Personal Finance- National & Global Finance

Just as there are indicators to gauge a business's finances, so are there indicators to measure the financial health at the national and even global level. The U.S. government- particularly the Federal Reserve, White House, and Congress- monitor these indicators and act (hopefully) to minimize the damage of economic crises such as the recent "Great Recession" (or Not-So-Great Depression), as well as to promote the long-term well-being of the U.S. economy. Oftentimes these indicators lead to disagreement amongst government officials and members of the Federal Reserve, as the course of action in each such case may be debatable and involve weighing one risk versus another. In response to a weak economy, the Federal Reserve will increase the supply of money by buying government securities, lowering the interest rate, and lowering the reserve requirement. This tends to increase economic activity, including investment, but runs the risk of undermining the economy by causing inflation. In response to a superheated economy, often characterized by excessive inflation, the Federal Reserve can contract the economy through reducing the supply of money by selling government securities, raising the interest rate, and raising the reserve requirement. As happened in 2001, this has the danger of causing a recession. Determining the ideal course of action is a non-trivial problem, involving navigating between the dangers of each possible scenario. The U.S. is one major participant in this global economy. Given the interconnectedness characterizing the current global economy, economic crises in one country can impact large portions of the world. The health of the global economy is thus of importance to everyone. Free trade is regarded as beneficial to everyone, whereas tariffs are seen as ultimately detrimental to all countries levying them. The reason is that while a country may levy tariffs and other protective measures to protect domestic companies from international competition, other countries will ultimately retaliate and impose protective trade measures of their own; the result (akin to the Prisoner's Dilemma in game theory) is that all players in the national economy lose in the end. The relative strength of one country's currency relative to another can be seen in shifts in the exchange rate between countries. If country A's currency gains strength while currency B's currency weakens buy comparison, $1 in country (using $ in the generic sense) will buy more $s in country B. This also provides an exchange rate risk in investing international; a country A resident who invests $1000 in country B and then tries to liquidate his investment will recover an amount less than his original investment. In addition to exchange rate risk, an international investor will want to invest in a country with a low inflation rate, high interest rate (thus, high real interest rate, defined as nominal interest rate - inflation rate), stable government (i.e. no regular unrest in the streets) which respects the market economy and will not arbitrarily seize assets held by others.

Personal Finance- Business Finance

The "finance" side of business involves a great amount of mathematical content. The financial health or situation of a business is evaluated mathematically. Crucial to this analysis is the basic equation Assets = Liabilities + Equity Put quite simply, this equation declares that the total value of assets (cash, equipment, inventory, real estate, etc.) of a business are the sum of the value owned by the business owners plus the amount borrowed from others, usually at a significant rate of interest. In any given period, profit = revenues (usually from sales) - expenses. We can then examine the financial well-being of the business based on any combination of ratios. Common ratios to consider are Return on Assets or Return/Assets, and Return on Equity or Return / Equity, both ratios usually measured over a period of 1 year. These ratios provide a benchmark measurement for investors, whose valuation of any particular company is largely based on these ratios. Financial analysts regard the value of a company, as with any investment, as equal to the expected present value of all future cash flows. Such cash flows can come from regular dividend payments and/or increase in market value (i.e. Stock price) in the company. The ratios which investors like to see will naturally vary by industry, as they are likely to demand lower return on equity of more conservative companies as compared to riskier, high-growth companies. Debt ratio = liabilities/assets is a measure of what proportion of a company's assets is financed through debt; the higher this ratio (and especially if this ratio is more than 1), the more leveraged the company is to be, and thus the riskier an investment the company becomes.

Personal Finance- Insurance

Throughout one's life, unexpected events inevitably occur. Accidents happen, things break down spontaneously, illnesses occur, and eventually we face death. Ultimately, though caution may reduce the frequency of such events and increase lifespan, the risk of such events will always exist. Insurance - car insurance, medical insurance, property insurance, life insurance- help by compensating us financially for unexpected major events in return for regular premium payments made to the insurance companies. (Car insurance is legally required, at least in California). Possession of insurance helps to provide a degree of security, by guarding us against the risk of severe financial losses resulting from unexpected, often catastrophic, events. We pay insurance companies to take the risk for us; the payments- or "premiums"- are the price the insurance companies demand of us as compensation for this risk. True, given that the insurance companies must make a profit (if only to pay the salaries and operating expenses within the business), the premium must represent an amount greater than the expected value of the company's payout to you. However, given that we are risk averse- particularly if we have family members who may suffer if we incur financial losses- most of us are wise to have insurance, particularly medical insurance, life insurance, property insurance, and the like. Having insurance also allows us to more accurately budget based on our expenses. Our insurance premiums are fairly predictable; we can surely add up the premiums for each of our insurances and determine the total cost of "insurance" for the year. This value is subject to far less variation compared to owning no insurance (except car insurance, as the law requires that), and then having to prepare for each of the possible contingency scenarios of facing unexpected huge medical expenses; having one's house damaged or destroyed in a fire, earthquake, flood, etc.; or laying the groundwork for your family members to continue on in the event of your disability or passage. Thus, it is accurate to say that the primary advantages to purchasing insurance are the security of not needing to fear financial harm resulting from major losses combined with allowing for more accurately budgeting (for a household) based on anticipated expenses, with far less variation than would be the case if deciding to decline insurance and simply "take one's chances."

