Personal Finances

Financial Planning

Learning Objectives

1. Define personal finances and financial planning.
2. Explain the financial planning life cycle.
3. Discuss the advantages of a college education in meeting short- and long-term financial goals.
4. Describe the steps you'd take to get a job offer and evaluate alternative job offers, taking benefits into account.
5. Understand the ways to finance a college education.
   

Before we go any further, we need to nail down a couple of key concepts. First, just what, exactly, do we mean by personal finances? Finance itself concerns the flow of money from one place to another, and your personal finances concern your money and what you plan to do with it as it flows in and out of your possession. Essentially, then, personal finance is the application of financial principles to the monetary decisions that you make either for your individual benefit or for that of your family.

Second, as we suggested in "Where Does Your Money Go?" - and as we'll insist in the rest of it - monetary decisions work out much more beneficially when they're planned rather than improvised. Thus our emphasis on financial planning - the ongoing process of managing your personal finances in order to meet goals that you've set for yourself or your family.

Financial planning requires you to address several questions, some of them relatively simple:

• What's my annual income?
• How much debt do I have, and what are my monthly payments on that debt?
  

Others will require some investigation and calculation:

• What's the value of my assets?
• How can I best budget my annual income?
  

Still others will require some forethought and forecasting:

• How much wealth can I expect to accumulate during my working lifetime?
• How much money will I need when I retire?

The Financial Planning Life Cycle

Another question that you might ask yourself - and certainly would do if you were a professional in financial planning - is something like, "How will my financial plans change over the course of my life?" Figure 14.3 "Financial Life Cycle" illustrates the financial life cycle of a typical individual - one whose financial outlook and likely outcomes are probably a lot like yours. As you can see, our diagram divides this individual's life into three stages, each of which is characterized by different life events (such as beginning a family, buying a home, planning an estate, retiring). At each stage, too, there are recommended changes in the focus of the individual's financial planning:

• In stage 1, the focus is on building wealth.
• In stage 2, the focus shifts to the process of preserving and increasing the wealth that one has accumulated and continues to accumulate.
• In stage 3, the focus turns to the process of living on (and, if possible, continuing to grow) one's saved wealth.

Figure 14.3 Financial Life Cycle

At each stage, of course, complications can set in - say, changes in such conditions as marital or employment status or in the overall economic outlook. Finally, as you can also see, your financial needs will probably peak somewhere in stage 2, at approximately age fifty-five, or ten years before typical retirement age.

Choosing a Career

Until you're eighteen or so, you probably won't generate much income; for the most part, you'll be living off your parents' wealth. In our hypothetical life cycle, however, financial planning begins in the individual's early twenties. If that seems like rushing things, consider a basic fact of life: this is the age at which you'll be choosing your career - not only the sort of work you want to do during your prime income-generating years, but also the kind of lifestyle you want to live in the process.

What about college? Most readers of this book, of course, have decided to go to college. If you haven't yet decided, you need to know that college is an extremely good investment of both money and time.

Table 14.1 "Education and Average Income", for example, summarizes the findings of a study conducted by the U.S. Census Bureau. A quick review shows that people who graduate from high school can expect to increase their average annual earnings by about 49 percent over those of people who don't, and those who go on to finish college can expect to generate 82 percent more annual income than that. Over the course of the financial life cycle, families headed by those college graduates will earn about $1.6 million more than families headed by high school graduates who didn't attend college. (With better access to health care - and, studies show, with better dietary and health practices - college graduates will also live longer. And so will their children).

Table 14.1 Education and Average Income

Education	Average income	Percentage increase over next-highest level
High school dropout	$20,873	—
High school diploma	$31,071	48.9%
College degree	$56,788	82.8%
Advanced higher-education degree	$82,320	45.0%

And what about the debt that so many people accumulate to finish college? For every $1 that you spend on your college education, you can expect to earn about $35 during the course of your financial life cycle. At that rate of return, you should be able to pay off your student loans (unless, of course, you fail to practice reasonable financial planning).

