Personal Finance Essay

Many people assume that handling personal finances is straightforward and can be done with little to no preparation. This paper delves into the many different aspects of personal finance. It discusses the tools that we are learning in class and explains how these tools that can be used to save for retirement. It offers tips to improve your financial standing both now and in the future. And finally, it compares these tips with advice offered by an expert, Suze Orman. Everyone needs to learn how to properly prepare their finances to reach their goals.

While doing so can be easy and rewarding, neglecting to do so can have a substantial negative impact on your future well-being. Financial Decisions The financial decisions that you make today will either assist or haunt you for many years to come. You need to treat your financial decisions as if you are running a business and remove your personal feelings from the decisions so that you can make clear, concise, and rational financial decisions. By using the tools that you have learned in your textbook thus far, you should be able to leverage the proper financial institution in meeting your investment goals.

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You should be able to construct a simplified Income Statement for proper financial analysis. You can use this information to create an Income to Debt ratio, which significantly impacts your credit score. You can calculate a true interest rate prior to making any long-term purchases. You should understand how long–term debts are amortized and how your payments effect the principal owed on these debts. And finally, you should understand the Time Value of Money so that you can properly assess the opportunities that you are confronted with (Brigham, 2007).

Critical to making any financial decision is separating the emotional side of a decision from the factual segment of the decision. Many times we find ourselves in a situation where an item that we want to purchase is available to us through financing but not through a cash purchase. In other cases, we find ourselves wanting to spend the cash that we have saved on non-essential items such as a night out with friends instead of paying for essential items such as food or rent. When we remove the emotions tied to the decision and strictly look at the financial facts, we are able to make decisions that will not negatively impact our future.

In the example above, this would allow us to calculate whether we can pay our rent and go out with our friends or whether we can only afford one of them. Once we begin to look at our financial decisions without emotional bias, we then find ourselves looking towards the future and leveraging the proper financial institutions. Saving for Retirement There are many financial institutions to assist us in reaching our financial goals. Large corporate banks offer both savings and checking accounts with low interest rates, which are good for short-term storage of our cash. These banks also offer personal loans with reasonable interest rates.

Credit Unions are cooperative associations in which you generally need to buy a membership. Credit Unions typically offer more competitive interest rates on their checking and savings accounts along with lower interest rates on their personal loans. Pension Funds are long-term retirement investments that are paid for and administered by your employer. Life Insurance companies allow you to purchase insurance against death or dismemberment. While this does not positively affect your personal wealth, it does offer financial aid to your loved ones during their time of morning.

Mutual Funds are businesses that take private savings and invest them in stocks, bonds, and other short-term investments. Individuals who are highly trained in the aspects of managing such investments typically run these funds. And finally, you can choose to invest in stocks, bonds, and other short-term investments on your own through brokers that buy and sell these commodities through markets such as the New York Stock Exchange. When you are ready to make your financial investments, you will need to study your finances to figure out how much to invest which can be done by using a simplified Income Statement.

Your income statement will list all of your incomes, debts, and taxes so that you can properly assess how much money you have for future investments (Brigham, 2007). It is critical to account for all of your debts to get a legitimate view of your finances. For instance, do not forget to account for food, gas, cell phone bill, entertainment, and other non-fixed monthly bills. In order to create an investment plan that you will stick to, you must include reasonable living expenses. If you do not include items such as entertainment, then long term acceptance of your investment plan will be dubious at best.

Once you have a reasonable income statement created, you will need to figure out your Debt to Income ratio. This is very easy to create with the information you have included in your income statement: add your monthly income and payments and then divide your monthly income by your monthly payments, if your ratio is above fifty percent, than you should work towards lowering your debt with a goal of less than 25 percent (Brigham, 2007). The lower your debt ratio, the higher your credit score will be which will allow you to be approved for loans with better interest rates.

Knowing the true interest rate on a loan is crucial to making educated financial decisions. There are many types of loans where the true interest rate is hidden from you. For instance, when leasing a car, you are given a lease rate where you pay an initial payment and a monthly payment. You are also supplied a total payment amount at the end of the contract. If you calculate the interest rate of the loan based on your initial payment, monthly payments, and total pay off amount, you will find that the interest rate is dramatically higher than the lease rate.

Along with understanding how to calculate an effective annual interest rate, you should also understand how amortization works for large long-term debts such as car loans or home loans. An amortized loan is a debt that is paid in equal payments over the life of the loan but instead pays the bulk of the interest early in the debt repayment schedule due to compound interest (Brigham, 2007). This means that by paying higher payments early in the loan you can substantially reduce the length of the loan.

