Test Yourself Questions
1-1 What is a standard of living? What factors affect the quality of life?
Standard of living, which varies from person to person, represents the necessities, comforts,
Although many factors such as geographic location, public facilities, local costs of living,
1-2 Are consumption patterns related to quality of life? Explain.
Generally, consumption patterns are related to quality of life, which depends on a
person’s socioeconomic strata. This implies that wealthy persons, who are likely to
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 income
that is spent (rather than saved), on average, for current needs rather than savings. Yes, it
is quite possible to find two persons with significantly different incomes with the same
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
accumulate wealth as either financial assets or tangible assets. Financial assets are intangible
assets such as savings accounts or securities, such as stocks, bonds and mutual funds.
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
provides the standard unit of exchange (in the case of the U.S., the dollar) by which
specific personal financial plans—and progress with respect to these plans—can be
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
makeup that determines the importance and role of money in his or her life, as well as
one’s particular money management style. Personal values also affect one’s attitudes to
Money is frequently a source of conflict in relationships, often because the persons
involved aren’t comfortable discussing this emotion-laden topic. Each person may have
different financial goals and personal values, leading to different opinions on how to
spend/save/invest the family’s money. To avoid arguments and resolve conflicts, it is
essential to first become aware of each person’s attitude toward money and his or her
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
results. It is important to set realistically attainable financial goals because they form the
Students’ descriptions of the steps to achieve a specific goal will, of course, vary. They
should follow the general guidelines in the chapter: define financial goals, develop
financial plans and strategies to achieve goals, implement financial plans and strategies,
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
their short-term financial goals in a year or less, intermediate-term goals in the next 2-5
In making personal financial goals, individuals must first carefully consider their current
financial situation and then give themselves a pathway to reach their future goals. People
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
financial planning process (introduced in Exhibit 1.3) results in separate yet interrelated
components covering all the important financial elements in your life. Some elements
deal with the more immediate aspects of money management, such as preparing a budget
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,
too, do financial goals and plans, because they are directly influenced by personal needs.
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 inconsequential,
particularly if the loss occurs annually over a period of several years. For example, if
Chad had invested $1,000 at an 8 percent return and subsequently had invested all
earnings from the initial investment at 8 percent, in 40 years he would have accumulated
By carefully considering his investment and banking choices, it is likely that Chad would
be able to get a 2 percent greater rate of return without taking on additional risk. This can
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
types of retirement plans, will affect your personal financial planning. You must evaluate
these benefits so that you have the necessary insurance protection and retirement funds. If
Tax planning involves looking at an individual’s current and projected earnings and
developing strategies that will defer and/or minimize taxes. For income tax purposes,
income may be classified as active income, passive income, or portfolio income. While
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
inconsistencies and vagaries of our economic system—and of life itself!—the goals of
and plans for retirement should be established early in life. If retirement goals are
1-14 Discuss briefly how the following situations affect personal financial planning:
a. Being part of a dual-income couple
Couples should discuss their money attitudes and financial goals and decide how to
manage joint financial affairs before they get married. Take an inventory of your financial
assets and liabilities, including savings and checking accounts; credit card accounts and
outstanding bills; auto, health, and life insurance policies; and investment portfolios. You
b. Major life changes, such as marriage or divorce
Major life changes such as marriage and divorce:
Marriage. Finances must be merged and there may be a need for life insurance.
c. Death of a spouse
The surviving spouse is typically faced with decisions on how to receive and invest life
insurance proceeds and manage other assets. In families where the deceased made most
1-15 What is a professional financial planner? Does it make any difference whether the
financial planner earns money from commissions made on products sold as opposed
to the fees he or she charges?
Unlike accounting and law, the field professional financial planning field is largely
unregulated, and almost anyone can call themselves a professional financial planner.
Most financial planners fall into one of two categories based on how they are paid:
commissions or fees. Commission-based planners earn commissions on the financial
products they sell, whereas fee-only planners charge fees based on the complexity of the
The way a planner is paid—commissions, fees, or both—should be one of your major
concerns. Obviously, you need to be aware of potential conflicts of interest when using a
1-16 Discuss the following statement: “The interactions among government, business,
and consumers determine the environment in which personal financial plans must
be made.”
Government, businesses, and consumers are the three major participants in the economic
system. Government provides the structure within which businesses and consumers
function. In addition, it provides a number of essential services that generally improve the
Businesses provide goods and services for consumers and receive money payments in
return. They also employ certain inputs in producing and selling goods and services. In
exchange they pay wages, rents, interest, and profit. Businesses are a key component in
Consumers are the focal point of the personal finance environment. Their choices
ultimately determine the kinds of goods and services that businesses will provide. Also,
consumer spending and saving decisions directly affect the present and future circular
flows of income. Consumers must; however, operate in the financial environment created
1-17 What are the stages of an economic cycle? Explain their significance for your
personal finances.
The stages of the economic cycles are expansion, peak, contraction, and trough. Each of
these stages relates to real gross domestic product (GDP), which is an important indicator
of economic activity. The stronger the economy, the higher the levels of real GDP and
employment. During an expansion, employment is high, the economy is active and
growing, and prices tend to rise. During an expansion, real GDP increases until it hits a
1-18 What is inflation, and why should it be a concern in financial planning?
Inflation is a state of the economy in which the general price level is rising. It is
important in financial planning because it affects what we pay for goods and services; it
impacts how much we earn on our jobs; it directly affects interest rates and, therefore, it
affects such things as mortgage and car loan payments. The most common measure of
1-19. “All people who have equivalent formal education earn similar incomes.” Do you
agree or disagree with this statement? Explain your position.
Disagree. Although higher levels of education may result in higher levels of income, this
does not mean that everyone with a given level of education will achieve a specified level
1-20 Discuss the need for career planning throughout the life cycle and its relationship to
financial planning. What are some of your own personal career goals?
Career planning is a critical part of the life cycle of the personal financial planning
process. The choice of a career affects the amount you earn. By setting both short- and
long-term career goals, you can incorporate them into your financial plans. For example,
if you need additional education and/or other training for a particular job, you may
Each student will, of course, have a different list of personal career goals based upon his
or her career orientation and goals. However, responses should include discussion of
personal financial planning and associated career planning goals and how a career choice
