Basic Ideas of Finance

Personal Finance
It is about creating productive
assets that is, resources that can be
used to create future economic
benefit, such as increasing
income, decreasing expenses or
storing wealth, as an investment,
and about protecting existing and
expected value in those assets.
 Basic Ideas of Finance
• 2.1 Income and Expenses
• 2.2 Assets
• 2.3 Debt and Equity
• 2.4 Income and Risk
 2.1 Income and Expenses

• Personal finance is the process of paying for or financing a

life and a way of living.
 Where Does Income Come From?

• Income is what is earned or received in a given period.

• Deposit accounts
• Owning stock
• Owning a piece of a partnership
 Income from Market-based Economy

• Selling labor
• Selling capital
 Where Does Income Go?
• Expenses are costs for items or
resources that are used up or
consumed in the course of daily
living.
• Income is less than expenses (budget
deficit)
• Income is greater than expenses
(budget surplus)
 Opportunity Costs and Sunk Costs
E.g., Suppose you can afford a new jacket or new boots, but not both, because your
resources—the income you can use to buy clothing—are limited. If you buy the
jacket, you cannot also buy the boots. Not getting the boots is an opportunity cost of
buying the jacket; it is cost of sacrificing your next best choice.

The money you spent on your jacket is a sunk cost. If it snows next week and you
decide you really do need boots, too, that money is gone, and you cannot use it to
buy boots. If you really want the boots, you will have to find another way to pay for
them.
 2.2 Assets
• An asset is any item with economic value that can be converted to cash.
• Car
• Savings account
• Money market account
• Shares of stock
• Forty acres of farmland
• Home
Assets Store Wealth
 Assets Create Income

An investment in an apartment house stores wealth

and creates rental income.
 Assets Reduce Expenses

Purchasing an asset and using it may be cheaper

than arranging for an alternative.
 2.3 Debt and Equity

Buying capital, that is, borrowing enables you to invest

without first owning capital.
 The Costs of Debt and Equity
• The cost of equity is in having to share the benefits from the
investment.
• Borrowing is renting someone else’s money for a period of time, and
the result is debt.
 The Uses of Debt and Equity

Debt is a way to make an investment that could not

otherwise be made, to buy an asset that you couldn’t buy
without borrowing.
 The Value of Debt
The value of debt
includes the benefits of
having the asset sooner
rather than later,
something that debt
financing enables.
 2.4 Income and Risk

Personal finance is not just about getting what you want;

it is also about protecting what you have.
 Example of Savings
1. Depositing into a statement savings account at a bank.
2. Contributing to a retirement account
3. Purchasing a certificate of deposit (CD)
4. Purchasing a government savings bond.
5. Depositing into a money market account.
 Tips for Personal Finance
1. If you can’t afford it without a  One of the most dangerous
credit card, don’t buy it. approaches to having a credit card is
living under the illusion that you can
afford things you actually do not
have the money to afford. One good
rule to live by is if you can't pay for
something in cash, then you can't
afford it with a card.
 Tips for Personal Finance
2. Have a fallback emergency fund.
Emergency savings are very important for
those “just-in-case” situations. Best
practice when trying to establish an
emergency savings is to have at least 6-
month of your salary saved up. This will be
something to cover your expenses if you
lose your job, have an injury that prevents
you from working, or for when you need
money for an unexpected, but necessary,
cost.
 Tips for Personal Finance
3. Pay off your credit card balances
in full.
There's always room in your personal
budget to cut out unnecessary spending
habits. This could be going to “Taco
Tuesday” at your favorite restaurant
only once a month, or cutting down on
your online shopping. The more you
shave away the wants and spend only
on the needs the better your finances
will be.
 Tips for Personal Finance

4. Everything is better with

a budget.
 Tips for Personal Finance
5. Do not use your credit card for
cash advances.
 Tips for Personal Finance
6. Limit the number of cards you
have.
Multiple credit cards mean multiple
payments and multiple cases of
tacked on interest. This is a setup for
the eventual need of debt
consolidation if you cannot handle
using the cards responsibly. The more
charges accumulated on each card
means more room to lose track of
your spending and payments.
 Tips for Personal Finance
7. Master sheet of expenses.
 Tips on Personal Finance
8. Master sheet of expenses. If the occasion arises where you
receive a pay increase, live off the
lower wage that you had before and
store the extra funds in savings.
After all, you've managed to make it
so far off your previous wage, put
the new funds in a place where they
will work harder for you.
 Tips on personal Finance
9. Collect coupons to save cash.