Understanding how to use these tools for your personal gain can significantly increase your overall wealth later in life. This is where the Time Value of Money can assist you in properly assessing the opportunities that you are confronted with. The Time Value of Money centers around the concept of opportunity cost. A dollar today is worth less than a dollar in the future because you have the opportunity to invest that dollar and gain interest on it. For instance, investing $20,000 today at only a 3% interest rate for 20 years would give you $46,292. 36.

While you could certainly spend the $20,000 today on a new car, you also have the opportunity to invest that money and double it in less than 16 years with no effort on your own except exercising the willpower required to not spend the money. Using all of these tools will help prepare your finances for long-term purchases, such as buying a car or home, along with helping prepare yourself for retirement. The earlier you begin saving for retirement the better off you will be. Many people think that retirement is way off in the future so choose not to invest in it now.

What they do not realize is that due to the Time Value of Money, small savings and investments now make up for substantial sums in the future. For example, investing only $100 per month at only 3% from the age of 18 through the typical retirement age of 65 will amount to well over $200,000. That works out to only $56,400 saved $100 per month. You should begin saving for your retirement now. Advantages and Disadvantages of IRAs, Roth IRAs, and 401Ks If you want your money to work for you, then you should definitely learn about the different retirement plans such as IRAs, Roth IRAs and 401k’s.

There are several advantages and disadvantages with these retirement plans but they are applicable for people of all needs. Traditional IRAs An advantage of an individual retirement account, also known as traditional IRA, is tax deduction (Department of Treasury, 2009). Individuals who invest in a traditional IRA get an immediate tax savings equal to the amount of the investment multiplied by their marginal tax rate. Individuals may be eligible to claim certain tax credits or deductions if the tax deductions lower their adjusted gross income below the threshold (Anonymous, 2010b).

A disadvantage of the traditional IRA is that account holders cannot deposit contributions more than the allowable amounts defined by tax law. The contribution restrictions change every year. Another disadvantage of the traditional IRA is that any distribution that is received before or after age 59. 5 will be taxed (Department of Treasury, 2010b). Roth IRAs An advantage of a Roth IRA is that direct contributions can be withdrawn tax and penalty free at any time. Rollover, converted contributions may be withdrawn tax and penalty free after the seasoning period, which is currently 5 years.

Earnings may be withdrawn tax and penalty free after the seasoning period if the condition of age 59. 5 or another qualifying condition is also met. Another advantage of a Roth IRA is that up to a lifetime maximum of $10,000 in earnings can be withdrawn for first time buyers if the money is used to buy a principal residence. One of the most important reasons why an individual would select a Roth IRA is that when the owner passes away, his/her spouse becomes the sole beneficiary. The owner can also pass down the retirement investment to heirs’ tax-free (Anonymous, 2010c).

A disadvantage of a Roth IRA is the income limitations. Any individual who is working for a living can invest assets in a Roth IRA account. However, one’s earned income cannot exceed the restrictions established during the given year. Another disadvantage of the Roth IRA is that you are not permitted to deposit more than the maximum “amount between January 2 and the tax deadline of April 15th of the following year” (Anonymous, 2010c). Also the Roth IRA is not tax deductible. 401Ks Most people know about the 401k plans through their employers.

A 401k plan is a retirement plan funded by employee contributions with matching contributions from the employer. An advantage of the 401k is that contributions are taken from pre-tax salary; therefore, the money will grow tax-free until withdrawal. Another advantage of a 401k is that if your company matches your contributions, it is like you are getting extra money on top of your salary. Another advantage of a 401k is that also having total control over your 401k because you can decide where to invest your future contributions or current savings.

However, a disadvantage of a 401k is that there is a 10% penalty on early withdrawals before age 59. 5. Another disadvantage of a 401k is that there are restricted investment choices. While most pension plans are protected by the Pension Benefit Guaranty Corporation, a 401k does not have this benefit. (Hansen, N. D. ). Tips for Managing your Personal Finance Having a cash management plan is a big first step towards being financially stable. Although many understand the importance of responsible personal finance, it may be difficult and overwhelming in the beginning.

There are numerous tips and techniques for managing one’s personal finance. However, despite how many times we’ve read or seen these tips online, or in books and magazines, many are rarely followed. We came up with 10 personal finance tips in which everyone can benefit from. First and foremost, take the time to learn more about personal finance! Educating yourself in the various subjects of personal finance will help enlighten you with ideas and ways you can improve upon your own financial needs. Only you know what you truly need to work on. There are many resources available online and at the library.

You may also consider speaking with a personal financial advisor or a personal banker. Your friends may also be valuable tools. Secondly, before you can properly manage your finances, find out where you currently stand financially. In order to strive for any financial goals, you must find your starting point. This may include sorting your financial statements from credit card statements, bank statements, mortgages, 401ks, etc. From here, one can properly set priorities and discover which areas need the most work. Our third tip is to continually improve your budget.

