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Chapter 1
Understanding the
Financial Planning Process
HOW WITH THIS AFFECT ME?
The heart of financial planning is making sure your values line up with how you spend and
save. That means knowing where you are financially and planning on how to get where you
want to be in the future no matter what life throws at you. For example, how should your plan
handle the projection that Social Security costs may exceed revenues by 2034? And what if the
government decides to raise marginal tax rates to help cover the federal deficit? An informed
financial plan should reflect such uncertainties and more.
This chapter describes the financial planning process and explains its context. Topics include
how financial plans change to accommodate your current stage in life and the role that
financial planners can play in helping you achieve your objectives. After reading this chapter
you will have a good perspective on how to organize your overall personal financial plan.
Major Topics
Personal financial planning provides major benefits that help us to more effectively marshal
and control our financial resources and thus gain an improved standard of living. Because the
emphasis in this text is on planning—looking at the future—we must examine many areas to
set and implement plans aimed at achieving financial goals. These areas are introduced in this
chapter and examined in detail in later chapters. The major topics covered in this chapter
include:
1-1 Identify the benefits of using personal financial planning techniques to manage
your finances.
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in
whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use.
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1-2 Describe the personal financial planning process and define your goals.
See Exhibit 1.3 for the six-step financial planning process. Defining financial goals and
understanding the personal financial planning process necessary to achieve them will
lead to attaining the financial goals you set. Most Americans believe that money gives
1-3 Explain the life cycle of financial plans, their role in achieving your financial
goals, how to deal with special planning concerns, and the use of professional
financial planners.
From goals you determine plans to achieve the goal. It is not a one and done process, but a
1-4 Examine the economic environment’s influence on personal financial planning.
1-5 Evaluate the impact of age, education, and geographic location on personal
income.
1-6 Understand the importance of career choices and their relationship to personal
financial planning.
Understanding the Financial Planning Process — Chapter 1
Financial Facts or Fantasies?
These may be used as a quiz or as a pre-test to get the students interested.
1. True False Your income level depends on your age, education, and career choice
2. True False Over the long run, gaining only an extra percent or two on an
investment makes little difference in the amount of earnings generated
3. True False Personal financial planning involves translating personal financial goals
into specific plans and arrangements that put these plans into action.
4. True False A savings account is an example of a tangible asset because it
represents something on deposit at a bank or other financial institution.
5. True False An improved standard of living is one of the payoffs of sound personal
financial planning.
FINANCIAL IMPACT OF PERSONAL CHOICES
Jacob Cuts Back on Lunch Out and Lattes
Jacob buys lunch out most days and buys a latte every morning. He believes he could cut back
a bit and save $5 a day, which is $35 a week and $140 a month. What is the impact of this
seemingly modest cutback?
Understanding the Financial Planning Process — Chapter 1
Financial Planning Exercises
The following are solutions to problems at the end of the PFIN 7 textbook chapter.
1. Benefits of Personal financial Planning: How can using personal financial planning
tools help you improve your financial situation? Describe changes you can make in at least
three areas.
2. Personal Financial Goals and the Life cycle: Fill out Worksheet 1.1, “Summary of
Personal Financial Goals,” with goals reflecting your current situation and your expected
life situation in 5 and 10 years. Discuss the reasons for the changes in your goals and how
you’ll need to adapt your financial plans as a result.
3. Personal Financial Goals: Recommend three financial goals and related activities for
someone in each of the following circumstances:
a. A junior in college
b. A 28-year-old computer programmer who plans to earn an MBA degree
c. A couple in their 30s with two children, ages 5 and 9
d. A divorced, 52-year-old man with a 16-year-old child and a 78-year-old father who is ill
Understanding the Financial Planning Process — Chapter 1
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in
whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use.
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c. Couple in their 30s with two children, ages five and nine—begin college fund for each
child; fund Roth IRAs for both parents; max out employer-sponsored retirement plan, such as
401k, each year.
d. Divorced 52-year old man with a 16-year old child and a 72-year old father who is ill—
engage the help of friends or family in carpooling teenager to school and activities; establish or
continue college fund; explore community or church programs which might provide assistance
for the father, such as Meals on Wheels or a visitation program; help father with estate
planning needs, hiring an attorney if needed.
4. Life Cycle of Financial Plans: Explain the life cycle of financial plans and their role in
achieving your financial goals.
As you move through life and your income patterns change, you’ll typically have to
5. Impact of Economic Environment on Financial Planning: Summarize current and
projected trends in the economy with regard to GDP growth, unemployment, and inflation.
How should you use this information to make personal financial and career planning
decisions?
6. Effects of Inflation: How does inflation affect interest rates, security prices, and
financial planning?
Understanding the Financial Planning Process — Chapter 1
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in
whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use.
