Introduction to Personal Finance

JOHN GRABLE teaches and conducts research in the Certified Financial Planner Board of Standards Inc. undergraduate and graduate programs at the University of Georgia where he holds an Athletic Association Endowed Professorship. Prior to entering the academic profession, he worked as a pension/benefits administrator and later as a Registered Investment Adviser in an asset management firm. Dr. Grable has served the financial planning profession as the founding editor of the Journal of Personal Finance and co-founding editor of the Journal of Financial Therapy and Financial Planning Review. He is best known for his work in the areas of financial literacy and education, financial risk-tolerance assessment, behavioral financial planning, and evidence-based financial planning. He has been the recipient of numerous research and publication awards and grants, and is active in promoting the link between research and financial planning practice where he has published over 150 refereed papers, co-authored several textbooks, co-authored a financial planning communication and counseling book, and co-edited a financial planning and counseling scales book and a personal finance handbook. Since earning his doctorate degree, Dr. Grable has served on the Board of Directors of the International Association of Registered Financial Consultants (IARFC), as Treasurer and President for the American Council on Consumer Interests (ACCI), and as Treasurer and board member for the Financial Therapy Association. He has received numerous awards, including the prestigious Cato Award for Distinguished Journalism in the Field of Financial Services, the IARFC Founders Award, the Dawley-Scholer Award for Faculty Excellence in Student Development, and the ACCI Mid-Career Award. He currently writes an economics and investing column for the Journal of Financial Service Professionals and provides research and consulting services through the Financial Planning Performance Lab. LANCE PALMER received his bachelor's and MBA degrees from The University of Utah and his doctorate degree from Utah State University. He is a co-founder of the University of Georgia (UGA) financial planning program where he continues to teach and conduct research with a focus on tax planning and financial behavior change. Dr. Palmer holds the Janette McGarity Barber Distinguished Professorship and teaches both undergraduate and graduate financial planning and personal finance courses within the UGA financial planning program. He is active in research-based financial education throughout Georgia and the country, and collaborates on the design, implementation, and evaluation of personal finance education interventions delivered in a variety of settings. He is a Certified Financial Planner professional and a Certified Public Accountant (UT). He has served on multiple editorial boards and as President of the Academy of Financial Services. He was selected as a Lilly Teaching Fellow, and received the Richard B. Russell Excellence in Undergraduate Teaching Award, the Engaged Scholar Award, and the Service-Learning Research Excellence Award. Working closely with Georgia United Credit Union and UGA Cooperative Extension, Dr. Palmer has helped to expand the service-learning Volunteer Income Tax Assistance program throughout Georgia. Under this program, students studying financial planning and accounting complete thousands of tax returns for families in the local community each year and provide thousands of hours of financial education and planning assistance to tax filers during the tax preparation process. Dr. Palmer is a co-founder of the UGA Financial Resiliency Lab, which seeks to build wealth among low-income individuals and families through financial education, coaching, goal development, and tax-time savings interventions.

