Twelve Key Elements of Practical Personal Finance

1
Twelve Key Elements of Practical Personal Finance
Common Sense Economics James Gwartney, Richard L.
Stroup, and Dwight R. Lee CommonSenseEconomics.com
2
A Personal Financial Epidemic?

• Why do Americans live under so much financial
  stress when their incomes are higher than ever?
• Financial insecurity is the result of the choices
  we make rather than the income we earn.
• The principles that lead to financial security
  are largely the same as the ones underlying a
  prosperous economy.

3
Who Needs Money?

• There is more to a good life than making money!!!
• But the desire for more wealth unseemly!!!
• Our life objectives are easier to achieve if we
  have more wealth.

4
Practical Element 1

• Discover your comparative advantage.

5
Comparative Advantage

• We are all relatively more productive in some
  areas than in others.
• Your comparative advantage is determined by your
  comparative abilities, not your absolute
  abilities.

6
Whats Your Comparative Advantage?

• Even if youre better at doing everything, you
  shouldnt.
• Specialize in what you are relatively the best
  atfor which you give up the least.
• Allow others work to be to your advantage.
• Self-sufficiency is for novels, not real life!

7
Practical Element 2

• Be entrepreneurial.
• In a market economy, people get ahead by helping
  others and discovering better ways of doing
  things.

8
Who are Entrepreneurs?

• People adept at discovering better ways of doing
  things and acting on these opportunities.
• Disproportionately wealthy 2/3 of American
  millionaires are entrepreneurs.

9
Entrepreneurs Success

• Entrepreneurial talent the ability to discover
  innovative new products, cost-reducing production
  methods, and profitable opportunities that have
  been overlooked by others.
• Tolerance for risk Self-employment is more
  risky, but greater risk and higher returns go
  together.

10
Entrepreneurs Success (cont.)

• High Savings Rates Investing in their businesses
  adds to entrepreneurs wealth.
• Hard Work Business owners tend to work longer
  hours.

11
Practical Element 3

• Spend less than you earn.
• Begin a regular savings program now.

12
Why Save?

• Saving is necessary to accumulate the capital
  needed to produce wealth.
• This is just as true for individuals as for
  nations.
• The most effective way to begin saving is by
  identifying and eliminating some discretionary
  spending.

13
Dont Wait!!!

• If you dont exert the willpower to save now, it
  is unlikely that you will do so later.
• If you wait to save until your income goes up, it
  is extremely costly in terms of the amount of
  money you will end up with at retirement.

14
Theres No Need to Suffer!

• Congress has made it possible to save with
  before-tax dollars.
• Savings is deducted from your taxable income,
  thereby reducing your taxable income.
• Many types of tax-deferred savings plans IRAs,
  401(k) plans, 403(b) plans, etc.
• There are MANY creative ways to spend less.
• Pay yourself first! Make saving a regular
  expense.
• Just do it!

15
Practical Element 4

• Dont finance anything for
• longer than its useful life.

16
Financing Consumption

• Why continue to pay for something- a car, a
  vacation, a television- that you are no longer
  able to use and enjoy?
• Purchase on credit only when buying a
  long-lasting asset with short-lasting financing.

17
When should you buy on credit?

• What goods and services can you pay for while you
  use them?
• homes
• automobiles (depending on lifespan)
• education
• Some assets even generate income or further
  service even after you finish paying for
  themthese can enhance your net worth!!!

18
Practical Element 5

• Two ways to get more out of your money
• Avoid credit card debt and consider purchasing
  used items.

19
Dont Undermine Your Future!!!

• The opportunity cost of saving for tomorrow is
  spending (and enjoying!) today.
• You CAN have more in the future while still
  enjoying today

ordinary people can have lots of nice things
and still accumulate a lot of money.
20
Credit Card Convenience

• Paying with a credit card is NOT spending your
  own money, but borrowing someone elses.
• Interest charged on credit cards outstrips
  returns that could be earned on investments!!!
• Think of your credit card as an extension of your
  checking accountUse your credit card only to
  access those funds.

