

Table 2-1

 Projected High-Growth Occupations

$100,000

$122,000

2,100,000

   $60,000

   400,000

Job Title	Employment in 2017	Median Annual Income
Accountants/auditors	1,440,000	$76,000
Advertising promotions managers	77,000	$95,000
Business operations specialists	396,000	$79,000
Child and social workers	324,000	$51,000
Compensation benefits managers	70,000		$100,000
Computer system design		2,100,000
Green construction		400,000	$75,000
Home health care services	1,900,000	$70,000
Human resource managers	72,000		$122,000
Industrial engineers	205,000	$98,000
Market research analysts	227,000	$81,000
Marketing managers	228,000	$153,000
Media and communications	46,000	$61,000
Medical/health service managers	305,000	$102,000
Property association managers	454,000		$60,000
Public relations specialists	231,000	$66,000
Sales managers	403,000
Retail stores
Social networking	$85,000
Training and development specialists	261,000	$74,000

Sources: Bureau of Labor Statistics, table 15, high-growth occupations, by educational attainment cluster and earnings; authors’ income projections to 2017.

www.bls.gov/ooh/fastest-growing.htm

 and 

www.bls.gov/news.release/ecopro.t05.htm

; authors’ projections to 2017.

High-demand occupations tend to pay high salaries and offer career advancement opportunities. Majors in engineering can yield starting salaries of $90,000 and above. Accountants, actuaries, nurses, pharmacists, and software engineers are also in high demand and they, too, are highly compensated. Your academic choices should, at least in part, be based upon employment trends. If you have the aptitude, you might pursue a degree in a field that pays well. Table 2-1 shows the projected job opportunities in high-growth occupations in the United States.

DID YOU KNOW 

The No-Limits Job

Many younger workers are employed in entry-level positions where they are expected to be on-call via a mobile device at all hours of the day and night. They face stressful demands from their companies, such as 300 or 400 daily e-mails and tweets and only a few less on weekends. These jobs encourage them to knock down the boundaries between life and work. This is affecting millennials, the creative class, and the workforce at large. ask about these things during an interview and decide about the job based on the answers you receive.

2.1f Finalize Your Career Plan

As you near graduation, you will be ready to develop a formal career plan. 

Figure 2-2

 provides an illustrative career plan. Your career plan should be realistic and flexible. Your career interests and goals will change over time, especially as you continue your education, gain work experience, and see how your friends fare with their jobs and avocations. Teaching music education might be your first career, but you may eventually realize that the accompanying small income could keep you on a tight financial budget forever. This issue might encourage you to consider a total career change—perhaps to sales in the music industry or a related field, where incomes are higher.

Assessing yourself and your career plans every few years is important to achieving success in your working life. What do you find satisfying and not so satisfying? Honest answers will help you, particularly as your interests evolve. Your work experiences should hone your abilities and skills. Learning new skills on the job is common, and if that is not happening in a job, move on and change employers and perhaps careers.

Figure 2-2
 Career Goals and Plans for Harry Johnson

DID YOU KNOW 

Entrepreneurship May Be Your Best Way

Starting a company out of a perceived opportunity occurs when people are hopeful about their situations. They are making a choice between working for someone or working for themselves. Participating in a new business creation is a common activity among U.S. workers over the course of their careers.

An entrepreneur is someone who organizes, manages, and assumes the risks of a business or enterprise. Don’t be afraid to take the chance to be part of a start-up company, especially while you are young because if you fail you can always return to the normal working world. If you succeed, well, the world is yours.

 CONCEPT CHECK 2.1

1. Distinguish between a job and a career.

2. How do your values affect your trade-offs in career planning?

3. What can be done to enhance your abilities and experiences without working in a job situation?

2.2 FINANCIAL AND LEGAL ASPECTS OF EMPLOYMENT

LEARNING OBJECTIVE 2

Analyze the financial and legal aspects of employment.

This section examines financial and legal aspects of employment to consider when analyzing your career plans.

2.2a Is College Worth the Cost?

Concerns regarding educational quality and student indebtedness are good ones. Only you—the student—can answer the question: “Is college worth the cost?” While in school avoid a major with a vague credential, appears low in knowledge and skills, and results in a crippling amount of debt. Besides the 
STEM majors
 (science, technology, engineering, and mathematics), there are numerous academic majors that teach employable skills and also pay good salaries upon graduation.

STEM majors

Academic majors in science, technology, engineering, and mathematics.

Education is more than an investment; it is a treasure. It is priceless. College is a place to think, to contemplate, to find out what is valuable, and question the value of what is made. You should be a reasonably literate citizen of the world who had some intelligent understanding of the larger-than-local interests.

Going to college does not require $25,000 or $50,000 in debt. It does not mean you borrow to pay for your rent and food as well as your tuition. If necessary, attend a less expensive school, live at home, work part-time, go to school part-time, and ask parents and other relatives for some financial assistance. Borrow as little money for tuition as possible. And no matter what, do not drop out of school before you graduate. Nearly 9 out of 10 graduates say their college expenses have been a good investment. College graduates also earn twice as much per hour as high school graduates. The return on investment for a bachelor’s degree is about 15 percent a year.

2.2b Place Dollar Values on Employee Benefits

Employee benefits are tremendously important to employees, especially when comparing the benefits provided by one employer with another. 

Employee benefits

 (or 

nonsalary benefits

) are forms of remuneration provided by employers to employees that result in the employee not having to pay out-of-pocket money for certain expenses. Examples include paid vacations, health care, paid sick leave, child care, tuition reimbursement, and financial planning services.

employee benefits
Forms of remuneration provided by employers to employees that result in the employee not having to pay out-of-pocket money for certain expenses; also known as nonsalary benefits.

DID YOU KNOW 

Do Not Give Up

$160,000

When Changing Employers

When changing jobs, nearly half of workers unwisely cash out all the money in their employer-sponsored retirement plan instead of roll it over to a new employer’s 401(k) plan, moving it to an IRA rollover account, of leaving it with the old employer (if that is allowed). If an individual has $50,000 in a 401 (k) account and cashes it out, that person gives up $160,000 in future dollars over the following 20 years earning 6 percent annually.

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−$ 2,500

+$50,000

If you cash out $50,000:	If you roll over $50,000:
20% required federal income tax withholding	−$10,000
5% additional tax (in 25% tax bracket)		−$ 2,500
10% required early-withdrawal penalty	−$ 5,000
5% state/local income tax
Total withdrawn	−$20,000		+$50,000
Money spent on new car, TV, home repair, vacation, etc.	− $30,000	Money invested in another tax-deferred retirement account that earns 6 percent annually
		Total	−$50,000
Additional investment actions taken	None	Money grows for 20 years
Investment balance after 20 years	$ 0	$160,000

DID YOU KNOW 

Value of Additional Education

Income over the Life Cycle According to Age and Education

Income varies over the life cycle. Higher incomes typically go to those with more education or more specialized education. The U.S. Census Bureau reports that young adults (ages 25–34) with a bachelor’s degree earn an average of $47,000 compared to $31,000 for a high school graduate and $80,000 for those with advanced degrees.