Personal Finance- The Business World

Owning and/or managing a business can be highly profitable, but requires accepting the risk of failure with the accompanying heavy financial losses owing to any of a number of factors. A successful business follows such practices (not all-inclusive) as a clearly defined set of short- and long-term goals, effective marketing to attract the business's target market, responsible financial decision-making, differentiating one's product from that offered by one's competitors. Given the potential of accidents and/or lawsuits owing to numerous unanticipated incidents, purchasing of liability insurance is essential. The smallest businesses are typically sole proprietorships, owned by a single person and essentially inseparable from the owner. Sole owners can enjoy huge profits, but also assume full personal and financial liability for the company. In lieu of being the sole owner, small firms can be owned by 2 or more partners, sharing the profits but also the liability. Large companies, "corporations", are usually owned primarily by a large number of investors who own equity in the company in the form of shares of stock, each representing a tiny piece of the company. Corporations have an existence separate from that of the owners; thus, although the owners share the profits or losses sustained by the company as a whole, personal liability attached to the company does not apply to the owners directly. Thus, fraud within a company does not implicate each of the individual owners of that company.

Personal Finance- Careers

The very nature of the "career" has changed over the past generation. Loyalty of employers to employees, and vice versa, declined during the 1980s and 1990s. With the exception of government positions, teaching, military careers, or the like, it became increasingly common for people to switch companies a few times or more during the course of their careers. Unfortunately, during the boom of the late 1990s, new college graduates, even with math or math-related degrees from highly rated universities were informed they were at a disadvantage when applying for the entry to junior level positions they were targeting owing to their lack of "experience." These companies were not interested in investing any significant amount of training into these highly intelligent young people who had followed society's "rules" and focused on their well-rounded studies while in college. Ironically, the young people who ultimately had the advantage were the less studious C-level college students, who barely passed their humanities classes, but stayed awake extremely late in their dorm rooms, engaging in such activities as computer games, experimenting with various cutting-edge computer technology and software, or other similar endeavors. Meanwhile, the very process of applying for employment changed rapidly. Up through the early 1990s, a motivated qualified job-seeker (especially with a strong college degree) who scanned through the Sunday classified section of the newspaper, cutting out all relevant job postings, and applied by sending an updated resume with appropriate cover letter to every job for which he was a good match could reasonably expect to be called in for interviews and secure employment within weeks to perhaps a few months. Each such job posting attracted perhaps a few dozen applicants, if that. By the late 1990s, online job postings replaced newspapers as the more effective method of accessing job openings. A single search engine had the capability of immediately accessing many individual newspapers or job listings, combined with the convenience of allowing keyword searches. This initially seemed to simplify the job search process. However, from 1999 on, as the internet increasingly became the primary method of applying for employment, employers became less receptive to being contacted by job seekers through any other means. "No phone calls" appeared frequently on job postings. Even at job fairs, recruiters could increasingly be heard to advise most job seekers to "apply online" and provide them with the company's career website. The "Great Recession" or "Not So Great Depression" (however you prefer to term it) struck in full force from 2007 through 2009, severely affecting the careers, job prospects, and financial well-being of a large proportion of the American population. An overly simplistic analysis would attribute the resulting and subsequent long-term unemployment and underemployment- 2 to 5 years in many cases- of even highly educated Americans to this period of extreme economic weakness. However, a more thorough analysis- as pointed out by spokespeople in the National Employment Council- would consider the developments of the prior 15 years, particularly the factors enumerated above.