21
The Worlds Most Expensive Vacation

• Sean charges 1,500 for a trip to the Bahamas.
• He pays the minimum payment (26.63 at 8
  interest) each month.
• 10 YEARS LATER this trip has cost Sean 3,195.40,
  and all he has left are faded photos.

22
It Pays to Buy Used!

• Can a used item satisfy you as well as a new
  item?
• Balance the time it takes to search for these
  items with the value of your time.

• There are savings to be had without having to
  sacrifice consumer satisfaction!

23
Practical Element 6

• Begin paying into a real-world savings account
  every month.

24
Rainy Days the Real World

• Life is full of surprises, and theyre usually
  expensive!
• The surprise is only in the timingSo it IS
  possible to plan for these surprises!
• Purchase peace of mind by building a
  cushionMake this a regular and mandatory
  expense!

25
Practical Element 7

• Put the power of compound interest to work for
  you.

26
Its a Miracle!!!

• Getting a head start brings a HUGE payoff.
• Compounding occurs when the interest youve
  already earned earns even more interest on
  itself.

27
(No Transcript)
28
Practical Element 8

• Diversify- dont put all of your eggs in one
  basket.

29
Risk vs. Return

• There are many types of risk that come with
  investing
• Market risk
• Inflation risk
• Financial risk
• Fraud risk
• There is no such thing as a guaranteed return!
• Diversification is the practice of holding a
  large number of unrelated assets.

30
The Law of Large Numbers

• Mutual funds are one way of diversifying
  investments in the stock market.
• While diversification cannot reduce the
  volatility of the stock market, it WILL reduce
  the volatility of your investment in it.
• When some firms do poorly, others do well.
• Business cycles have differential effects on
  companies.

31
Double Jeopardy

• Does your employer offer a company stock-based
  retirement program?
• IF you have confidence in the company, take
  advantage of the opportunity.
• As soon as the plan permits, sell these shares to
  purchase other investments.
• Failure to do so puts you in double jeopardy You
  are now beholden to your employer both for your
  job and your retirement investment. You are NOT
  diversified!!!

32
Practical Element 9

• Indexed equity funds can help you beat the
  experts without taking excessive risk.

33
The Random Walk Theory

• No one can predict the future of the stock
  market.
• The random walk theory suggests that current
  stock prices are the best reflection of the
  markets value.
• The future price of a stock is driven by
  unforeseeable events.
• Since we can only see the present, it is
  impossible to beat the market.

34
Practical Element 10

• Invest in stocks for long-run objectives
• as the need for money approaches, increase the
  proportion of bonds.

35
What About Diversification?

• Merely an extension of the diversification
  concept
• Because the stock market is volatile, you want to
  reduce your risk when you know you need a cash
  stash.
• Avoid selling off stocks when the market is at a
  low point.

36
So Why Not Just Hold Bonds?

• Bonds offer a lower return than stocks, but with
  less risk.
• Inflation risk and interest rate risk are larger
  problems with bonds.
• Buy bonds that mature at the time you anticipate
  needing the cash.
• Transfer capital gradually from stocks to bonds.

37
Practical Element 11

• Beware of investment schemes promising high
  returns with little or no risk.

38
Theres no such thing as a free lunch!!!

• If its such a good deal, why do they need to
  sell it to you???
• The principal-agent problem makes you vulnerable.
• A potential conflict exists between the investor
  and the agent being paid to do something for the
  investorBecause the agent has more information
  about the product than you, you are at a
  disadvantage.

39
Tips for Avoiding Investment Fraud

• If it looks too good to be true, it probably is.
• Deal only with parties that have a reputation to
  protect.
• Never purchase an investment solicited by
  telephone or email.
• Do not allow yourself to be forced into a quick
  decision.
• Do not allow friendship to influence an
  investment decision.
• If high-pressure marketing is involved, grab your
  checkbook and run!!!

40
Practical Element 12

• Teach your children how to earn money and spend
  it wisely.

41
Teach Your Children Well

• Teach children money is earned It doesnt grow
  on trees!
• Money both helps us get what we want, AND helps
  others get what they want.
• Success in general is realized by setting goals
  and working hard to achieve themFinancial
  success is no different!