To put monetary values on employee benefits, you may (1) place a market value on the benefit or (2) calculate the future value of the benefit.

Place a Market Value on the Benefit If instead of enjoying a certain employee benefit, you had to pay out-of-pocket dollars for it, you can easily determine its market value. Private child care might cost $300 a week in your community; thus, when child care is provided free from your employer, that is a whopping $15,000 ($300 × 50 weeks) saved annually. Actually, it is more because after paying $7000 in income and Social Security taxes you would likely have to earn perhaps $22,000 to have $15,000 left over. An employer-provided paid-for life insurance policy with a face value of $50,000 might cost $100 to $400 if you had to buy it yourself.

Calculate the Future Value of the Benefit An employer that provides a 401(k) retirement plan offers a valuable benefit. If an employer provides a match of $1200 a year to your $1200 in contributions, all the money in the account will grow free of income taxes until the funds are withdrawn. Over 20 years, the annual employer contributions of $1200 growing at 6 percent annually to more than $44,000 (using 

Appendix A.3

). That is in addition to your $1200 a year contributions for a total of over $88,000.

2.2c Know Your Legal Employment Rights

You have legal rights both during the hiring process and after you are hired. When selecting employees, employers may not discriminate based on age, gender, race, color, sex, marital/family status, religion, national origin, birthplace, age, and disability (if the person can perform the essential job tasks). Laws in many states and cities also prohibit discrimination against gays and lesbians in the hiring process. Once hired, you have many rights. Employers must do the following:

• Pay the minimum wage established by federal, state, or local laws

• Provide unemployment insurance

• Provide workers’ compensation benefits for job-related injuries or illness

• Pay Social Security taxes to the government, which are then credited to the employee’s lifetime earnings account maintained by the Social Security Administration

The law requires that hourly employees be paid overtime for extra work hours put in beyond the standard 40-hour workweek. Salaried employees are not paid overtime, and the vast majority of college graduates have salaried jobs. In addition, a woman cannot be forced to go on maternity leave before she wants to do so if she does choose to take leave. You have the rights not to be unfairly discriminated against or harassed and to be employed in a safe workplace.

You have the right to take leave for personal or family medical problems, pregnancy, or adoption. You also have the right to privacy in such personal matters. When you leave an employer, you have the right to continue your health insurance coverage, perhaps for as long as 18 months [using the provisions in the Consolidated Omnibus Budget Reconciliation Act (COBRA) as discussed in 

Chapter 11

], by paying the premiums yourself. If you believe you have been wronged, you may assert your legal rights.

RUN THE NUMBERS

Assessing the Benefits of a Second Income

A second income might add surprisingly little to your total earnings because of all the costs associated with earning it. In this example, a nonworking spouse is considering a job that pays $30,000 annually. The total net amount of the extra $30,000 income is a mere $8805, thus adding only $734 ($8805/12 = $767) a month to total earnings.

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Total

      300

    1,200

Total

1. Second Income
Annual earnings	$30,000
Value of benefits (life insurance)		300
1 $30,300
2. Expenses
Federal income taxes (25% rate × $30,000)	$  7,500
State/local income taxes (6% rate × $30,000)	1,800
Social Security taxes (7.65% × $30,000)	2,295
Transportation and commuting (50 weeks @ $40)	2,000
Child care (9 months after-school only)	3,600
Lunches out (50 weeks, twice a week at $10)	1,000
Work wardrobe (including dry cleaning)		1,200
Other work-related expenses (magazines, dues, gifts)
Take-out food for supper (too tired to cook; $100 per month)
Guilt complex purchases (to make up for time lost with others)	600
2 $21,495
3. Net Value of Second Income
Total of 1 from above	$30,300
Subtract total of 2 from above	21,495
Total accurate net amount of second income	$  8,805

DID YOU KNOW 

What to Do When You Lose Your Job

What should you do when you are laid off from your job?

1. 
Think of yourself as being employed

. Your job is to find a new job. Set a work schedule for yourself and a location at home from which to do the work.

2. 
Get your finances in order

. Determine how much money you have and the level of unemployment benefits you might be able to receive. Determine how long you can continue to pay your bills in the usual fashion.

3. 
Tap into your network

. Let people know that you are looking for work. Rebuild your network if necessary. Build contacts with other unemployed persons in your field so that you can share successful and unsuccessful strategies.

4. 
Take a hard look at the prospects for a possible rebound of employment opportunities in your career field

. Some of the jobs lost in the recent economic turmoil are the result of temporary sluggishness in an industry. Others will never come back.

5. 
Get retrained

. This is especially important if your career field will see permanent reductions in the needed level of workers. Local community colleges are especially focused on retraining programs and may have financial assistance to help you.

6. 
Be prepared to move

. Some geographic areas of the country are poised to rebound faster than others. Those which will grow fastest are places with strong public schools and colleges, highly educated workers, and emerging high-tech and information-age industries.

7. 
Don’t be afraid to be a temp

. Many firms will hire temporary workers at first when recovering so that they can quickly downsize if necessary. They will look first to hire the temporary workers into their permanent work force.

 CONCEPT CHECK 2.2

1. Summarize how education level and age affect income.

2. What two techniques can be used to place monetary values on employee benefits?

3. Choose three career advancement tips and explain how each one might apply in someone’s personal situation.

2.3 EFFECTIVE EMPLOYMENT SEARCH STRATEGIES

LEARNING OBJECTIVE 3

Practice effective employment search strategies.

Once you have undertaken some career planning, you will want to start the process of getting a job in your preferred career field. This is an effort that takes much effort. A successful job search might require 25 to 40 hours per week of your time. Effective search strategies follow.

2.3a Assemble an Attention-Getting Resume

The Internet is a valuable resource for you in all aspects of career planning, including preparing a résumé. A 

résumé

 is a summary record of your education, training, experience, and other qualifications. It is often submitted with a job application. Your résumé, usually one or two pages in length, should be carefully written and contain zero errors or inconsistencies in message, content, and appearance. A survey of top executives reveals that 75 percent will not even consider an applicant whose résumé has one or more typos. Resumes should be in PDF format so they can be viewed on a variety of mobile devices.

résumé
Summary record of your education, training, experience, and other qualifications.

DID YOU KNOW 

Prospective Employers Can Check Your Credit Report

Thirteen percent of employers obtain the credit reports of prospective job candidates. A lousy credit history can suggest a lot about a person’s inability to manage important tasks. Federal law requires that individuals (1) are aware that consumer credit reports may be used for employment purposes and must agree to such use and (2) are to be notified promptly if information in a consumer report may result in a negative employment decision. About 20 states prohibit employers from using credit reports when hiring.

Its primary function is to provide a basis for screening people out of contention for jobs. When you supply a résumé, you are providing documentation for some kind of subjective evaluation against unknown criteria. Large employers, recruiters, and local and national websites screen resumes using an applicant tracking software system, also known as APS, to screen online resumes.