Naturally, there are exceptions to these average outcomes. You'll find English-lit majors stocking shelves at 7-Eleven, and you'll find college dropouts running multibillion-dollar enterprises. Microsoft cofounder Bill Gates dropped out of college after two years, as did his founding partner, Paul Allen. Current Microsoft CEO Steve Ballmer finished his undergraduate degree but quit his MBA program to join Microsoft (where he apparently fit in among the other dropouts in top management). It's always good to remember, however, that though exceptions to rules (and average outcomes) occasionally modify the rules, they invariably fall far short of disproving them: in entrepreneurship as in most other walks of adult life, the better your education, the more promising your financial future. One expert in the field puts the case for the average person bluntly: educational credentials "are about being employable, becoming a legitimate candidate for a job with a future. They are about climbing out of the dead-end job market".


This is not to say, however, that all degrees promise equal job prospects. Figure 14.4 "Top 25 Fastest-Growing Jobs, 2006–2016", for example, summarizes a U.S. Bureau of Labor Statistics projection of the thirty fast-growing occupations for the years 2006–2016. Veterinary technicians and makeup artists will be in demand as never before, but as you can see, occupational prospects are fairly diverse.

Figure 14.4 Top 25 Fastest-Growing Jobs, 2006–2016

Major	Average Earnings with Bachelor's Degree	Major	Average Earnings with Bachelor's Degree
Chemical engineering	$67,425	History	$45,926
Aerospace engineering	$65,649	Biology	$45,532
Computer engineering	$62,527	Nursing	$45,538
Physics	$62,104	Psychology	$43,963
Electrical engineering	$61,534	English	$43,614
Mechanical engineering	$61,382	Health technology	$42,524
Industrial engineering	$61,030	Criminal justice	$41,129
Civil engineering	$58,993	Physical education	$40,207
Accounting	$56,637	Secondary education	$39,976
Finance	$55,104	Fine arts	$38,857
Computer science	$52,615	Philosophy	$38,239
Business management	$52,321	Dramatic arts	$37,091
Marketing	$51,107	Music	$36,811
Journalism	$46,835	Elementary education	$34,564
Information systems	$46,519	Special education	$34,196

Financing a College Education

Let's revisit one of the facts included in the earlier discussion: for every $1 that you spend on your college education, you can expect to earn about $35 during the course of your financial life cycle. And let's say you're convinced (as you should be) that getting a college degree is a wise financial choice. You still have to deal with the cost of getting your degree. We're sure this won't come as a surprise: attending college is expensive - tuition and fees have gone up sharply, the cost of books has skyrocketed, and living expenses have climbed. Many students can attend college only if they receive some type of financial aid. Though the best way to learn what aid is available to you is to talk with a representative in the financial aid office at your school, this section provides an overview of the types of aid offered to students. Students finance their education through scholarships, grants, education loans, and work-study programs. We'll explore each of these categories of aid:

• Scholarships, which don't have to be repaid, are awarded based on a number of criteria, including academic achievement, athletic or artistic talent, special interest in a particular field of study, ethnic background, or religious affiliation. Scholarships are generally funded by private donors such as alums, religious institutions, companies, civic organizations, professional associations, and foundations.
• Grants, which also don't have to be repaid, are awarded based on financial need. They're funded by the federal government, the states, and academic institutions. An example of a common federal grant is the Pell Grant, which is awarded to undergraduate students based on financial need. The maximum Pell Grant award for the 2011–12 award year (July 1, 2011, to June 30, 2012) is $5,550.
• Education loans, which must be repaid, are available to students from various sources, including the federal government, states, and academic institutions. While recent problems in the credit markets have made college loans more difficult to obtain, most students are able to get the loans they need. The loans offered directly to undergraduate students by the federal government include the need-based, subsidized Federal Stafford, the non–need-based unsubsidized Federal Stafford, and the need-based Federal Perkins loans. With the exception of the unsubsidized Federal Stafford, no interest accrues while the student is enrolled in college at least part time. There are also a number of loans available to parents of students, such as the Federal Parent PLUS program. Under this program, parents can borrow federally guaranteed low-interest loans to fund their child's education.
• Work-study is a federally sponsored program that provides students with paid, part-time jobs on campus. Because the student is paid based on work done, the funds received don't have to be repaid.
  