Personal Finance- Credit and Loans

We previously examined the case of accumulation and investment of savings. However, most of us- even those who are fortunate enough to secure well-paying jobs- would find it inconvenient to delaying purchasing cars, a house, or have our kids delay college until amassing enough savings to pay the entire cost outright. This is the purpose of credit and loans; it allows people with a solid income and history of responsible financial conduct to borrow large amounts of money from banks to purchase high-ticket items, and subsequently repay the bank the amount owed plus interest. Interest rates are typically 5% or higher for home loans. Credit cards are essentially loans, in which the borrower (credit card holder) controls the balance owed by paying off the credit card in part or in whole every month. This degree of control comes with a price; typical credit card interest charges are 18% of the unpaid credit card balance, and penalties are levied every month in which the minimum payment is not made. One's ability to qualify for loans, especially home and car loans, is largely determined by one's credit score, a numerical score as calculated by the 3 major credit bureaus, whose value is based on a person's financial/credit history. A person with many cases of defaults, late payments, etc. will have a low credit rating, with harsher penalties for severe and/or repeated defaults. A person with a clear or nearly clear credit history will tend to have a high credit score, and thus be most likely to be approved when applying for a loan. A normal credit score is in the 600-700 range; anything above 700 is considered "good", with anything below 600 considered "poor." A person with a poor credit score is considered a risky investment for a bank or other lender; thus, such a person who does find a means for securing a loan can expect to have high interest payments. This is a natural consequence of the direct correlation between risk and return; in a similar sense as when you might invest in a risky stock, a person with a poor credit score is considered a high-risk investment for a bank, and thus should entitle a bank to demand a high return rate in consequence of approving such a risky individual for a loan. If you should find yourself with a low credit score owing to a history of default, please beware of companies offering to "repair" your credit score for a price in order to help you qualify for a loan. Such an arrangement is a waste of your money, which is more effectively spent in paying off your debts directly. Any errors on your report can be corrected by you directly contacting the credit bureaus and sending documentation to correct such erroneous data. Credit scores based on accurate data cannot be "repaired" except through paying off your creditors and proving financial responsibility (no additional defaults) over time.

Personal Finance- Financial Planning

As a member of a household- whether as an individual or a man or woman of a nuclear family unit- it is advisable to make financial plans based on current income and expenses, as well as projections of future income and expenses. Income is usually in the form of job wages/salary, though unearned income from investments may also occur, especially for those fortunate enough to own stock or receive interest from bank or other accounts or other sources. A portion of one's income must be paid (by law) to the U.S. federal government as well as one's state government on an annual basis; you- perhaps (recommended) with an accountant's assistance- are required to complete the required paperwork, including a 1040EZ or equivalent form, in calculating taxes owed to the government (or refund owed to you if more money was already withheld than was needed). In general, expenses consist of anything requiring payment of money, including planned expenses such as food, utilities, insurance, etc. as well as unplanned expenses such as unplanned repairs, replacement of broken items, etc. The amount of money you/your household is able to save towards long-term goals (i.e. college tuition for kids, retirement, etc.) equals after-tax income minus the sum of all expenses for the year. (There are various options for investing these savings to possibly obtain a substantial return over time). There are possible objections to the notion of making long-term goals. Examples are: "How can I accurately anticipate unplanned expenses?" "How can I know what my salary will be at any future point in time? What if I am laid off and unemployed or underemployed for a long period of time?" This last question might be posed much more frequently in this day and age, following the recent and present situation of highly educated people facing extended unemployment despite their best efforts. The trauma of the recent economic "Great Recession" (or "not-so-great Depression", as others have termed it) should have taught us to save more given the unanticipated setbacks that may strike in the future; however, recent surveys and news reports indicate a general return to complacency and perhaps excessive spending. If this assessment is accurate, we may expect to pay the price as the effects of the next recession are magnified due to current poor financial planning.