We live in a world of income inequality based in part on what is known as skill-based-technological-change (SBTC), and if you do not have the skills you better get some. If you do have the skills, show them off in your résumé. Use nouns and noun phrases, such as “Microsoft Office” or “Excel” so the scanning process picks them up. A good place to find keywords is to review 10 employment ads with similar job titles in your field and see which words are repeatedly mentioned.

A Harvard professor observed that, “The world no longer cares about what you know; the world only cares about what you can do with what you know.” Thus, you should focus your résumé on skills and competencies that are most relevant to the position you aspire to hold. When it is necessary to technically fulfill a requirement in the employment process, tailor a special edition of your résumé to fit that special set of circumstances. Resumes are usually presented in a 
chronological format
 (information in reverse order with the most recent first), 
skills format
 (aptitudes and qualities), or 
functional format
 (career-related experiences). See 

Figures 2-3

, 

2-4

, and 

2-5

 for sample resumes. The most common mistake in a résumé is to fill it up with a long list of functions and responsibilities that you had in your previous jobs instead of evidencing the specific accomplishments that made a difference in the companies for which you worked.

chronological format

Resume that provides your information in reverse order, with the most recent first.

skills format

Resume that emphasizes your aptitudes and qualities.

functional format

Resume that emphasizes career-related experiences.

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Figure 2-3
 Sample Chronological Resume

Figure 2-4
 Sample Functional Resume

Figure 2-5
 Sample Skills Resume

DID YOU KNOW 

Top Personality Traits Employers Want Most

Most employers want a good cultural fit when hiring. Here is what they are looking for:

1. Professionalism

2. High-energy

3. Confidence

4. Knows how to think

5. Organizational skills

6. Bottom-line oriented

7. Team player

8. Results-oriented

9. Can defend opinions

10. Effective communicator

Colleges have career centers with sample resumes and professional staff who can offer personal advice. You can also find examples of resumes on the Internet. Monster.com has 500,000 online resumes, and it’s easy to find resume templates by searching for them online. However, posting your résumé on an Internet site or sending out resumes is not conducting a significant job search. Realize also that if your résumé is posted on the Internet your current employer can view it.

Some high-tech and marketing companies are skipping resumes altogether and hiring based solely on tweets, the online text-based messaging service of up to 140 characters. A tweet or two or five over five days may provide the company with everything they need to know about you and your online personality. But most jobs will still require resumes.

2.3b Target Your Preferred Employers

A key step in the job search process is to think about both the industries in which you would prefer employment and which employers might be best for you. If, for example, you want to work in the health care industry, you must visit the websites of health trade associations and various health care firms. Learn as much as you can about the health care industry. How broad is the industry? What types of companies are at the retail level? At the wholesale level? What kinds of firms provide services to the industry? Which companies are the largest? Which have the fastest growth rates? Which employers have employment facilities in geographic areas that are of interest to you? What are the leading companies? Which are the “employers of choice” that are family friendly or offer especially good benefits? What are the employee benefits at different companies? Knowing the industry and specific employers of interest to you tells you whom to target for employment in your career path. “Liking” a company can mean receiving early notices of job openings and other news.

ADVICE FROM A PROFESSIONAL

Career Advancement Tips

The essence of career advancement is to build your job-related knowledge and skills for the future by learning. You do not want to fall behind your coworkers and those who work for other employers, as they may be your future job market competitors. Change jobs when appropriate to obtain a different or better position that advances your career or when deemed necessary to entirely alter your career. To advance in your career, consider the following:

• Mentors and Sponsors. Ask one or two people to serve as your mentors, people with whom you can regularly discuss your career progress. A 

mentor

 is an experienced person, often a senior coworker, who offers friendly career-related advice, guidance, and coaching to a less experienced person. Getting someone to sponsor you is even better. A 

sponsor

 is a powerfully positioned champion who “leans in” with you by advocating on their proteges’ behalf and guiding them toward key players and assignments.

mentor
An experienced person, often a senior coworker, who offers friendly career-related advice, guidance, and coaching to a less experienced person.

sponsor
A powerfully positioned champion who “leans in” with an employee by advocating on their proteges’ behalf and guiding them toward key players and assignments.

• Traits. Exhibit passion, self-discipline, confidence, and determination in your everyday responsibilities.

• Volunteer. Volunteer for new assignments.

• Training. Sign up for employer-sponsored seminars and training and certification opportunities.

• Conferences. Attend meetings and conferences in your field. Become a member of your local professional association and become active in its leadership.

• College Courses. Take advanced college courses and complete a graduate degree.

• Professional Reading. Stay alert to what is happening in your career field by reading professional and trade publications.

• Current Events. Be up to date on current events and business and economic news by reviewing websites and reading newspapers, news magazines, and business periodicals.

• Nonwork Activities. Be actively involved in something besides work, such as coaching children’s athletics, playing softball, singing in a choral group, or teaching reading to illiterate adults.

Dana Wolff

Southeast Technical Institute, Sioux Falls, SD

2.3c Identify Specific Job Opportunities

The next step is to identify specific job openings that fit your skill set and provide opportunities for advancement in your career. Record your job search progress below using the Decision-Making Worksheet “Keeping Track of Your Job Search.”

Internet, Career Websites and Job Boards You can use the Internet to obtain career advice, review job opportunities by industry and company, and conduct specialized job searches. You also can review resumes, create your résumé, create a cover letter, and post your résumé. The Internet allows you to review salary information, calculate living costs in different communities, and research career fairs. Just about all your search information on the Web can be saved for your future use.

Use 
job boards
 in your search, too. These are websites devoted to helping employers find suitable new employees by providing job listings, job sites, job search tips, job search engines, and related articles; some allow posting of resumes. Check out targeted industry sites, such as 

SalesJobs.com

, 

Indeed.com

, or 

Bridgespan.org

. Also search Google for “niche job websites” in specific industries.

job boards

A website devoted to helping employers find suitable new employees by providing job listings, job sites, job search tips, job search engines, and related articles; some allow posting of resumes.

Career Fairs 

Career fairs

 are university-, community-, and employer-sponsored opportunities for job seekers to meet with perhaps dozens or even hundreds of potential employers over one or more days. Here you can schedule brief screening interviews with a half-dozen or more employers in a single day. Career fairs are advertised in local newspapers, on television, and on the Internet. Search “career fairs” on the Internet as well as at 

CareerBuilder.com

 and 

NationalCareerFairs.com

. There usually are not many jobs at career fairs but participating definitely will help you practice your interviewing skills.

career fairs
University-, community-, and employer-sponsored events for job seekers to meet with many employers quickly to screen potential employers.

Classified Advertisements Advertisements in newspapers and professional publications usually are not very important in the job search process. However, big newspapers, such as the Atlanta Journal-Constitution and Chicago Tribune, advertise many jobs in large geographic areas. Others such as the New York Times and The Wall Street Journal have jobs for the whole country. And others like the Financial Times (

aboutus.ft.com/careers

) describe overseas opportunities.

