chapter 4 note - CHAPTER 4 FINANCIAL PLANNING, TAXATION,...

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1 CHAPTER 4 FINANCIAL PLANNING, TAXATION, AND THE EFFICIENCY OF FINANCIAL MARKETS By Dr. M. Metghalchi The PROCESS OF FINANCIAL PLANNING Investing means giving up current purchasing power (current consumption) in order to have higher future purchasing power (consumption). The steps in financial planning are: 1- specify financial goals 2- Each individual needs to identify sources of funds, take an inventory of assets owned and liabilities owed. 3- Look at the stability of the individual's employment and his or her tax environment 4- Play a role in the construction of a financial plan. Anticipated changes in any of these factors affect the construction of financial plans. A pro forma balance sheet is a forecast of the individual's assets, liabilities, and equity (net worth) as of a moment in time (e.g., year end or at retirement). A cash budget enumerates receipts and disbursements over a period of time (e.g., six months). Constructing a balance sheet and a cash budget helps financial planning since these financial statements bring into focus the individual's current financial position and where funds come from and where they are used. (See page 96 for balance sheet and page 97 for cash budget). Financial planning is dynamic. The individual's resources change; the tax laws change; children grow up and leave home; the individual may experience a major sickness or loss. These events may require a financial plan to be altered. In addition, the financial environment may change, or the portfolio may not be performing as well as expected. The forecasted return may not have been realized, so the financial plan and the financial statements may have to be reworked. Financial planning does not cease once the initial plan is constructed and executed. The initial plan is the first step in a lifetime of constructing and
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2 modifying financial plans designed to meet the individual's changing financial goals and resources. Financial goals include the followings: 1. The capacity to meet financial emergencies The financing of specific asset purchase (Down payment of 2. a home) 3. Planning income level at retirement 4. Leaving assets (estate) to heirs or charity 5. Enjoying and managing accumulation of wealth Almost all individual go through three phases, referred as FINANCIAL LIFE CYCLE which has three stages 1) Accumulation, when an individual is in the 30-50 years old; 2) Preservation, here individual should reduce debt and also reduce risk in investment decision, from 50 to retirement age; 3) Use, here the individual is retired and is receiving income from his/her accumulated wealth in the first two stages in addition to social security and pension income. Stock investing should be a major part in the first stage, somehow reduced in the second stage, and be at really reduced in the third stage. It should be reduced in the third stage because if market drops very badly, then there is not enough time to recoup the market wher as in stage one even if the market drops, there is enough time and the investor will for sure recoup as in the long
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This note was uploaded on 09/21/2011 for the course FINANCE 4320 taught by Professor Omaral-nasser during the Spring '11 term at University of Houston-Victoria.

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chapter 4 note - CHAPTER 4 FINANCIAL PLANNING, TAXATION,...

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