1 Beginning Your Financial Journey: The Interior Finance Point of View 1-1

Your Starting Point 1-2

1.1 Your Journey to Financial Well-Being 1-4

Your Internal View of the Financial World 1-4

Launching Your Lifetime Financial Journey 1-5

The Journey to Financial Well-Being 1-7

1.2 Human Capital: An Essential Element of Financial Well-Being 1-11

Human Capital 1-11

Social Capital 1-14

The Impact of a Pandemic on Human and Social Capital 1-15

The College Payoff 1-16

1.3 Financial Risk Tolerance and Financial Goal Achievement 1-21

Financial Risk Tolerance 1-21

Financial Risk Tolerance and Wealth Accumulation 1-22

Risk Perception and Risk Preference 1-23

1.4 Financial Goals and Time Perspective 1-27

Setting SMART Financial Goals 1-27

Thinking About Time 1-29

Maintaining Commitment to Your Goals 1-31

1.5 Psychology and Financial Well-Being 1-35

Procrastination 1-35

Heuristics 1-37

Using Heuristics as a Decision-Making Tool 1-40

2 Tools for Your Financial Journey 2-1

What’s in Your Financial Toolbox? 2-2

2.1 The Power of Compound Growth 2-3

Overview of Interest 2-3

Compound Growth 2-4

APR and APY Formulas 2-6

Consider Interest Strategically 2-7

2.2 Overview of Time Value of Money 2-11

Understanding the Time Value of Money (TVM) 2-11

The Basic TVM Concepts 2-11

A TVM Shortcut: The Rule of 72 2-15

2.3 Time Value of Money Calculations 2-18

Methods for Solving TVM Problems 2-18

Solving TVM Problems 2-18

Other TVM Calculations 2-25

2.4 Your Starting Point: The Balance Sheet 2-29

Determining Your Net Worth 2-29

The Importance of Net Worth 2-33

Financial Ratios: Guideposts Along Your Financial Journey 2-33

2.5 The Personal Budget 2-37

The Five Steps of Resource Management 2-37

The Budget 2-38

Financial Ratios 2-41

The Value of Tracking Expenses 2-43

2.6 Your Financial Plan 2-46

Overview of a Financial Plan 2-46

Creating a Financial Plan: The Six Steps 2-47

Determining Your Financial Score 2-48

3 Earnings and Income: The Building Blocks of Your Financial Journey 3-1

The Real Cost of Summer Vacations 3-2

3.1 Income: Produce More Than You Spend 3-3

Creating Wealth 3-3

Saving Your Income Surplus 3-5

Escaping the Perils of Debt 3-7

3.2 Employment Earnings 3-11

Overview of Earnings 3-11

Who Makes More Money? 3-14

3.3 Self-Employment Income 3-18

Overview of Self-Employment 3-18

The Pros and Cons of Self-Employment 3-19

Business Structures 3-21

3.4 Investment Income 3-25

Earned Income Versus Unearned Income 3-25

Interest and Dividends 3-26

Wealth over the Life Span 3-30

3.5 Capital Gains Income 3-33

Overview of Capital Gains 3-33

How to Achieve Capital Gains 3-35

3.6 Government Benefits: The Safety Net for Income 3-39

Government Financial Assistance 3-39

Other Sources of Assistance 3-42

Social Security 3-43

4 Personal Taxation 4-1

The Inescapable Reality of Taxation 4-1

4.1 Understanding Your Taxes 4-3

Types of Taxes 4-3

Forms of Taxation 4-7

Taxes and the Government 4-8

4.2 Federal Income Tax Base 4-13

Overview of Federal Income Tax Returns 4-13

Entering Personal Information 4-16

Calculating Total Income 4-21

4.3 Federal Income Tax Rates 4-27

Federal Income Tax Brackets and Marginal Tax Rates 4-27

Capital Assets and Tax Rates 4-30

Effective Tax Rates 4-31

4.4 Federal Income Tax Credits 4-34

Understanding Tax Credits 4-34

Common Federal Income Tax Credits 4-35

Importance of Filing a Tax Return 4-40

4.5 Federal Self-Employment Taxes 4-43

Employee Versus Self-Employment Taxes 4-43

Calculating Self-Employment Taxes 4-46