Employment Agencies An 
employment agency
 is a firm specializing in locating employment positions for certain types of employees, such as secretaries, salespeople, engineers, managers, and computer personnel. Most employment agencies are paid fees by organizations that hire them to find new employees. Others charge the job hunter fees, sometimes very high amounts. Only talk with those firms whose companies pay the fees. Governments also have state or city employment offices that offer free services. Often these are not the best ways to find a good job, although sometimes they are very successful.

employment agency

Firm that locates employment for certain types of employees.

DID YOU KNOW 

Money Websites for Career Planning

Informative websites for career planning, including job boards and sites that account for 30 percent of newly hired people are:

CareerBuilder.com

 (

www.careerbuilder.com

)

CareerBuilder.com
 key résumé words (

www.careerbuilder.com/article/CB-464-cover-Letters-Resumes-What-are-Resume-Keywords/

)

FlipDog (

www.flipdog.com

)

LinkUp (

www.linkup.com

)

Monster (

www.monster.com

)

NationJob (

www.nationjob.com

)

ResumeMachine.com (

www.resumemachine.com

)

RileyGuide (www.resumemachine.com)

SimplyHired (

www.simplyhired.com

)

DECISION-MAKING WORKSHEET
 

Keeping Track of Your Job Search

Below is a list of task areas in worksheet format that you can use to help keep track of your job search progress. Create more columns to the right so you can input important information, such as dates when you completed each effort.

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_________

_________

_________

_________

_________

_________

_________

_________

_________

_________

_________

_________

_________

_________

_________

_________

_________

_________

_________

_________

_________

_________

_________

_________

_________

_________

_________

_________

_________

_________

_________

_________

_________

_________

_________

_________

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_________

_________

_________

_________

_________

_________

_________

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_________

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_________

_________

_________

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_________

Date Done

Deadline to Do More

1. Identify your values.

_________

2. Decide on economic, psychic, and lifestyle trade-offs.

3. Clarify career-related interests.

4. Assess abilities, experiences, and education.

5. Identify employment trends.

6. Create career goals and plans.

7. Target preferred employers.

8. Analyze your work-style personality.

9. Compare salary and living costs in different cities.

10. Calculate values on employee benefits.

11. Create an expanding list of networking contacts.

12. Obtain excellent letters of reference.

13. Compile revealing personal stories.

14. Assemble a résumé.

15. Prepare a cover letter.

16. Identify job opportunities:

a. Career websites

b. Job boards

c. Career fairs

d. Classified advertisements

e. Employment agencies

17. Interviewing:

a. Research the company.

b. Create responses for anticipated interview questions.

c. Create positive responses to list of negative questions.

d. Evaluate your interview performance.

18. Send thank-you notes.

19. Negotiate for salary.

20. Accept the job.

2.3d Write an Effective Cover Letter

A 

cover letter

 is a letter of introduction sent to a prospective employer designed to express your interest in obtaining an interview. An effective cover letter helps introduce and sell you to the prospective employer. The cover letter should be specifically written for each position for which you are applying. See 

Figure 2-6

 for an example. Expand upon a couple of details from your résumé, explaining how your talents and experience can benefit the employer. Communicate your enthusiasm for the job. When appropriate, mention a networking contact.

cover letter
A letter of introduction sent to a prospective employer to get an interview.

Address your cover letter, written on high-quality paper, to a specific person and request a brief meeting. If the hiring manager’s name is not in the job announcement, telephone the employer and speak with a receptionist in the correct department. Be candid about your reason for needing a specific person’s name. Your letter should try to secure a face-to-face meeting to obtain more information and gather impressions. End the letter with a sentence stating that you will be telephoning or e-mailing within two weeks to reassert your interest in the position. Then, do so! Be sure to use a professional and nondescript e-mail address (like 

Jsmith@yahoo.com

 or Jsmith@aol.com) instead of something like 

cutelady@cutelady.com

. Your cover letter should include a signature block that provides a link to your online résumé.

Figure 2-6
 Sample Cover Letter

DID YOU KNOW 

Sean’s Success Story

Sean began his college career without a specific major in mind, although he knew he was interested in working with people. During his sophomore year, Sean took a class in public relations. He enjoyed the class immensely and realized that the public relations field fit his interests, abilities, and aptitudes. He declared a major in communications and talked to his advisor about jobs he could take to help him understand the field better and make good contacts for the future. Sean volunteered at his local chamber of commerce and signed up for an internship at a public relations firm between his junior and senior years. At graduation, he mapped out a career plan and soon found a job in a small public relations firm that would help him learn all of the various aspects of working in such a firm. Sean has been with the company for two years and was promoted to project manager. His long-term goal is to one day own his own public relations firm.

2.3e Obtain Strong Reference Letters

College students too often simply ask a couple of professors they like to write them a letter of recommendation. Professors typically give their best judgments in these letters. This may include identifying some student weaknesses as well as strengths. Students who ask for a letter from an instructor who does not know them well also risk receiving a bland, boilerplate, or average kind of reference.

Ask only those professors who know you and your schoolwork well and give them a copy of your résumé. Approach them with a request similar to “Are you willing to give me a strong, positive letter of recommendation? I need one that points out my better qualities and performance here at college.” If the instructor hesitates too long or gives you some negative feedback, consider asking a different professor for a recommendation. If your recommenders are willing to give you a separate copy of their letters, you will have them in your personal files to photocopy for future use.

2.3f Formally Apply for the Job

You can’t get a job without applying for it. Personalize your cover letter and résumé to fit the specific job of interest. Send it to the prospective employer. Many large employers prefer to receive job inquiries via the Internet, often through their website. If so, follow the application instructions perfectly. Other employers prefer a written letter and résumé. It may be smart to do both.

DID YOU KNOW 

Stay Positive in a Sluggish Job Market

In many parts of the country a sluggish job market is causing financial strains for many and can delay career advancement. It has psychological impacts as well. Here are strategies that can help you cope.

1. Stay physically active and eat well. Exercise and staying fit have both physical and psychological benefits.

2. Be up front about your anxiety, frustration, stress, and even fears. Share your concerns with family and friends.

3. Maintain a positive frame of mind. Delays are not permanent and the job market will turn around.

4. Stay involved in your professional network.

5. Volunteer both for the good you will be doing and for the possibilities for networking it provides.

If you have not received a response to a job inquiry within two or three weeks, send a follow-up inquiry by adding a brief new opening sentence to your cover letter and send the revised letter with your résumé. When employers express interest in you as a prospective employee, they may request that you complete their official job application form. Be accurate in your responses.

2.3g Interview for Success

The interview is the single most important part of your search for employment. A 

job interview

 is a formal meeting to discuss an individual’s job qualifications and suitability for an employment position. When you are invited for an interview, be prepared. This is a sales event in a traditional environment, so be professional. To succeed you should have an up-to-date haircut and wear clothes that are in fashion. Look the interviewer in the eye and lean forward as this suggests you are interested. When talking focus on the company’s needs not yours. Be sure to bring up how you have been keeping up with technology and changes in your field of work.

job interview
Formal meeting between employer and potential employee to discuss job qualifications and suitability.