Personal Finance- Saving & Investing

You will hopefully achieve the situation where- owing to your earnings exceeding your total expenses over an extended period- you begin to amass some savings. You then will have options as to what to do with your savings. In general, there is a direct correlation between risk and expected returns. You can fairly accurately describe the situation visually by drawing an upward sloping line, represented on a graph such that risk is along the horizontal axis and expected returns on the vertical axis. Low risk/low return investments include savings accounts and investment CDs at the extreme lower left, with a risk of virtually zero (if under $250,000 at an FDIC-insured bank). Moving slightly up on the line, we have money market funds; money that has been deposited into investment banks and not presently invested in stocks, bonds, etc. is often automatically held in money market funds when being held on the sidelines. While superficially almost indistinguishable from savings account and almost equally liquid, they do involve investment in short-term notes and bonds, and thus have a slight risk. Returns are better than most savings accounts, commensurate with CDs of several months (with the benefit that your money is not tied up for several months with these funds). Higher returns come with the price of slight risk; losses are rare, but possible. In 2008, at the height of the recent financial crisis, some money market funds lost as much as 3% in value. Although significant, this is far less than the losses of 50% or more faced by investors and retirees highly invested in the stock market. Moving further up this line, highly rated "safe" bonds, such as municipal and government bonds, offer higher returns, well over 2%. (Being tax-free, this usually converts to over 3% on taxable bonds). The government being unlikely to collapse and default, we consider these bonds safe. Corporate bonds of large companies are a bit further up, as there is the potential of even such large companies failing unexpectedly; thus, we would expect higher interest rates from such corporate bonds. Moving up further still, we reach "junk bonds"- bonds with low ratings, usually owing to uncertainty regarding a company's stability. For accepting such uncertainty, investors expect the highest returns among bonds. Approaching the upper right area of this line, high risk/high returns, we find stocks. Moving up along the line, we first pass conservative stocks (large companies unlikely to fail), and then progressively speculative stocks, with progressively risky stocks valued to provide increasing expected returns. Finally, at the upper right end we find the most speculative investments, such as venture capital, money offered by investors in return for equity in companies with an at-best shaky likelihood of success. Venture capitalist demand extremely high returns, with 40-50% being reasonable, given the strong possibility they will lose their entire investment. The decision of how to invest is ultimately up to you. You must decide how much risk you are willing to accept in order to increase your expected returns. Investment firms managing large portfolios, such as family trusts, tend to diversify and hold a mixture of bond and stock funds, a "moderate" approach allowing for moderate returns with moderate risk; you might find such an approach for savings you want to have appreciate in the long-term without excessive risk. Use of stockbrokers in brokerage firms for purchasing individual stocks or stock indices has fallen drastically over the past decade. In lieu of paying stockbrokers hundreds of dollars per trade, investors can invest with online investment firms, with commissions as low as $10 per trade, and financial information once provided by stockbrokers is now easily accessible online.

Personal Finance- Banking

Upon reaching your 18th birthday, one of your first actions should be to open bank account(s) (unless you already have minor or custodian accounts which will fall under your control the day you turn 18). You will find a bank account essential for several purposes- writing checks or transferring funds to pay bills, depositing paychecks, safely storing your savings and withdrawing cash when needed, and establishing a financial history in your own name prior to applying for credit. The so-called "Big 4" banks (the huge, 4 largest banks)- namely Bank of America, Citibank, Wells Fargo, and Chase- are usually the most convenient ones to establish accounts, given the easy access to these banks, ATM machines, online banking, etc. throughout the country. However, since these banks have minimum balance requirements often as high as $300 for even basic accounts, with monthly service fees assessed if ever your balance falls under this amount, if your savings are less than this you may be better off starting off at a credit union or other smaller bank with lower minimum balance requirements. You may have noticed that I omitted what was traditionally a strong motivation for opening bank accounts- namely, interest payments. In response to the recent "Great Recession", the Fed opted to lower the interest rates to barely above zero, and hold them there for an extended period. Thus, banks nowadays pay us a ridiculously low interest rate of 0.01% to 0.1% (not a typo), even though they still make at least 4% interest on home loans and over 15% on credit card interest charges. The interest we are paid is surely more than eaten up by the cost of gas to drive to the nearest bank or even corner ATM machine. Thus, for the past 6 years interest has practically vanished as a benefit to holding bank accounts. The other benefits to opening personal accounts still apply, however. Traditionally, however, it has been advisable to maintain a checking account with funds to which you may need immediate access, and perhaps a combination of savings account and/or investment CD's to provide significant income from interest. CD's offer the highest return, as compensation for agreeing to not touch the CD account prior to the maturity date, or face stiff penalties (typically the entire amount of the interest paid) for withdrawing early; use of CD's and high-interest savings accounts should be adequate to provide returns slightly higher than the inflation rate, thus preventing inflation from eating away at your savings.. All of the above-described accounts are considered low-risk, low-return investments. The Big 4 banks (or any other bank you use) should protect your accounts up to $250,000 per person per account type through the FDIC, meaning that if the bank fails the government will reimburse your money, up to $250,000. You should see a sign in the bank itself advertising this fact; if not, the bank should be avoided. If your assets exceed $250,000, you should spread out your funds amongst multiple banks and/or account types, or perhaps in a money market fund or other investment in an investment account (to be discussed later). Many banks do offer a high-risk, high-return investment option. They will offer to invest your savings (if sufficiently high in amount, usually several thousand dollars or more) in mutual fund accounts- basically, in the stock market(s). These accounts are not FDIC insured, and may lose value; they will tend to fluctuate with the stock market. There is, for example, a 529 fund which will invest money to be used for your kids' education, with the idea that the stock markets should appreciate substantially by the time any current kids reach college age. While on average the return will be higher from such an investment, there is a strong element of gambling involved; you need to decide whether you are willing to risk losing money to potentially reap the benefits from such speculative investments. The bank, by the way, takes a percentage of this investment, even if they lose money for you.

