CHAPTER 22 - MANAGING PERSONAL FINANCES:



CHAPTER 14 –PERSONAL FINANCE

ANSWERS

LEARNING THE LANGUAGE

|1. Term insurance |9. 401(k) plan |17. Future value |

|2. Individual Retirement |10. Present value |18. Certified financial planner |

|Account (IRA) | | |

|3. Annuity |11. Disability insurance |19. Keogh |

|4. Social Security |12. Executor |20. Universal life |

|5. Power of attorney |13. Roth IRA |21. Amortization |

|6. Whole life insurance |14. FICO |22. Deductible |

|7. Contrarian approach |15. Variable life insurance |23. Rider |

|8. Will |16. Co-payment |24. Insurance |

ASSESSMENT CHECK

Learning Goal 1

The Need for Personal Financial Planning

1. Six steps you can take to get control of your finances are:

a. Take an inventory of your financial assets.

b. Keep track of all your expenses.

c. Prepare a budget.

d. Pay off your debts.

e. Start a savings plan.

f. If you have to borrow money, only borrow it to buy assets that have the potential to increase in value.

2. The process for developing a personal balance sheet begins with the fundamental accounting equation – assets = liabilities + owner’s equity. This process starts with listing your assets, such things as a TV, DVD, computer, and so on. Your assets are evaluated on their current value, not the purchase price. If you have debts list them. Subtract debts from your assets to get your net worth.

3. To determine your net worth, subtract your liabilities from your assets.

4. The best way to keep track of expenses is to carry a notepad with you wherever you go and record what you spend as you go through the day. Develop certain categories, or accounts, to make the task easier and more informative. At the end of the week, record your journal entries into a record book.

5. Items that are important to include in a household budget are:

a. mortgage or rent f. furniture

b. utilities g. life insurance

c. food h. car insurance

d. clothing i. medical care

e. vehicles

6. Running a household takes the same careful record keeping, the same budgeting process and forecasting, the same control procedures and the same need to periodically borrow funds to run a household’s finances as it does to run a small business.

7. After you pay your monthly expenses the first thing to do with the money remaining is to pay off your debts.

This is because it is better to pay off a debt that costs 16 percent than to put the money in a bank account that earns a very low rate of interest.

8. A good way to plan for large purchases such as a car is to save some money each month in a separate account. Then when it comes time to make the purchase, you’ll be able to make a significant down payment so that you can reduce finance charges.

9. The best way to save money is to pay yourself first. That is, take your paycheck, take out money for savings, and then plan what to do with the rest.

10. You should only borrow money to buy assets that have the potential to increase in value or generate income, or to cover the most unexpected expenses.

11. A good rule of thumb with regard to using credit cards is to never charge more on a credit card than you are able to pay off at the end of the month.

Learning Goal 2

Managing Credit and Building Financial Base

12. To accumulate capital, you have to live frugally and earn more than you spend. The necessary lifestyle is one of sacrifice, not luxury.

13. The investment benefits of buying a home include:

a. A home is an investment you can live in.

b. Payments are relatively fixed, and as your income rises, payments get easier to make.

c. It is a good way to force yourself to save.

d. A home is a good asset to use when applying for a loan.

14. Interest on mortgage payments and real estate taxes are tax deductible. During the first few years, almost all the mortgage payments go for interest on the loan so almost all the early payments are tax deductible.

15. One of the worst places for young people to keep long-term investments is in a bank or savings and loan.

16. One of the best places to invest over time has been the stock market. The stock market has historically paid a higher rate of return than other investment choices.

17. The best time to buy stocks is when stock prices are low. This is called a contrarian approach.

18. If you finance a large purchase with a credit card, you may end up spending more than if you pay with cash, because of the finance charges on a credit card.

19. Three reasons why credit cards are an important element in a personal financial system are:

a. Credit cards may be needed as a form of identification.

b. They are a way to keep track of purchases.

c. Credit cards are convenient.