Malcolm Gladwell, author of Blink, argues that when you meet someone for the first time, “your mind takes about two seconds to jump to a series of conclusions.” It is not intuition or a snap judgment; it is rapid rational thinking. A human resources manager can read you the moment you walk into the door from your smile, first few sentences, tone of voice, the way you walk, the clothes you wear, how you stand, the grip of your handshake, and how you sit. You must present yourself as a confident and energetic professional.

Practice your “blink” before every interview, so you will be ready for a conversation on Skype instead of a traditional face-to-face interview. If this happens to you, get ready. If interviewing at home, make the background neat, make sure your face is well lit, eliminate the chance of interruptions, sit still, and practice beforehand. Professional recruiters estimate that perhaps only 20 percent of college seniors adequately prepare for their interviews.

DID YOU KNOW 

Bias Toward Underestimating Incomes

People engaged in career planning have a bias toward certain behaviors that can be harmful, such as a tendency toward underestimating the fair value of their labor in the future. This suggests that people overvalue the pay of a new job and undervalue the value of future economic benefits. What to do? Consider staying at the employer a long time to enjoy the higher pay later on in life.

Five Good Points to Raise in an Interview Make five key points during your interview: (1) “Let me tell you about the time that I solved a similar problem” (and then tell a story), (2) “Does that make sense, please clarify” (demonstrates that you are thorough and accurate), (3) “I saw that announcement about your company on a website” (shows off your genuine interest in the firm), (4) “Why did you come to work here?” (shows that you are curious about the company), (5) “I’d love the opportunity to join this company” (implies that you will accept an offer, if made).

Do Lots of Research Before the Interview Before the interview, research the company. Try to know more about it than the interviewer. Learn how the company makes money, its operations and history, profitability, expansion plans, and other recent developments. Research the company’s history. Also research the company’s competitors and the industry. You cannot spend enough hours on this effort!

Know the major industry trends and news and be able to talk about how they could affect the company. Know what the company is good at and how this relates to your skills. Be familiar with the job description. Find out what it is like to work at the specific company. When you do a background check on companies, you might seek out candid posts from current or former employees about salaries, company culture, and lousy bosses. However, be wary about unsubstantiated information. See CareerBuilder (www.careerbuilder.com), Glassdoor (

www.glassdoor.com

), Jobster (

www.jobster.com

), PayScale (

www.

payscale.com

), LinkedIn (

www.linkedin.com

), and Vault (

www.

vault.com

).

Prepare Responses for Anticipated Interview Questions Your responsibilities during the interview are to remain calm, reveal your personality, be honest, convey your best characteristics, handle questions well, and communicate your enthusiasm about the job. Always answer in a controlled manner. During the interview, be confident that you are the best person for the job and project yourself accordingly.

Job interviewers seem to ask similar questions. You know they are coming so prepare good, personal responses for the following inquiries:

1. Tell me about yourself.

2. How would your instructors and previous employers describe you?

3. What did you like the most about college, and the least?

4. Tell me what you know about our company.

5. Why are you interested in working for this company?

6. What unique abilities and experiences qualify you for the job?

7. Describe some of your strengths and weaknesses.

8. What experiences have you had working with teams and coordinating such efforts?

9. Give an example of an ethical challenge you faced and tell how you handled it.

10. Relate a time when you were faced with a very difficult problem and how you handled it.

11. Describe the supervisors who motivated you to do your best work.

12. What were some of the best and worst aspects of your last job?

13. What do you do in your leisure time?

14. Describe your career plans for two and five years from now.

DID YOU KNOW 

Your Worst Financial Blunders in Career Planning

Based on others’ financial woes you will make mistakes career planning when you:

1. Neglect to fully research a company before going for an interview.

2. Fail to match your interests and preferred work style with the requirements of the career.

3. Disregard networking by not getting involved in local career-related professional associations.

Create Positive Responses to Negative Questions Be prepared to “turn any negative into a positive” when asked such questions. One popular negative question is, “What are your weaknesses?” Interviewers who ask this type of question want to determine whether the applicant possesses certain qualities such as honesty, self-awareness, humility, sincerity, zest, and skill in managing shortcomings and mistakes. Denying weakness or being evasive means you don’t get the job.

Practice your interview skills beforehand. Practice your responses, especially to negative questions. Perhaps make a videotape of a mock interview, and after evaluating your performance, do it again.

Compile Revealing Personal Stories Assemble some personal stories about yourself that reveal some of your better characteristics. For a single job at a company you could have five or more interviews in one day, and during the interview process, you are expected to talk about yourself. Therefore, prepare by writing down some concise stories or statements, perhaps about the time you took over caregiver duties for your siblings while your mother was hospitalized, or facilitated resolving some internal conflicts among the officers in your student club, or assisted a high school teacher to coordinate and supervise 20 students on a field trip, or worked 14 straight hours at Walmart during a weather emergency. Preparing as many as a dozen stories will give you many ways to talk about your positive qualities without just saying, “I’m good.” Everyone else says that! Communicate that message about yourself in part by telling stories to illustrate your better qualities.

You need not volunteer information in an interview that might hurt you, but respond to questions accurately. Misrepresenting facts, making even small distortions, will cast doubt on everything in your résumé and on everything you said in the interview, and you will not be hired.

Be certain to ignore tweets and do no texting at any time during an interview visit. Even better, turn off your cellphone. Your entire focus should be on the interview experience.

Prepare Questions to Ask the Interviewer A key to success in any interview is to show your enthusiasm and interest in the position and organization. Compliment the interviewer’s company based on some facts learned in your pre-interview research. Also, prepare some questions to ask, perhaps about future company plans, company policies, employee benefits, specific duties, and job expectations. You will want to inquire about the corporate culture, too. Write down your questions so you will have your thoughts clear in your mind. Consider the following questions:

• “What qualifications make for an ideal candidate?”

• “What attracted you to this company?”

• “If you hire me, what can I accomplish in the next six months that will make you glad you did?”

• Toward the end of the interview and after restating your interest in the position, ask, “What is the next step?”

Personality Tests One-third of employers give job candidates personality tests assessing team orientation, strengths important to a job, emotional intelligence, motivation, and true work-style inclinations. Don’t try to game the employer by telling them what they want to hear—the “right” answer. Being honest confirms what the prospective employer already knows about you.

Be Ready for Telephone Interviews When returning a telephone call or engaging in an interview present yourself in a professional manner. Have a pen or pencil and paper handy. Be aware of distractions in your surroundings, such as traffic noise. If necessary, arrange to call the interviewer back when you find a quiet place. Speak clearly, and eliminate the “uhs” and “umms.” The interviewer will notice if you take a sip of coffee or a bite out of a bagel.

After the Interview, Evaluate It and Send Thank-You Notes After a job interview, take a few minutes to objectively evaluate your performance. Write down any questions you were asked that were different from what you expected and make some notes about ways to improve in your next interview. The more interviews you have, the better you will be able to present yourself. Also, immediately mail thank-you notes expressing your appreciation for the opportunity to interview and restate your interest in the position. Four out of five successful job seekers send thank-you notes to everyone they meet.

