Personal Financial Planning: Steps, Impacts of Inflation and Interest Rates, Simple and Compounded I

Step-by-Step Guide to Creating a Personal Financial Plan

Part 1: Personal Financial Planning

1. Using a paragraph for each step, describe in your own words the six steps to creating a personal financial plan that should help to guide the investing process.

2. Using a paragraph for each, discuss the impacts of (a) inflation and (b) interest rates on the financial planning process.

3. Describe in one paragraph the difference between simple interest and compounded interest, and provide an example.

4. Using the time value of money tables provided in the textbook or a financial calculator, calculate solutions for the following problems. Show your work or keying sequences, as demonstrated in the example below.

Example Question

Jane Smart wishes to partially finance her son’s university education. She will contribute $2,000 per year into investments returning 6% per annum for the next 12 years. How much in total will Jane be contributing to her son’s education?

Example Solution

Show your work as in either (i) or (ii).

i. $2,000 x 16.870 (FV Annuity 6%, 12 yrs) = $33,740

or

ii. Calculator (TI BA II +): 12 N, 6 I/Y, -$2,000 PMT, FV = $33,740 (rounded)

Required:

a. Kristen deposits $1,000 into a GIC paying 4% per annum. What is the future value of the GIC if it is left untouched for 5 years?

b. Stacey and Steven will need $20,000 to pay for their wedding in 3 years’ time. They can earn a return of 3% per annum. How much will they need to deposit in a lump sum amount today (present value) so that they will have the funds needed to pay for the wedding?

c. Every year end, Triton invests $3,000 in Canadian growth stocks via his mutual fund for retirement savings. If Triton averages a 10% annual return and plans to retire 30 years from now, how much will he have in his mutual fund at retirement? (Solve for future value of an annuity.)

d. Tim is 25 years old and plans to retire at age 65. He wishes to have a $500,000 lump sum available at retirement to cover annual living expenses beyond his pension income. If Tim invests in the stock markets and receives an average return of 9% per annum, how much would he have to deposit each year to save up the desired $500,000?

Part 2: Fundamentals of Investing

1. In one to two paragraphs, respond to the following comment made by Frank:

“I work as a department store greeter and earn only enough to pay my monthly bills. With such a small income, there is no value in starting an investment program.”

2. Consider the many factors that can affect investment choices. Then,

a. discuss safety and risk as factors affecting investment choice.

b. explain the difference between investing and speculating.

c. explain the concept of “investor risk tolerance.” What are the three drivers of risk tolerance?

d. describe five types of risks that investors face when considering investment alternatives.

e. using a single paragraph, explain the difference between assets that focus on investment income and assets that focus on investment growth. In your answer, provide three examples of assets that are primarily income oriented, and three examples of assets that are growth oriented.

f. describe the reward/risk trade-off:

Level of Risk:
1. Financial security  2. Safety and income  3. Growth  4. Speculation

. For each of these four levels of risk, list at least three types of investments that would be appropriate (three per level).

i. Of these four levels of risk, which level would you expect to provide the highest reward (investment return) and which level would you expect to provide the lowest reward?

a. define investment liquidity, and explain why having too little or too much liquidity may be detrimental to the investor.

b. explain the process of diversification and why it is important to investors.

1. 
Investment alternatives

a. Discuss the main difference between equity financing and bond financing from the issuer’s perspective.

b. Provide three reasons investors might choose segregated funds over mutual funds.

c. Provide two reasons investing in real estate can be risky.

d. What is the main reason investors are attracted to trusts as a type of investment, such as a real estate investment trust (REIT)?

2. Interest income, dividend income, and capital gains income

a. The textbook refers to interest income being taxed as ordinary income. Explain what is meant by ordinary income and what this means for tax purposes.

b. Explain why dividend income may have a preferred tax treatment.

Explain the difference between a capital gain and a taxable capital gain by defining the percentage of capital gains (often referred to as the inclusion rate) an investor is taxed