7
high interest rates as the lenders demand more money to compensate their decreasing
purchasing power. High rates of inflation also have a harmful effect on the prices of stocks and
bonds. The rate of inflation not only affects what an individual pays for the goods and
services, but also affects what an individual earns in his/her job. High inflation rates decrease
the purchasing power of an individual and he/she needs more money to achieve the financial
goals. Thus, inflation affects the financial planning of an individual.
7. Effect of Age and Geography on Income: Evaluate the impact of age, and geographic
location on personal income.
Age, education, and geographic location all impact personal income. For example, the amount
8. Career choices and Financial Planning: Assume you graduated from college with a
major in marketing and took a job with a large, consumer-products company. After three
years, you are laid off when the company downsizes. Describe the steps you’d take to
“repackage” yourself for another field.
Possible steps to “repackage” yourself might include:
9. Career Planning: Leo Johnson, a 52-year-old retail store manager earning $90,000 a
year, worked for the same company during his entire 25-year career. Tom was laid off and
is still unemployed 10 months later, and his severance pay and unemployment compensation
have run out. Because he adopted careful financial planning practices, he now has
sufficient savings and investments to carry him through several months of unemployment.
Leo is actively seeking work but finds that he is overqualified for available, lower-paying
jobs and underqualified for higher-paying, more desirable positions. There are no openings
for positions equivalent to the manager’s job he lost. He lost his wife several years earlier
and is very close to his two grown children, who live in the same city.
Tom has these options:
Understanding the Financial Planning Process — Chapter 1
●
Keep looking for a new job.
●
Move to another area of the country where store manager positions are more plentiful.
●
Accept a lower-paying job for two or three years and then go back to school evenings to
finish his college degree and qualify for a better position.
●
Consider other types of jobs that could benefit from his managerial skills.
a. What important career factors should Leo consider when evaluating his options?
b. What important personal factors should he consider when deciding among his career
options?
c. What recommendations would you give him in light of both the career and personal
dimensions of his options noted above?
d. What career strategies should today’s workers use in order to avoid Leo’s dilemma?
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in
whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use.
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10. Income and Education: Using Exhibit 1.8, discuss the relationship between annual
income and the highest level of education completed. Provide specific examples of the
difference between having no high school diploma and having a bachelor’s degree, and
between having a bachelor’s degree and a professional degree.
In an individual’s career, the annual income earned is directly proportional to the level of
Answers to Test Yourself Questions
The following are questions and solutions are part of legacy questions that have been in
previous editions. You could use them as class discussion questions, exam questions or
additional homework.
1-1 What is a standard of living? What factors affect the quality of life?
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whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use.
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1-2 Are consumption patterns related to quality of life? Explain.
1-3 What is average propensity to consume? Is it possible for two people with very
different incomes to have the same average propensity to consume? Why?
The average propensity to consume is the percentage of each dollar of a person’s
1-4 Discuss the various forms in which wealth can be accumulated.
An individual’s wealth is the accumulated value of all items he or she owns. People
1-5 What is the role of money in setting financial goals? What is the relationship of
money to utility?
Money is the exchange medium used as the measure of value in our economy. Money
1-6 Explain why financial plans must be psychologically as well as economically
sound. What is the best way to resolve money disputes in a relationship?
Money is not only an economic concept; it is also a psychological one that is linked
through emotion and personality. Each person has a unique personality and emotional
1-7 Explain why it is important to set realistically attainable financial goals. Select one
of your personal financial goals and develop a brief financial plan for achieving it.
Realistic goals are set with a specific focus and a reasonable time frame to achieve
1-8 Distinguish between long-term, intermediate, and short-term financial goals.
Give examples of each.
Individual time horizons can vary, but in general individuals would expect to achieve
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in
whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use.
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1-9 What types of financial planning concerns does a complete set of financial plans
cover?
Financial plans provide the roadmap for achieving your financial goals. The six-step
1-10 Discuss the relationship of life-cycle considerations to personal financial planning.
What are some factors to consider when revising financial plans to reflect changes
in the life cycle?
Personal needs and goals change as you move through different stages of your life. So,
1-11 Chad Jackson’s investments over the past several years have not lived up to his
full return expectations. He is not particularly concerned, however, because his
return is only about 2 percentage points below his expectations. Do you have any
advice for Chad?
The loss of two percentage points on investment returns is anything but
Understanding the Financial Planning Process — Chapter 1
© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in
whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website or school-approved learning management system for classroom use.
13
1-12 Describe employee benefit and tax planning. How do they fit into the financial
planning framework?
Employee benefits, such as insurance (life, health, and disability) and pension and other
1-13 “There’s no sense in worrying about retirement until you reach middle age.”
Discuss this point of view.
This statement reflects a very limited and too often expressed point of view. Due to the
1-14 Discuss briefly how the following situations affect personal financial planning:
a. Being part of a dual-income couple
