Personal Finance Planning: Taxes, Assets & Investing

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  • 0:00 What Is Personal Budgeting?
  • 0:43 Income, Expenses &…
  • 2:44 Retirement, Savings &…
  • 5:00 Assets, Liabilities, &…
  • 6:30 Protecting &…
  • 7:45 Lesson Summary
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Lesson Transcript
Instructor: Tammy Galloway

Tammy teaches business courses at the post-secondary and secondary level and has a master's of business administration in finance.

In this lesson, we'll define a budget and then discuss how to construct a budget. You'll also learn about taxes, net worth, saving, and investing as it relates to securities and retirement. We'll also discuss asset protection and estate planning.

What Is Personal Budgeting?

Sydney earns over $100,000 per year, but she's always broke, month after month. Even more embarrassing, she's a financial planner and helps clients manage their money.

The process Sydney uses with her clients involves several steps. The first step is to create a personal budget. A budget is a forecast of income and expenses. Her second step is to create a saving and investment plan and calculate her clients' net worth by reviewing their assets. Then, she discusses with her clients how to protect those assets. She decides to institute a little self-help program and analyze her own finances. Let's take a closer look.

Income, Expenses, and Discretionary Income

Sydney's only income is $100,000; however, she does not take home that much. Her gross pay before deductions is $100,000, but after income and payroll taxes and health insurance are taken out, she brings home $90,000 annually.

Income taxes are a percentage of monthly income paid to the government based on wages and vary for each American. Payroll taxes are also a government levy. The mandated 2015 payroll deduction is 7.65% of an employee's gross pay.

Payroll taxes are comprised of two components: Medicare and Social Security. Medicare deductions pay for a healthcare program for retirees and the disabled. Social Security deductions provide monthly income for four types of individuals: retirees, the long-term sick and disabled, and dependents after the death of a parent. In sum, after taxes and deductions, Sydney's net pay is $7,500 monthly ($90,000/12 months).

Next, Sydney reviews her expenses, which are costs to maintain her household. Her expenses include a mortgage payment, car and student loan payments, home and car insurance, utilities, lawn care, and food, all of which total $6,500. Sydney's a little puzzled because she should have $1,000 left over every month ($7,500 - $6,500). Why is she still broke?

After a review of her bank statements, she finds several transactions at retail stores, daily purchases from a local coffee shop, and entertainment spending totaling almost $1,000 monthly. Sydney decides to make some changes in this area and budget only $400 for these miscellaneous items, leaving $600 of discretionary income. Discretionary income is the amount left over for saving, investing, and non-reoccurring, non-essential items, such as a vacation.

Retirement, Saving, and Investing

Since Sydney now has discretionary income, she's able to participate in a retirement plan. Retirement plans come in two types: an employer-sponsored plan or individual retirement account. A pension is an example of an employer-sponsored plan, which involves a deduction from an employee's gross monthly income. The employer invests the amounts until the employee retires, after which they pay the employee a specific, monthly amount for life.

A 401K can be employer sponsored, or an individual can open a retirement account at a bank. In both instances, Sydney can determine how much she wants to contribute. After reviewing her budget, she decides to invest $200 in retirement.

Now for investing. Sydney smiles as she reviews her remaining discretionary income because she always tells customers they must crawl before they can walk. She means clients are so excited to invest in the stock market or buy other securities; however, they must have at least 6 months of expenses saved before investing. This nest egg ensures they're able to maintain their lifestyle in the event of unemployment or illness.

Therefore, if Sydney's expenses are $6,500, she must have $39,000 ($6,500 x 6) of savings before investing. It seems like it will take Sydney a while to save that much; however, once you consider job promotions, other increases in income, and a reduction in expenses (paying off her car), it will take her less than 8 years to save if she transfers the increases to savings. Nevertheless, her long-term investing goal includes buying stocks and bonds.

Stock is a share of a corporation, and if the company experiences growth, it will pay the investor a percentage of the profits, called dividends. Stocks in general are risky since the market is unpredictable and you could lose your investment. Bonds, on the other hand, have less risk. Bonds are an IOU, or a loan to the corporation which they promise to pay back in the long term, but will pay interest annually until repayment. Bonds are a contractual agreement between the investor and corporation; therefore, they carry less chance of loss.

Assets, Liabilities, and Net Worth

Next, Sydney reviews her assets, which are the things she owns. Examples include her house, car, furniture, clothes, and jewelry.

The opposite of assets are liabilities, which are the obligations she owes. It does make sense to pay cash for smaller purchases, such as her daily coffee habit, and use credit for larger purchases, such as furniture; however, if she wants to make a substantial purchase, such as when she purchased her house and car, she financed those assets and is paying them off over time. The loans she obtained for the house and car are called liabilities.

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