Find a Great Job

Getting a Job Offer

Most likely your college has a career center. The people working there can be a tremendous help to you as you begin your job search. But most of the work has to be done by you. Like other worthwhile projects, your job search project will be very time-consuming. As you get close to graduation, you'll need to block out time to work on this particularly important task.

The first step is to prepare a résumé, a document that provides a summary of educational achievements and relevant job experience. Its purpose is to get you an interview. A potential employer will likely spend less than a minute reviewing your résumé, so its content should be concise, clear, and applicable to the job for which you're applying. For some positions, the person in charge of hiring might read more than a hundred résumés. If you don't want your résumé kicked out right away, be sure it contains no typographical or grammatical errors. Once you've completed your résumé, you can use it to create different versions tailored to specific companies you'd like to work for. Your next step is to write a cover letter, a document accompanying your résumé that explains why you're sending your résumé and highlights your qualifications. You can find numerous tips on writing résumés and cover letters (as well as samples of both) online. Be sure your résumé is accurate: never lie or exaggerate in a résumé. You could get caught and not get the job (or - even worse - you could get the job, get caught, and then get fired). It's fairly common practice for companies to conduct background checks of possible employees, and these checks will point out any errors. In effect, says one expert, "you jeopardize your future when you lie about your past".

After writing your résumé and cover letter, your next task is to create a list of companies you'd like to work for. Use a variety of sources, including your career services office and company Web sites, to decide which companies to put on your list. Visit the "career or employment" section of the company Web sites and search for specific openings.

You could also conduct a general search for positions that might be of interest to you, by doing the following:

• Visiting career Web sites, such as Monster.com, Wetfeet.com, or Careerbuilder.com (which maintain large databases of openings for all geographical areas)
• Searching classified ads in online and print newspapers
• Attending career fairs at your college and in your community
• Signing up with career services to talk with recruiters when they visit your campus
• Contacting your friends, family, and college alumni and letting them know you're looking for a job and asking for their help

Once you spot a position you want, send your résumé and cover letter (tailored to the specific company and job). Follow up in a few days to be sure your materials got to the right place, and offer to provide any additional information. Keep notes on all contacts.

Evaluating Job Offers

Let's be optimistic and say that you did quite well in your interviews, and you have two job offers. It's a great problem to have, but now you have to decide which one to accept. Salary is important, but it's clearly not the only factor. You should consider the opportunities the position offers: will you learn new things on the job, how much training will you get, could you move up in the organization (and if so, how quickly)? Also consider quality of life issues: how many hours a week will you have to work, is your schedule predictable (or will you be asked to work on a Friday night or Saturday at the last minute), how flexible is your schedule, how much time do you get off, how stressful will the job be, do you like the person who will be your manager, do you like your coworkers, how secure is the job, how much travel is involved, where's the company located, and what's the cost of living in that area? Finally, consider the financial benefits you'll receive. These could include health insurance, disability insurance, flexible spending accounts, and retirement plans. Let's talk more about the financial benefits, beginning with health insurance.

