Twelve Key Elements of Practical Personal Finance

Common Sense Economics

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A Personal Financial Epidemic?

do Americans live under so much financial stress when their incomes are higher than ever? insecurity is the result of the choices we make rather than the income we earn. principles that lead to financial security are largely the same as the ones underlying a prosperous economy.
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Financial

The

Who Needs Money?

Practical Element #1

Discover your comparative advantage.

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Comparative Advantage

We are all relatively more productive in some areas than in others. Your comparative advantage is determined by your comparative abilities, not your absolute abilities.

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Whats Your Comparative Advantage?

Even if youre better at doing everything, you shouldnt. Specialize in what you are relatively the best atfor which you give up the least. Allow others work to be to your advantage. Self-sufficiency is for novels, not real life!
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Practical Element #2

Be entrepreneurial.
In a market economy, people get ahead by helping others and discovering better ways of doing things.
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Who are Entrepreneurs?

People adept at discovering better ways of doing things and acting on these opportunities. Disproportionately wealthy 2/3 of American millionaires are entrepreneurs.

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Entrepreneurs Success:
1.

Entrepreneurial talent: the ability to discover innovative new products, costreducing production methods, and profitable opportunities that have been overlooked by others. Tolerance for risk: Self-employment is more risky, but greater risk and higher returns go together.
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2.

Entrepreneurs Success (cont.)

High Savings Rates: Investing in their businesses adds to entrepreneurs wealth. Hard Work Business owners tend to work longer hours.

4.

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Practical Element #3

Spend less than you earn. Begin a regular savings program now.
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Why Save?

Saving is necessary to accumulate the capital needed to produce wealth. This is just as true for individuals as for nations. The most effective way to begin saving is by identifying and eliminating some discretionary spending.

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Dont Wait!!!

If you dont exert the willpower to save now, it is unlikely that you will do so later. If you wait to save until your income goes up, it is extremely costly in terms of the amount of money you will end up with at retirement.
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Theres No Need to Suffer!

has made it possible to save with before-tax dollars.

Savings is deducted from your taxable income, thereby reducing your taxable income. Many types of tax-deferred savings plans: IRAs, 401(k) plans, 403(b) plans, etc.

There

are MANY creative ways to spend

less.

Pay yourself first! Make saving a regular expense. Just do it!

Practical Element #4

Dont finance anything for longer than its useful life.

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Financing Consumption

Why continue to pay for something- a car, a vacation, a television- that you are no longer able to use and enjoy? Purchase on credit only when buying a long-lasting asset with short-lasting financing.
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When should you buy on credit?

homes automobiles (depending on lifespan) education

Some assets even generate income or further service even after you finish paying for themthese can enhance your net worth!!!
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Practical Element #5

Two ways to get more out of your money:

Avoid credit card debt and consider purchasing used items.

Dont Undermine Your Future!!!

The opportunity cost of saving for tomorrow is spending (and enjoying!) today. You CAN have more in the future while still enjoying today

ordinary people can have lots of nice things and still accumulate a lot of money.
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Credit Card Convenience

Paying with a credit card is NOT spending your own money, but borrowing someone elses. Interest charged on credit cards outstrips returns that could be earned on investments!!! Think of your credit card as an extension of your checking accountUse your credit card only to access those funds.
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The Worlds Most Expensive Vacation

Sean charges $1,500 for a trip to the Bahamas. He pays the minimum payment ($26.63 at 8% interest) each month. 10 YEARS LATER this trip has cost Sean $3,195.40, and all he has left are faded photos.
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It Pays to Buy Used!

a used item satisfy you as well as a new item? the time it takes to search for these items with the value of your time.

Balance

There

are savings to be had without having to sacrifice consumer satisfaction!

Practical Element #6

Begin paying into a realworld savings account every month.

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Rainy Days & the Real World

Life is full of surprises, and theyre usually expensive! The surprise is only in the timingSo it IS possible to plan for these surprises! Purchase peace of mind by building a cushionMake this a regular and mandatory expense!
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Practical Element #7

Put the power of compound interest to work for you.

Its a Miracle!!!

Getting a head start brings a HUGE payoff. Compounding occurs when the interest youve already earned earns even more interest on itself.
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Practical Element #8

Diversify- dont put all of your eggs in one basket.

Risk vs. Return

There are many types of risk that come with investing: Market risk Inflation risk Financial risk Fraud risk

There is no such thing as a guaranteed return! Diversification is the practice of holding a large number of unrelated assets.

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The Law of Large Numbers

Mutual funds are one way of diversifying investments in the stock market. While diversification cannot reduce the volatility of the stock market, it WILL reduce the volatility of your investment in it. When some firms do poorly, others do well. Business cycles have differential effects on companies.

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Double Jeopardy

Does your employer offer a company stock-based retirement program? IF you have confidence in the company, take advantage of the opportunity. As soon as the plan permits, sell these shares to purchase other investments. Failure to do so puts you in double jeopardy You are now beholden to your employer both for your job and your retirement investment. You are NOT diversified!!!
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Practical Element #9

Indexed equity funds can help you beat the experts without taking excessive risk.

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The Random Walk Theory

No one can predict the future of the stock market. The random walk theory suggests that current stock prices are the best reflection of the markets value. The future price of a stock is driven by unforeseeable events. Since we can only see the present, it is impossible to beat the market.
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Practical Element #10

Invest in stocks for long-run objectives; as the need for money approaches, increase the proportion of bonds.
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What About Diversification?

Merely an extension of the diversification concept Because the stock market is volatile, you want to reduce your risk when you know you need a cash stash. Avoid selling off stocks when the market is at a low point.

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So Why Not Just Hold Bonds?

Bonds offer a lower return than stocks, but with less risk. Inflation risk and interest rate risk are larger problems with bonds. Buy bonds that mature at the time you anticipate needing the cash. Transfer capital gradually from stocks to bonds.

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Practical Element #11

Beware of investment schemes promising high returns with little or no risk.

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Theres no such thing as a free lunch!!!

If its such a good deal, why do they need to sell it to you??? The principal-agent problem makes you vulnerable.

A potential conflict exists between the investor and the agent being paid to do something for the investorBecause the agent has more information about the product than you, you are at a disadvantage.

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Tips for Avoiding Investment Fraud

3.

4.

5.

6.

If it looks too good to be true, it probably is. Deal only with parties that have a reputation to protect. Never purchase an investment solicited by telephone or email. Do not allow yourself to be forced into a quick decision. Do not allow friendship to influence an investment decision. If high-pressure marketing is involved, grab your checkbook and run!!!
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Practical Element #12

Teach your children how to earn money and spend it wisely.

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Teach Your Children Well

Teach children money is earned It doesnt grow on trees! Money both helps us get what we want, AND helps others get what they want. Success in general is realized by setting goals and working hard to achieve themFinancial success is no different!
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