Practice a healthy habit of making a monthly spending analysis in order to help identify areas where one can reduce expenses. This can help show exactly where one’s money is being spent. The use of financial management software such as Quicken can effectively help organize your finances. Our fourth tip is to start saving and invest. It is never too early to save. The use of an automated savings account can help you put your money to work. One can fund an IRA where the contribution limit for 2010 is $5000 for both regular and Roth IRAs, $6000 if one is 60 years or older.

If you can afford to fund a larger amount, consider taking advantage of your employer’s 401k plan. You may consider saving for your children’s college education. Establishing a custodial account for your child in which transferring $250 each month can earn almost $39,000 over 10 years at a 4% earnings rate! Our fifth tip is to borrow wisely. The truth of the matter is that borrowing will always cost money. So it is important to choose when and what to borrow carefully. If applying for a credit card, make sure to read all the terms and conditions in order to choose the best card possible based on your needs and requirements.

For example, if you usually pay the full balance monthly, then interest rates will not really be applicable to you, so look for other perks or rewards such as ‘cash back’. However, if you carry over balances, then interest rates should be your main concern. The general rule of thumb is to never borrow what you cannot repay. It seems like common sense, but this is a major problem with many Americans today. People are borrowing for luxuries when they cannot afford the basic necessities. Instead, reserve some of that borrowing capacity for emergencies! If you feel like your borrowing is out of control, then stop!

Cut up those credit cards! Seek help early when you feel like you are overwhelmed with debt. You can contact lenders and they will usually refer you to a 3rd party non-profit organization to help you develop a workable repayment plan. An example of such an organization is www. debtadvice. org. Our next two tips work in unison. Our sixth tip is to make sure you pay your bills on time. By doing so, you can avoid those unnecessary late fees. Keep track of how much money you really have. Late payments will adversely affect your credit score. Our seventh tip is to pay off credit card balances in full each month.

Leaving a balance on your credit card will leave you with a painfully high APR to pay off which can lead to further debt. It never feels good to throw away money that could be saved or invested. Our eighth tip is to review your spending habits. If you struggle with saving, go back into your monthly spending analysis and credit card statements to see which areas you can live without. Reduce your monthly bills such as cell phone plans and television cable. Even consider upgrading your home with more energy efficient appliances, or even change the light bulbs, every little bit counts.

A good example of areas where you can reduce your spending habit would be reducing your weekly consumption of fast foods or reducing how often you purchase your favorite cup of coffee. You can decide to cut Starbucks from your weekly routine. For example, going to Starbucks 3 times a week, where each drink costs about $3, costs close to $40 a month, which can result to spending almost $430 a year. Our ninth tip is to know your credit score. Your credit score is your ‘borrowing reputation’ of the financial world. It is crucial to know what your score is and the reasons why you received that particular score.

The three main agencies that provide credit scores and reports to consumers are Experian, Transunion, and Equifax. These companies will generate credit reports that will usually help indicate areas that you need work on. The advantage of having a good credit score will allow you to obtain good offers for credit cards, auto loans, mortgages and refinances. If your credit score is low, two easy ways to help boost them is to make sure to pay your monthly bills on time and reduce your credit card balances. Our last tip is to organize your records.

You should always organize your records in an orderly fashion. Keep all your statements, bills, receipts, etc. in one place. This will help you keep track of your financial progress. Purchase a file cabinet and sort your financial records by category. Maintaining organized financial records will save you from the headaches and will save you a lot time. This task requires little maintenance and discipline, so why not get started? Comparison with Suze Orman’s Tips Suze Orman is a well-acclaimed financial advisor who has her own program on CNBC.

She is also the author of seven New York Times Best Sellers. Her advice and knowledge has influenced people all over the globe who want to do more than just spend their money. A lot of these tips we have listed for managing personal finances are also recommended by Suze Orman herself. Orman suggests that one should take a snapshot of their finances and current portfolio which is similar to our second tip, “finding where you stand financially. ” If living with a spouse, Orman states that you should combine your income and manage half for the necessities and the other half into savings.

This advice highlights our fourth tip to start saving and investing. It is important to have emergency cash in case of a lay-off or an unexpected event. Orman presents challenges that support frugality such as: “do not spend any cash for one day, don’t use your credit card for one week and don’t eat out at a restaurant for one month” (Anonymous, 2010d). This advice promotes a healthy and conservative financial lifestyle where you free up money that would have otherwise been unnecessarily spent. This extra money can either be saved or invested for a stronger return.

Today, where everyone seems to stress about paying off their credit debts, Orman urges people to use credit cards as little as possible, and instead recommends utilizing cash and other available resources whenever possible (Oraman, 2008). Finance is all about planning and spending money wisely and responsibly. Hopefully this paper will help equip you with the proper direction, guidance and resources to start managing your personal finance. With a little effort and discipline, you can live comfortably both now and in the future.