20. The danger of a credit card is that too often, consumers are tempted to make purchases they would not make if they had to pay cash or write a check, and pile up debt as a result.

21. Every person should get a credit report once a year. The advantage to seeing your credit report is so that you may monitor your activity. If someone had your social security number and managed to open an account in your name, the credit report would provide you with that information.

22. The FICO score is the information that is used to determine whether or not you should get a loan, and the interest rate you should pay.

Learning Goal 3

Protecting Your Financial Base: Buying Insurance

23. a. Liability insurance – means that if you hit someone else with your car, your insurance would

pay to repair the damage on your vehicle, but not on the other.

b. Full coverage – means that the insurance would pay for both your car and the other person’s car.

c. Uninsured motorist coverage – pays for damages to your car if you are hit by someone without insurance.

24. A couple or business should buy life insurance to provide protection from risks of a sudden drop in income from the loss of a spouse or business partner.

25. Term insurance has not savings feature and typically costs less the younger you are when you buy it. The price is fixed for the term of the policy (for example, 10 years) but will increase when renew the policy, based on your age.

26. Newsweek magazine suggests that a family should have 7 times the family income plus $100,000 for college.

27. Whole life insurance is also called permanent insurance. You pay the same premium for your entire life. With whole life insurance some part of the money you pay for the insurance goes toward pure insurance and another part goes toward savings, so you are buying both insurance and a savings plan. A universal life policy is a form of whole life insurance that lets you choose how much of your payment should go to insurance and how much to investments.

28. Variable life insurance is similar to universal life insurance except that your excess premium is invested in stocks, mutual funds, or other high-yielding securities. Death benefits may vary reflecting the performance of the investments.

29. An annuity is a contract to make payments to a person for life or for a fixed period. A fixed annuity is an investment that pays the policy holder a specified interest rate. A variable annuity provides investment choices identical to mutual funds.

30. Hospital costs are too high to risk financial ruin by going uninsured. It is a good idea to supplement health insurance policies with disability insurance that pays part of the cost of a long-term sickness or an accident. Your chances of becoming disabled at an early age are much higher than your chances of dying from an accident.

31. Guaranteed replacement cost means that the insurance company will give you whatever it costs to buy all of the items you have insured, rather than the depreciated cost of the items.

30. A rider on an insurance policy will cover expensive items that may not be covered under a regular homeowners or renter’s policy.

Learning Goal 4

Planning Your Retirement

32. According to studies, if you want to have 80% of your income after you retire:

at age 25 you should save 12% of your income, but if you wait 20 years

at age 45 you should save 24% of your income.

The lesson is to start saving early.

33. The problems surrounding the Social Security system stem from the fact that the number of workers paying into social security is declining, but the number of people retiring and living longer is increasing dramatically. The result is likely to be serious cuts in benefits, a much later retirement age, reduced cost of living adjustments and/or much higher social security taxes. Young people will not be able to count on Social Security to provide them with enough money to retire on.

34. A traditional IRA is a good deal for people who qualify because the invested money isn’t taxed when the money is invested. That means fast and good returns.

35. The earlier you start saving the better because your money has a chance to double and double again. For example if you save $4000 a year for 35 years in an IRA and earn 11 percent a year, you will accumulate savings of more than $1.5 million.

34. People who invest in a Roth IRA don’t get up-front deductions on their taxes like they would with a traditional IRA, but earnings grow tax free and are tax free when they are withdrawn.

37. Some investment choices for IRAs include stocks, bonds, mutual funds, or precious metals. You can switch from fund to fund or from investment to investment with your IRA funds.

38. The benefits of 401(k) plans are:

a. The money you put in reduces your present taxable income.

b. Tax is deferred on the earnings.

c. Employers often match part of your deposit.

39. With a 401(k) plan you can usually select how the money in the plan is invested: stocks, bonds, and in some cases real estate. The money invested in a 401k should be diversified, and not put into only one company.