4.6 Income Tax-Planning Strategies 4-51

Lowering Your Tax Base 4-51

Tax-Exempt Income 4-53

Importance of Tax Knowledge and Organization 4-54

5 Checking Accounts, Credit Scores, and Credit Cards 5-1

Credit Cards: Tools or Trouble? 5-1

5.1 Checking Accounts: The Basics 5-3

Overview of Checks 5-3

Opening and Using a Checking Account 5-4

Know Before You Spend 5-6

5.2 Debit and Prepaid Cards and Electronic Transfers 5-12

Purchases and Transactions 5-12

Electronic Payment Methods 5-13

Hybrid Payment Methods 5-14

Choosing the Best Payment Method 5-16

5.3 Costs of Borrowing 5-19

Overview of Loans 5-19

Loans and Collateral 5-19

Choosing the Right Loan 5-22

Calculating Interest 5-23

5.4 Credit Reports 5-28

What Is a Credit Report? 5-28

Contents and Accessibility of a Credit Report 5-30

Analyzing Your Credit Report 5-31

5.5 Credit Scores 5-35

The Purpose of Credit Scores 5-35

Developing Credit Scores 5-36

How Credit Scores Are Used and Updated 5-39

5.6 Credit Cards 5-43

Characteristics of Credit Cards 5-43

Credit Card Payments 5-46

Qualifying for a Credit Card 5-47

6 Loans and Housing Decisions 6-1

Paying for College: The Facts 6-2

6.1 High-Cost Consumer Loans 6-3

Alternative Financial System Loans 6-3

Pros and Cons of Alternative Loans 6-5

How to Avoid Expensive Loans 6-7

6.2 Personal Loans 6-10

Importance of Personal Loans 6-10

Types of Personal Loans 6-11

6.3 Financial Aid and Student Loans 6-17

The Process of Obtaining Federal Financial Aid 6-17

Federal Student Loans 6-18

Financial Aid in Practice 6-19

6.4 Approaches to College Education Funding 6-25

Calculating the Costs and Benefits of a College Education 6-25

Saving for College 6-28

Other Ways to Help Pay for College Expenses 6-32

6.5 Auto Loans 6-36

The Value of an Automobile 6-36

Steps in Purchasing an Automobile 6-37

Buying Versus Leasing 6-40

6.6 Housing: The Basics of Renting 6-44

Renting Versus Buying 6-44

Finding a Rental 6-45

The Rental Lease 6-47

Tenant Rights 6-49

6.7 Buying a Home 6-53

Owning a Home 6-53

Shopping for a Mortgage 6-56

Maximizing Housing Wealth 6-59

7 The Foundation of Savings 7-1

What’s in Your Account? 7-1

7.1 Risks, Returns, and the Investment Pyramid 7-3

Risk Defined 7-3

Saving and Investing: An Introduction 7-6

The Investment Pyramid 7-7

7.2 Building and Maintaining an Emergency Fund 7-12

Overview of Emergency Funds 7-12

Creating Your Own Emergency Fund 7-13

The Risks of Going Without an Emergency Fund 7-15

7.3 Savings Accounts 7-19

Overview of Savings 7-19

Motivating Yourself to Save 7-19

Where to Save Your Money 7-21

Safe Assets for an Emergency Fund and Short-Term Savings 7-21

7.4 Using Roth IRAs Effectively 7-28

Overview of Roth IRAs 7-28

Roth IRA Withdrawals 7-29

Opening, Funding, and Using Your Roth IRA 7-31

7.5 U.S. Savings Bonds 7-36

Overview of U.S. Savings Bonds 7-36

Types of U.S. Savings Bonds 7-37

Purchasing and Redeeming U.S. Savings Bonds 7-38

The Long-Term Value of U.S. Savings Bonds 7-39

7.6 Custodial Accounts and Asset Ownership for Minors 7-43

Property Ownership as a Minor 7-43

Financial Benefits of Transferring Assets to Minors 7-45

Other Beneficiary Accounts 7-46

7.7 Financial Frauds and Identity Theft 7-49

Financial Frauds 7-49

Protecting Yourself from Financial Fraud 7-51

Identity Theft 7-52

8 Investments 8-1

Investment Highs and Lows 8-1

8.1 Stocks: An Introduction 8-4

Overview of Stock 8-4

Why Buy Stock? 8-6

Using Stocks to Create Wealth 8-7

8.2 Stocks: Valuation and Ownership 8-12

Stock Ownership 8-12

Valuing Stocks 8-13

