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Personal Financial Planning Notes

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Chapter 3 - Budget and Savings

Net Worth Planning

Net worth planning involves:

* the calculation of current net worth

* setting a net worth goal for next year

* developing specific strategies for meeting that goal

Main reasons for undertaking net worth planning:

1. Establish financial discipline.

2. Prepare a strategy to achieve a future financial target.

3. Measure financial progress on a regular basis.

4. Develop the confidence to feel financially secure about the future.

At a specific point in time, net worth equals:

* Total fair market value of all assets owned (e.g. house, securities) LESS

* All outstanding liabilities owed (e.g. mortgage, loans).

Cash Management Planning

The only way net worth can grow is to have a positive net cash flow, or savings. A zero cash flow can increase net worth if used to pay down debt. Savings are positive when the annual cash inflow exceeds the annual cash outflow. For families with inadequate savings, the technique for improving the cash flow consists of:

* decreasing expenses

* increasing income

* enhancing investment return

Expense reduction techniques include:

* analysis of current expenses

* current expense control

* debt restructuring

Enhanced investment return techniques include:

* reorganization of the investment portfolio

* concentration on tax savings

* conversion of a growth oriented stock portfolio into an income-oriented stock or fixed income portfolio

* asset repositioning

Analysis of Cash Flow Statement

Systematic savings planning strategy refers to the development of specific plans that have the ability to:

* generate the required savings

* systematically direct these savings toward the targeted areas so the specific financial goals can be achieved.

Savings Planning

Positive savings increases net worth in one of three ways:

* an increase in assets

* a decrease in liabilities

* or a combination of both

You need to calculate the amount of savings required to achieve each of the specific goals. If actual expenses exceed the estimated expenses, you may either reduce the actual expenses or revise the estimates.

Effective Savings Strategies

* Goal setting - unrealistic goal setting is perhaps the most important reason for the failure of savings strategies.

* Automatic savings plans, where you deduct money straight from your pay cheque and invest it.

* Savings first approach, where you avoid buying on credit to avoid interest charges and invest the savings.

* Self-rewarding plan, where you purchase a "reward" after meeting a goal.

Emergency Funding Strategies

Sources of an emergency fund include a chequing account, savings account, CSBs, cashable GICs, money market funds, or other money market securities. A rough guideline is that a client should have the equivalent of three months gross salary set up as an emergency fund. Clients who do not want to have their funds tied up in very liquid investments which tend to offer lower returns, may consider setting up a line of credit or home equity loan with their financial institution or taking advantage of the cash surrender value of a life insurance policy.

Credit and Debt Planning

There are several broad forms of consumer debt including credit cards, charge accounts, personal lines of credit, and personal loans.

The Total Debt Service (TDS) ratio is a rough guide for the amount of debt that an individual can afford. The TDS is calculated as annual mortgage or rent payments, plus property taxes, plus heating expenses, plus 50% of condominium fees, plus debt payments divided by annual gross family income. Ideally, the TDS should not be above 40%.

The other rough guide for measuring creditworthiness is the Gross Debt Service (GDS) ratio. The GDS is calculated as annual mortgage or rent payments, plus property taxes, plus heating expenses, plus 50% of condominium fees divided by annual gross family income. Ideally, it should not be above 32%.


Reasons for saving:

* to accumulate funds for an emergency

* to have funds to purchase goods and services

* to increase net worth, or "capital formation"

Investments for emergencies and to purchase goods and services consist of liquid assets such as GICs, CSBs, and money market funds. The main criterion for capital formation savings is long-term growth requiring investments such as stocks and bonds.

Chapter 4 - Residential Mortgages

The Mortgage Marketplace

The mortgage marketplace is divided into two parts: the primary and secondary markets. The primary mortgage market is where new mortgages originate or are created. The secondary mortgage market is where existing mortgages and/or securities comprised of existing mortgages are bought and sold.

The Primary Market

The major providers of mortgage funds in the primary market are chartered banks, trust companies, credit unions and life insurance companies. Mortgage brokers also



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