terms and themes
notes
lecture
- Chapter 1 highlights
- Risk and risk tolerance
- Risk and return
- Gross domestic product (GDP) and the business cycle
- Behavioral economics — heuristics and biases
- Financial literacy: how well you understand and use personal financial information
- Risk-taking: doing something that involves the possibility of a financial gain or loss
- Risk: uncertainty associated with any physical, social, emotional, environmental, labor market, or financial activity
- Financial risk tolerance: willingness to make a financial decision that has the possibility of a financial gain or loss
- You can take more risk when you’re younger
financial risk tolerance and wealth accumulation
economic cycle (business cycle)
- Economy moves in big cycle with four phases
- Usually don’t see recession coming
- Hard to plan for specifics, but can plan for inevitability
- GDP
- Sometimes tool isn’t perfect, but you use it because it’s the best tool you have
- Capturing gains: converting investments back to cash
- When long term goals become short term goals
- Mitigate risk of market turning before you need the money
- Pay attention to time horizon
- You can ride out a recession
time
- Long-term goals: represent a big-picture idea of where you want to be financially
- More than five years in future
- Short-term goals: immediate actions needed to reach long-term goals
biases
heuristics
- Our minds use heuristics to make decisions more quickly and easily than if we were to think hard about every choice
- Heuristics are
- Based on past experiences
- Automatic and rarely use much analysis
- Can help you make quick decisions, however, they sometimes lead to problematic choices and outcomes
- Example: buying things quickly when marked on sale
- Personal preference for keeping things the same
- When making decision, we overemphasize the good aspects of current situation and underestimate benefits that come from making a change
- Afraid to make decision
- Choose not to choose
time value of money (TVM) calculations
- Savings earns interest
- Interest gets added to savings
- New larger amt of savings earns interest
- Interest added to savings
- Your best ally is time
- Compounding
- Starts slowly
- The longer you let money grow, the more you’ll have in the future assuming fixed interest rate
- The more interest you earn, the more you will accumulate over time
- The higher the interest rate return you want or need to earn, the more calculated risk you need to take
- TVM Glossary
- FV: future value
- PV: present value
- N: number of periods
- I: interest rate
- PMT: a series of more than one equal payments or deposits, AKA annuity
- Financial Calculators - TVM
reading
economy
- GDP calculated by adding up how much a country produces in goods and services a year
risk
- Financial risk tolerance: willingness to engage in behavior that may result in a financial loss
- Risk perception + risk preference = willingness to take risk
- Initial financial risk perceptions are often false
setting goals
- Long-term goals = map
- Short-term goals and daily tasks = compass
- Goal time horizons
- Ultra-short term: 9- months
- Short-term: 9 months – 2.5 years
- Short-intermediate term: 2.5 – 5 years
- Long-intermediate term: 5 – 10 years
- Long-term: 10+ years
- If goal has ultra-short to short time horizon, need to make cautious decisions
- Psychological time perspective
- Commitment and motivation
- External factors
- Internal factors
psychology