DID YOU KNOW 

How to Interview Over a Meal

More people lose a job interview over lunch than during the formal interview because they fail to realize that going to lunch is a continuation of the interview rather than a social situation. Employers want to hire people with some degree of refinement, people who will mix well with clients and executives. It is smart to engage in conversation over a meal, of course, but let the host do most of the talking. Good etiquette tips include the following:

• Order something that is less expensive than what the host has ordered.

• Keep your elbows off the table.

• Break (don’t cut) your bread or roll before buttering.

• Use the bread knife (the small knife to the right of your plate).

• Use the small fork outermost from the plate for the first course.

• Don’t salt and pepper your meal before tasting it.

• Cut your meat one bite at a time.

• Don’t talk with food in your mouth.

• Don’t order beer, wine, or liquor.

• Avoid ordering soup or pastas because they can be too messy.

• Be extremely polite and respectful of the servers.

• Never complain about a meal.

• Leave it to your host to signal the server.

• If confused, be patient and follow the lead of the host.

• Leave your napkin on your chair when excusing yourself.

• When the meal is over, thank the host and state that you want the job.

2.3h Negotiate and Accept the Job

Wait until after the job has been firmly offered to discuss salary. Ask for the salary range for the position. Do not be the first to give a definitive dollar amount. Your objective in negotiating is to obtain a salary 20 percent above the highest figure because you are an exceptional candidate and you will perform at the highest level anticipated. Don’t sell yourself short. Even if the job posting states “salary is not negotiable,” do so. Your competitors will.

Focus on both gross and net pay. A gross income of $60,000 shrinks to about $40,000 after subtracting federal income, Social Security, and Medicare taxes. Additional deductions for contributions for medical care, retirement, and flexible benefits may drop the take-home pay to $37,000, or $3083 a month. You can then add back the value of employer-paid benefits such as life insurance and the employer match in their retirement plan, but you cannot take that money home.

Compare Salary Offers Comparing salary offers from employers located in different cities can be tricky without sufficient information on the approximate cost of living in each community. Sometimes those costs vary drastically. Information from the Internet reveals, for example, that life in a high-cost city such as Seattle is more expensive than life in a lower-cost city such as Portland, Oregon. The data are reported in index form, with the “average cost” community being given a rating of 100.

The following example demonstrates how to compare salary offers in two cities. Assume the Seattle (city 1) index is 138, and Portland’s (city 2) is 114. You want to compare the buying power of a salary offer of $52,000 in Portland with a $65,000 offer in Seattle. The costs can be compared using 

Equations (2.1)

 and 

(2.2)

.

Thus, the $65,000 Seattle salary offer would buy $53,695 of goods and services in Portland, an amount more than the Portland offer of $52,000. All things being equal (and they are both nice cities), the Seattle offer is slightly better ($53,695−$52,000=$1,695).

To compare the buying power of salaries in the other direction, reverse the formula:

Thus, the $52,000 Portland offer can buy only $62,947 of goods and services in Seattle—an amount less than the $65,000 Seattle salary offer. All things being equal, the Seattle offer is still better. For fairer comparisons, add the value of employee benefits and redo the calculations. Note that non salary benefits for college graduates are typically valued at 25 to 30 percent of the salary.

FINANCIAL POWER POINT

 

Common Job Interview Mistakes

1. Inappropriate attire

2. Being late or at the wrong time/date

3. Displayed little knowledge of employer or industry

4. Poorly prepared to discuss abilities, skills, and experience

5. Unable to discuss career plans and goals

6. Overly aggressive/entitled about job expectations

7. Demonstrated little enthusiasm

8. Poor eye contact

9. Use slang or overly casual language

10. Checking phone/texting/tweeting

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DID YOU KNOW 

How to Deal with Rejection

The job search process is filled with rejections. Before you land a job, you might have 5 or even 100 potential employers say “No!” Don’t let employment rejections strip you of your self-esteem, or you will begin to falsely think that there is something wrong with you. A rejection is simply an indicator that there is an inadequate match between your qualities and the employer’s needs as perceived in the interview.

After a turndown, when possible, ask the company for a review of the strengths and weaknesses of your interview. Make an effort to improve for the next interview. Then, forget the disappointment and move on with your job search.

DID YOU KNOW 

Happiness Peaks at $75,000

Researchers at harvard and Princeton find that happiness peaks at an income of about $75,000. Once you reach $75,000 in the United States the beneficial aspects of more money taper off. More stuff does not make you happier either. To be happier, shift spending from buying stuff, like cars and electronics, to experiences, like trips and special evenings out. Buying for others increases happiness, too.

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Compare Salary and Cost of Living You may compare salary figures and the cost of living in different communities at the following websites [most use the ACCRA Cost of Living data (

www.coli.org/

)]:

• CityRating.com (

www.cityrating.com/costofliving.asp

).

• CNNMoney.com (

cgi.money.cnn.com/tools/costofliving/costofliving.xhtml

)

• Moving.com (

www.moving.com/real-estate/compare-cities/index.asp

)

• Realtor.com (

www.homefair.com/real-estate/cost-of-living.asp

)

• Salary.com (

swz.

salary.com

/costoflivingwizard/layoutscripts/coll_start.aspx

)

Compare Other Community Resources Comparing salary offers among various cities where you might work is only part of the decision where and whether to relocate. Here are some resources for other important aspects of the decision:

The cost of housing—

www.zillow.com

Quality of life issues—

money.cnn.com/magazines/moneymag/best-places/

Moving costs—

www.citytocitymoving.us/

DID YOU KNOW 

How to Get a Raise

Find out what people in your field earn by talking with others, reviewing trade publications, and checking online at sites such as 

Glassdoor.com

, vault.com, payscale.com, salary.com, and 

HotJobs.com

. Then talk with your boss and write down well-defined, achievable, and measurable goals that you can work toward. This may occur during a formal annual review. Document your accomplishments in writing and keep records. Throughout the year, perhaps on a quarterly basis, discuss these with your boss. Do so in sit-down meetings rather than in brief hallway conversations.

Schedule a meeting with your boss before the scheduled time for the annual personnel review. Never mention how much you need a big raise and instead focus on your performance. If the boss cannot give you all the money you deserve, ask for a bigger bonus, enhanced health or retirement benefits, a more flexible work schedule, a change in work hours, permission to occasionally telecommute, or more vacation time.

Wait and Negotiate Be comfortable with silence, and wait for a response. If the offer is less than what you were expecting, explain that point. Be firm but amicable. This will enhance the employer’s respect for you. Tell the employer that you are not willing to start at the bottom or middle of the salary ladder. Reiterate your two or three strongest selling points. Be certain to make a short list of these points beforehand. If the employer states that the offer is final, reply that you need a day or two to think it over. Never turn down an offer until you are absolutely positive you must do so.

Seattle has a lot to offer, but it comes at a price.

DID YOU KNOW 

Turn Bad Habits into Good Ones

Do You Do This?

Avoid getting to know your professors

Ignore student professional associations

Use an old résumé

Simply change the name/address when writing a cover letter

Plan to move back to your hometown after graduation

Focus primarily on gross pay when deciding on a job opportunity

Do This Instead!