Applying Knowledge and Intuition 8-16

8.3 Bonds: An Introduction 8-20

Overview of Bonds 8-20

Types of Bonds 8-23

Investing in Bonds 8-24

8.4 Mutual Funds 8-31

Overview of Mutual Funds 8-31

Mutual Fund Management 8-32

Purchasing Mutual Funds 8-35

8.5 Exchange-Traded Funds 8-41

Limitations of Mutual Funds 8-41

Overview of Exchange-Traded Funds 8-42

Why Use an ETF? 8-43

8.6 Domestic Versus Foreign Investments 8-48

Overview of Foreign Investments 8-48

Why Foreign Investments? 8-49

Buying Foreign Investments 8-50

8.7 Risks, Returns, and Investment Portfolios 8-54

The Three Rules of Risks 8-54

Risk Tolerance and Your Portfolio 8-56

Risks and Returns Revisited: Volatility and Inflation 8-59

8.8 Brokerage Accounts 8-63

Overview of Brokerage Accounts 8-63

Placing Orders 8-65

Reading a Brokerage Statement 8-67

8.9 Investing in Real Estate 8-70

Overview of Real Estate 8-70

Real Estate Investment Trusts 8-72

Real Estate Risks 8-73

8.10 Investing Alternatives: Collectibles, Auctions, and Other Techniques 8-78

Overview of Collectibles 8-78

Collectible Dealers 8-79

Market Equilibrium 8-81

8.11 Protecting Your Investments 8-86

Protecting Yourself as an Investor 8-86

A Cautionary Tale 8-87

Working with a Financial Advisor 8-89

9 Risk Management: The Role of Insurance 9-1

Risky Behavior? 9-2

9.1 Insurance: What It Is and Why You Need It 9-4

Human Capital and Health 9-4

The Risk Matrix and Health 9-4

Protecting Your Health 9-5

Overview of Insurance Companies 9-7

9.2 Health Insurance 9-11

Overview of Health Care 9-11

Health Insurance Costs 9-12

Types of Health Insurance Policies 9-15

Obtaining Health Insurance 9-17

9.3 Disability Insurance: Protecting Your Income from Life’s Unexpected Events 9-22

Overview of Disability 9-22

Disability Insurance 9-24

Disability Insurance Costs 9-25

9.4 Life Insurance: Do You Really Need It? 9-29

The Basics of Life Insurance 9-29

Types of Life Insurance 9-29

Do You Need Life Insurance? 9-32

9.5 Automobile Insurance 9-37

Overview of Automobile Insurance 9-37

Liability Coverage 9-41

Car Accidents: What to Do and Not Do 9-44

9.6 Homeowner’s and Renter’s Insurance: Protecting Your Personal Belongings 9-47

Insurance and Risks 9-47

Homeowner’s Insurance 9-49

Renter’s Insurance 9-51

9.7 Long-Term Care Insurance 9-56

Overview of Long-Term Care Insurance 9-56

Who Needs Long-Term Care Insurance? 9-58

Medicare and Medicaid 9-59

Becoming a Help Provider 9-60

10 Planning for the Future: Retirement and Estate Planning 10-1

Taking Charge of Your Long-Term Future 10-2

10.1 Planning for Your Retirement 10-4

Overview of Retirement Planning 10-4

Estimating Your Financial Retirement Needs 10-5

Saving for Retirement 10-7

Getting Your Employer’s Help: Matching Contributions 10-8

10.2 Individual Retirement Accounts (IRAs) 10-14

Overview of IRAs 10-14

IRA Contributions 10-18

IRAs and Your Overall Retirement Plan 10-20

10.3 Property Ownership and Trusts 10-25

Titles and Transfers of Property 10-25

Trusts 10-27

Gifts and Inheritances 10-28

10.4 Wills: A Fundamental Estate Planning Tool 10-32

Transferring Property After Death 10-32

Wills 10-33

Creating a Will 10-35

10.5 Living Wills and Powers of Attorney 10-40

Overview of Living Wills 10-40

Other Medical Documents 10-42

Power of Attorney 10-43

10.6 Obtaining Help from Financial Professionals 10-47

Overview of the Financial Professional Marketplace 10-47

Financial Help: Two Approaches 10-48

Navigating the Financial Advice Marketplace 10-49

Glossary G-1

Index I-1