Personal Finance- Economic Basics

The modern economic system, using money as the means of exchanging goods, is seen to provide the greatest total amount of utility to humanity as a whole, by creating the most efficient distribution of resources and level of activity in every area. While a pure market economy allows the "invisible hand" to guide this allocation of resources, and allows the severely impoverished to literally perish if their insufficient means prevent their affording the basic necessities of life, a socialist/welfare state imposes government control of economic activity to both provide sufficient means for all citizens to maintain a reasonable standard of life while preventing extravagance among the wealthiest members of society. The United States is essentially a "mixed economy" which is a balance or compromise between these two extremes; socioeconomic classes continue to exist, but the government manages and subsidizes programs to provide even the poorest Americans with access to food, clothing, education, etc. Gross Domestic Product (GDP), total value of all resources in the country, is seen to increase at a healthy rate (perhaps 3-5%) when the economy is strong, at an anemic pace (0-2%) in a sluggish economy, and to decrease during recessions. The distinction between "recession" and "depression" is unclear. The economy is cyclical, with periodic recessions being normal and necessary to direct readjustments needed for the economy's long-term growth.

Personal Finance

Personal Finance- a subject which seems to be of increasing interest among high school students within the California Virtual Academies- is a case of an academic subject with the strong potential to integrate numerous key mathematical concepts to young people's everyday lives. Students who opt to take this class do so with a number of possible motives. Some students are college-bound, already firmly grounded in upper level math, and are taking this as an elective class to acquire exposure in economics, accounting, banking, investing, and the business world. Other students are not necessarily college-bound, seeking to complete their 3rd year of required math with classes such as this which do not involve upper level math that they are unlikely to ever use (from their perspective), and find that Personal Finance covers information that they will find useful immediately upon reaching their 18th birthday. The challenge "When am I going to ever use this?"- a rather cynical question expressed by students in many math classes- is one which is very rarely uttered by students in this particular class. Indeed, the material covered in personal finance is essential for high school students to acquire both to manage their own finances as they enter adulthood, and to avoid being scammed by people who actively endeavor to profit from people's lack of knowledge and awareness in this area. In the posts that follow, I provide a summary of what I hope students will derive from this course. This certainly does not effectively summarize or replace the course text, or provide any readers with an advantage in taking quizzes or completing the written assignments; rather, it might more accurately reflect what is in the back of my mind, as the key concepts I hope students will acquire and retain as a result of completing this course.

Psychohistory

This blog would be incomplete without some discussion of psychohistory. I should begin with a disclaimer; if you, dear reader, are unfamiliar with the science of "psychohistory", this is no surprise- unless you have read Isaac Asimov's Foundation series, and understand the reference. Psychohistory is a fictional science formulated about 22,000 years in our future, according to Isaac Asimov's fictional robot/empire/foundation historical universe, and incorporates the notion that human behavior can be reduced to mathematical equations. One of the primary principles involved is that while the behavior of an individual human being is extremely difficult to predict- with increasingly large numbers of humans being incorporated into the system, we have increasing ability to predict accurately. Those with basic knowledge of statistics should recall the law of large numbers; a similar principle applies here, with the average behavior of a large number of repetitions more accurately predictable than a single event. "Wait a minute," you might exclaim. "There is nothing new here!" In this you would be correct. Indeed, the basic principle of psychohistory is derived directly from economic theory, which in turn is largely the product of the Enlightenment (18th century). Economics does involve the representation of human behavior in the (now global) marketplace in mathematical form. A primary principle of economics is the notion that while an individual human being is essentially unpredictable, within a large system we have the "extremes" represented by different humans' personalities and the like cancelling each other, so that we can with increasing accuracy model the system based on the behavior of the "average" human being. Economics- and the areas of finance and accounting- are thus of particular interest to mathematicians, not merely because of the amount of math involved in these areas, but because of the ability to express the behavior of human beings in mathematical form, and potentially their future behavior.