Visit one professor in his/her office on a regular basis

Join and take a leadership role in at least one association

Update your résumé frequently

Write a new cover letter for each job application

Explore employment opportunities in several new cities

Factor take-home pay, employee benefits, and cost of living into your job decisions

If the terms are right, accept the job. Give your new employer your acceptance orally as well as in writing. Obtain a letter confirming your acceptance of the job at the agreed-upon salary with benefits, such as moving expenses, flexible hours, and extra vacation days.

2.3i At Work Practice the Four Rules of Career Success

Experts say you should focus on just four things.

1. Competence: Be as good at your job as possible.

2. Confidence: Be able to formulate and communicate your ideas in a way that inspires others.

3. Caring: Put the interests of your company, coworkers, and customers ahead of your own.

4. Come: Arrive early and stay late—every day—even at least for 10 to 15 minutes.

2.3j Periodically Update Your Career Plan

Getting that desired job does not mean that your career planning efforts are over. Indeed, they have only just begun. You know that employers formally evaluate their employees on a regular basis and you should do the same for your career plan.

DO IT NOW!

You know more about personal finance after reading this chapter, so get started right now by:

1. Preparing your résumé.

2. Contacting your school’s placement office to explore careers in your field.

3. Visiting one of your professors to seek a mentoring relationship.

CONCEPT CHECK 2.3

1. Offer suggestions on correctly assembling a résumé and cover letter, and explain how the two documents differ.

2. Explain how to compare salary and living costs in different cities.

3. Summarize the best methods to identify job opportunities.

4. List five suggestions to interview for success.

WHAT DO YOU RECOMMEND NOW?

Now that you have read the chapter on the importance of career planning, what do you recommend to Nicole in the case at the beginning of the chapter regarding:

1. Clarifying her values and lifestyle trade-offs in career planning?

2. Enhancing her career-related experiences before graduation?
3. Creating career plans and goals?
4. Understanding her work-style personality?
5. Identifying job opportunities?

BIG PICTURE SUMMARY OF LEARNING OBJECTIVES

LO1 Identify the key steps in successful career planning.

Career planning is identifying an employment pathway that aligns with your interests and abilities and that is expected to provide the lifestyle and work style you find enjoyable and satisfying. It includes clarifying your values; identifying one or more desired career fields; reviewing your abilities, experiences and education; taking advantage of networking; aligning yourself with tomorrow’s employment trends; and finalizing your career plan and beginning your career.

LO2 Analyze the financial and legal aspects of employment.

The financial side of career planning includes placing dollar values on employee benefits and knowing your legal employment rights.

LO3 Practice effective employment search strategies.

Smart job search strategies include assembling an attention-getting résumé, targeting your preferred employers, identifying specific job opportunities, writing an effective cover letter, obtaining strong reference letters, formally applying for the job, interviewing for success, negotiating and accepting the job, practicing the four rules of career success, and periodically updating your career plans. This includes comparing salary offers in different cities.

LET’S TALK ABOUT IT

1. Interviewing Tips. List three interviewing tips for new college graduates looking for employment when in many parts of the country a sluggish job market exists.

2. Interview Mistakes. Thinking about some common mistakes that people make in job interviews, which five are the worst? Make a list often things people should do to improve success in an interview.

3. Career Trade-offs. People regularly make decisions in career planning that have trade-offs. Identify some benefits and costs people are faced with as well as two lifestyle trade-offs.

4. Keeping Track Topics. Review the task areas in the Decision-Making Worksheet “Keeping Track of Your Job Search” on page 52, and identify what you think are the five that likely are the most difficult for people to accomplish. For each of the five, offer a suggestion that might help people accomplish the task.

5. Assessing the Benefits of a Second Income. Adding a second income to a family either by having another person work or by working two jobs often seems to be a good way to add financial resources. But the impact is not always as large as people hope. Review the example given in the “Run the Numbers” box on page 46 and discuss the pros and cons of a second income in that example.

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PAGE 46

DO THE MATH

1. Economic Trade-off of Graduate School. Jessica Sotomajor hopes to earn an extra $600,000 over her remaining 40-year working career by going to night school to obtain a master’s degree. If her income projection is correct, that’s an average of $15,000 more money a year. Jessica’s employer is willing to pay 75 percent, or $45,000, toward the $60,000 schooling costs, so she must pay out $15,000 of her own money.

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(a) What is the forgone lost future value of her $15,000 over the 40 years at 6 percent? (Hint: See 

Appendix A.1

.)

(b) What would be the forgone lost future value of $60,000 over 40 years if Jessica had to pay all the costs for her master’s degree? (Hint: See Appendix A.1.)

2. Comparing Salary Offers. Using Equations (2.1) or (2.2), if the cost-of-living index was 132 for Chicago and 114 for San Antonio, compare the buying power of a $50,000 salary in Chicago with a $47,000 offer in San Antonio.

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3. Future Value of Employer’s Match. Tyler Winkle’s employer makes a matching contribution of $1200 a year to his 401(k) retirement account at work. If the dollar amount of the employer’s contribution increases 4 percent annually, how much will the employer contribute to the plan in the twentieth year from now? (Hint: See Appendix A.1.)

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4. Cashing Out 401(k) Plan. Emily Amarrada has accepted a new job and is thinking about cashing out the $30,000 she has built up in her employer’s 401(k) plan to use to buy a new car. If, instead, she left the funds in the plan and they earn 6 percent annually for the next 30 years, how much would Emily have in her plan? (Hint: See Appendix A.1.)

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FINANCIAL PLANNING CASES

CASE 1

Harry and Belinda Johnson Consider Inflation and Children

Throughout this book, we will present a continuing narrative about Harry and Belinda Johnson. Following is a brief description of the lives of this couple.

Harry graduated with a bachelor’s degree in interior design last spring from a large Midwestern university near his hometown. Belinda has a degree in information technology from a university on the West Coast and is employed in a medium-size public relations firm. Harry and Belinda both worked on their school’s student newspapers and met at a conference during their junior year in college. They were married last June and live in an apartment in Kansas City. They will face many financial challenges over the next 20 years, as they buy their first home, decide on life insurance needs, begin a family, change jobs, and invest for retirement.

(a) Harry receives $3000 in interest income annually from a trust fund set up by his deceased father’s estate. The amount will never change. What will be the buying power of $3000 in ten years if inflation rises at 3 percent a year? (Hint: Use 

Appendix A.2

.)

(b) Belinda and Harry have discussed starting a family but decided to wait for perhaps five years in order to get their careers off to a good start and organize their personal finances. They also know that having children is expensive. They figure that the extra expense of a child would be about $5000 annually until high school graduation. How much money will they likely cumulatively spend on a child over 18 years assuming a 3 percent inflation rate? (Hint: Use Appendix A.3.)

CASE 2

Victor and Maria Hernandez Consider a Career Change

Throughout this book, we will present a continuing narrative about Victor and Maria Hernandez. Following is a brief description of the lives of this couple.