• Employer-sponsored health insurance plans vary greatly. Some cover the employee only, while others cover the employee, spouse, and children. Some include dental and eye coverage while others don't. Most plans require employees to share some of the cost of the medical plan (by paying a portion of the insurance premiums and a portion of the cost of medical care). But the amount that employees are responsible for varies greatly. Given the rising cost of health insurance, it's important to understand the specific costs associated with a health care plan and to take these costs into account when comparing job offers. More important, it's vital that you have medical insurance. Young people are often tempted to go without medical insurance, but this is a major mistake. An uncovered, costly medical emergency (say you're rushed to the hospital with appendicitis) can be a financial disaster. You could end up paying for your hospital and doctor care for years.
• Disability insurance isn't as well known as medical insurance, but it can be as important (if not more so). Disability insurance pays an income to an insured person when he or she is unable to work for an extended period. You would hope that you'd never need disability insurance, but if you did it would be of tremendous value.
• A flexible spending account allows a specified amount of pretax dollars to be used to pay for qualified expenses, including health care and child care. By paying for these costs with pretax dollars, employees are able to reduce their tax bill.
• There are two main types of retirement plans. One, called a defined benefit retirement plan, provides a set amount of money each month to retirees based on the number of years they worked and the income they earned. This form of retirement plan was once very popular, but it's less common today. The other, called a defined contribution retirement plan, is a form of savings plan. The employee contributes money each pay period to his or her retirement account, and the employer matches a portion of the contribution. Even when retirement is exceedingly far into the future, it's financially wise to set aside funds for retirement.
  

Key Takeaways

• Finance concerns the flow of money from one place to another; your personal finances concern your money and what you plan to do with it as it flows in and out of your possession. Personal finance is thus the application of financial principles to the monetary decisions that you make, either for your individual benefit or for that of your family.
• Financial planning is the ongoing process of managing your personal finances to meet goals that you've set for yourself or your family.
• The financial life cycle divides an individual's life into three stages, each of which is characterized by different life events. Each stage also entails recommended changes in the focus of the individual's financial planning:

1. In stage 1, the focus is on building wealth.
2. In stage 2, the focus shifts to the process of preserving and increasing the wealth that one has accumulated and continues to accumulate.
3. In stage 3, the focus turns to the process of living on (and, if possible, continuing to grow) one's saved wealth.

• According to the model of the financial life cycle, financial planning begins in the individual's early twenties, the age at which most people choose a career - both the sort of work they want to do during their income-generating years and the kind of lifestyle they want to live in the process.
• College is a good investment of both money and time. People who graduate from high school can expect to improve their average annual earnings by about 49 percent over those of people who don't, and those who go on to finish college can expect to generate 82 percent more annual income than that. The area of study designated on your degree often doesn't matter when you're applying for a job: when poring over résumés, employers often look for the degree and simply note that a candidate has one.
• The first step in your job search is to prepare a résumé, a document that provides a summary of educational achievements and relevant job experience. Your résumé should be concise, clear, applicable to the job for which you are applying, and free of errors and inaccuracies.
• A cover letter is a document that accompanies your résumé and explains why you're sending your résumé and highlights your qualifications.
• To conduct a general search for positions that might be of interest to you, you could:

1. Visit career Web sites, such as Monster.com, Wetfeet.com, or Careerbuilder.com.
2. Search classified ads in online and print newspapers.
3. Attend career fairs at your college and in your community.
4. Talk with recruiters when they visit your campus.
5. Contact people you know, tell them you're looking for a job, and ask for their help.

• When you're invited for an interview, you should research the company, practice answering questions you might be asked in the interview, and think up pertinent questions to ask the interviewer.
• When comparing job offers, consider more than salary. Also of importance are quality of life issues and benefits. Common financial benefits include health insurance, disability insurance, flexible spending accounts, and retirement plans.

1. Employer-sponsored health insurance plans vary greatly in coverage and cost to the employee.
2. Disability insurance pays an income to an insured person when he or she is unable to work for an extended period of time.
3. A flexible spending account allows a specified amount of pretax dollars to be used to pay for qualified expenses, including health care and child care. By paying for these costs with pretax dollars, employees are able to reduce their tax bill.

• There are two main types of retirement plans: a defined benefit plan, which provides a set amount of money each month to retirees based on the number of years they worked and the income they earned, and a defined contribution plan, which is a form of savings plan into which both the employee and employer contribute. A well-known defined contribution plan is a 401(k).

Exercise

(AACSB) Analysis

Think of the type of job you'd like to have. Describe the job and indicate how you'd go about getting a job offer for this type of job. How would you evaluate competing offers from two companies? What criteria would you use in selecting the right job for you?