40. A Keogh plan is for small business people who don’t have the benefit of a corporate retirement system. This can be an alternative for doctors, lawyers, real estate agents, artists, writers and other self-employed people.

41. The advantage of Keogh plans is that participants can invest up to $40,000 per year.

42. A Keogh plan is like an IRA because funds aren’t taxed until they are withdrawn, nor are the returns they earn. As with an IRA account, there is a 10 percent penalty for early withdrawal. Also, funds may be withdrawn in a lump sum or spread out over the years like an IRA.

43. A financial planner is an individual who assists in developing a comprehensive program that covers investments, taxes, insurance, and other financial matters.

A CFP is a certified financial planner. This person will have completed a curriculum on 106 financial topics and a 10-hour exam.

44. A financial supermarket provides a wide variety of financial services ranging from banking services to mutual funds, insurance, tax assistance, stocks, bonds, and real estate.

45. Most financial planners begin with life insurance, and explore health and disability insurance. Financial planning covers all aspects of investing all the way to retirement and death. A financial planner can steer you into the proper mix of IRA investments, stocks, bonds, precious metals, real estate and so on.

46. The steps involved in estate planning include:

a. Select a guardian for your minor children.

b. Prepare a will.

c. Prepare a durable power of attorney.

47. A durable power of attorney gives an individual you name the power to take over your finances if you become incapacitated. A similar document for health care delegates power to a person named to make health decisions for you if you are unable to make such decisions yourself.

CRITICAL THINKING EXERCISES

Learning Goal 1

1. Obviously, everyone will have different answers. This is primarily to get you started on the road to good personal financial planning. It is important to take a look at how you spend your money, what areas need to be curtailed, what kinds of assets you have been able to accumulate, whether or not you are spending less than you earn, your debts and credit card bills, and so on.

Learning Goal 2

2. A. This is another section where each individual will have varied answers. Some suggestions may include: living at home while going to school, buying used books, keep clothing allowances to a minimum, walking or riding a bike when you can, eating at home, or if you are in a house or apartment, making meals at home. For students returning to school after being out for a while, the methods of accumulating capital will be different - and you may already have discovered ways of your own!

B. Prices in different parts of the country vary widely. Some areas that have been hit by unemployment may have seen a decline in the price of homes. The housing market was in a slump at the beginning of 2008, and there may be some real bargains out there!

C. In this example, with a house payment of $1200, and a 28% tax bracket, you can calculate your real cost by multiplying $1200 x .28, which equals $336. Subtract $336 from $1200 and your real cost will be $864 with an interest deduction.

3. Your answers will vary. If you have no credit cards yet, use this information to make good decisions about whether to apply for a credit card, and how to use it.

Learning Goal 3

4. Your answers to this exercise will be determined by what your situation is. If you are married and have children your insurance needs will be different from someone who is younger and/or unmarried.

Learning Goal 4

5. A. Your answers will vary depending upon your own personal circumstances.

B. An IRA is a good deal for a young investor, because the invested money is not taxed. When you put money into an IRA you save in taxes. If you continue to invest in an IRA, you will have a significant amount of money by the time you retire. The earlier you start, the better. For example if you start putting $2,000 a year in an IRA between the ages of 23-28 at 12% interest, you would have invested only $12,000, but even if you never add another penny by the time you are 65 you will have almost $900,000, because of compounded interest. If you continued nonstop from age 23 until age 65, you would have almost $2 million.

PRACTICE TEST

MULTIPLE CHOICE TRUE-FALSE

1. c 1. T

2. a 2. T

3. d 3. T

4. d 4. F

5. c 5. T

6. d 6. F

7. b 7. F

8. a 8. F

9. c 9. T

10. d 10. T

11. b 11. T

12. c 12. T

13. b 13. F

14. d 14. T

15. c 15.. F

................
................

In order to avoid copyright disputes, this page is only a partial summary.

Google Online Preview   Download