Victor and Maria, both in their late 30s, have two children: Jacob, age 13, and Nicholas, age 15. Victor has had a long sales career with a retail appliance store. Maria works part time as a medical records assistant. Victor is somewhat satisfied with his career but has always wondered about a career as a teacher in a public school. He would have to take a year off work to go to college to obtain his teaching certificate, and that would mean giving up his $43,000 salary for a year. Victor expects that he could earn about the same income as a teacher.

(a) What would his annual income be after 20 years as a teacher if he received an average 3 percent raise every year? (Hint: Use Appendix A.1.)

(b) Victor could earn $4000 each year teaching during the summers. What is the accumulated future value of earning those annual amounts over 20 years assuming a 5 percent raise every year? (Hint: Use Appendix A.3.)

CASE 3

Julia Price’s Career Plans Change

Julia has recently undergone a severe career crisis. After nearly ten years as a professional engineer, her position was phased out by her company due to a loss of government contracts, and she has been offered a position in the marketing department. The new job will require that she interact with purchasing agents for various companies that are current and potential customers of her company. The job pays more but will require considerable travel. She will be using her engineering background, but the primary tasks all will relate to presenting herself and her company in the best possible light to these other firms. Julia thinks she should take the new job and make a personal commitment to doing it for one year and, if she does not truly enjoy the work, seek a new engineering job within her company or at another employer. Offer your opinions about her thinking.

CASE 4

Matching Yourself with a Job

After completing his associate of arts degree four months ago from a community college in Rochester, New York, Juan Ramirez has answered more than a two dozen advertisements and interviewed several times in his effort to get a sales job, but he has had no success. Juan has never done sales work before, but he did take some business classes in college, including “Personal Selling.” After some of the interviews, Juan telephoned some of those potential employers only to find that even though they liked him, they said they typically hired only those people with previous sales experience or who seemed to possess terrific potential.

(a) If Juan actually were well suited for sales, which work values and work-style factors do you think he would rate as “very important”?

(b) What would you recommend to Juan regarding how to find out about the depth of his interest in a sales career?

(c) Assuming Juan has appropriate personal qualities and academic strengths to be successful in a sales career, what additional strategies should he consider to better market himself?

CASE 5

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Career Promotion Opportunity

Nina and Ting Guo of Lima, Ohio, have been together for eight years, having married just after completing college. Nina has been working as an insurance agent ever since. Ting began working as a family counselor for the state of Ohio last year after completing his master’s degree in counseling. Recently Nina’s boss commented confidentially that he was going to recommend Nina to be the next person promoted, given a raise of about $15,000, and relocated to the home office in St. Louis, Missouri. Nina thinks that if offered the opportunity she would like to take it, even if it means that Ting will have to resign from his new job.

(a) What suggestions can you offer Nina when she gets home from work and wants to discuss with her husband her likely career promotion?

(b) What lifestyle factors and benefits and costs issues should Nina and Ting probably discuss?

BE YOUR OWN PERSONAL FINANCIAL MANAGER

1. Work-Style Personality. Do you know your preferred work-style personality? Take the time to complete the worksheet on page 41 or you can use Worksheet 6: What Is My Work-Style Personality from “My Personal Financial Planner.”

2. Values Clarification. Go online and do a Web search or “values clarification assessment” to bring up a long list of possible values clarification exercises. Complete one or more exercises and then compare the results to what you have been thinking in terms of your academic major in college and possible careers.

3. Career Field Exploration. Visit the Career Guide to Industries at 

www.bls.gov/ooh/about/career-guide-to-industries.htm

 to determine the earnings, benefits, and employment outlook for a position in a career field that interests you. Complete Worksheet 7: Career Field Research from “My Personal Financial Planner” to write up your results including an assessment of how well your work-style personality and values fit the career field that you researched.

4. Compare Salary Offers. Use two actual salary offers or two desired offers in two cities of your choosing to compare the salary offers based on the different costs of living in the two cities. See Worksheet 8: Comparing Salary Offers in Two Different Cities from “My Personal Financial Planner” as a guide for your analysis.

5. Assess the Benefits of a Second Income. Using real or example data assess the benefits of a second income for a dual-earner household in your salary range. Use the example provided in the text on page 46 or Worksheet 9: Assessing the Benefits of a Second Income from “My Personal Financial Planner” for your assessment.

ON THE NET

Go to the Web pages indicated to complete these exercises.

1. Research the Occupational Outlook Handbook. Go to the website for the Occupational Outlook Handbook at 

www.bls.gov/oco/home.htm

. Select two occupational areas that are of interest to you, and for each, determine the likely starting salary, career path, future salary expectations, and demand for people with the skills appropriate for the occupation.

2. Research the National Unemployment Rate. Go to the website for the Bureau of Labor Statistics’ assessment of the labor outlook in the United States at 

www.bls.gov/bls/employment.htm

. Browse through the information provided to determine the current national unemployment rate for the nation as a whole and for a city or area of interest to you. Compare current statistics with those of one year ago and with projections for five and ten years in the future.

3. Research a Career of Interest. Check the U.S. Department of Labor’s Career Guide to Industries at 

www.bls.gov/oco/cg

 to learn about the earnings, benefits, educational requirements, and employment outlook for a career of interest to you. Make a written summary of your findings.

4. Check Out Income Levels. Are your current perceptions about the income level typical for various career fields correct? Visit 

www.payscale.com

 and research salary data on five to seven fields including your own.

ACTION INVOLVEMENT PROJECTS

1. Interview a Human Resource Manager. Use the Internet and/or Yellow Pages to find a local company that employs people in your prospective career field. Request an interview with the human resource manager. Ask about salary levels, employee benefits, and the career ladder. Make a written summary of your findings.

2. Prepare a Resume. Using the newspaper want ads or

Monster.com

find a job listing for a position in your career field. Prepare a résumé for the job. Review Figures 2-3, 2-4, and 2-5 on pages 48 and 49 and create or update your résumé accordingly. Take the job listing and documents to your faculty advisor and ask him or her for feedback.

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PAGE 48

3. Cover Letter. Review Figure 2-6 on page 53 and create or update a sample cover letter to accompany your résumé when applying for a job.

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4. Where Do You Want to Live? It is highly likely that one of the best job opportunities for you at graduation will require that you move away from your hometown and/or where you went to college. While that new location is unknown now, it is not too early to begin thinking of where you might need and/or want to live. Use the list of websites on page 58 to compare housing costs, quality of life issues, and moving costs for three cities of interest to you.

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5. Clarify Your Values. To help you clarify your values, review the section titled “Clarify Your Values and Interests” on page 36 and make a list of your 10 most important ones.

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6. Trade-Offs. To clarify your lifestyle trade-offs, review the section titled “Lifestyle Trade-offs” on page 38 and given the list and make a list of your choices for trade-offs.

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7. Anticipated Interview Questions. Review the questions in the section on “Prepare Responses for Anticipated Interview Questions” on page 55 and write out concise sample responses to each question.

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Visit the Garman/Forgue companion website at 

www.cengagebrain.com

.