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1Financialplanninginahousehold
TheX-axisgivestheageofthememberofthehousehold(from25to65years).
TheY-axisgivesthevalueofcapital.Itcanbeobservedthatthroughouttheprofessional
lifeofthepersonher/hishumancapitalisconvertedintoafinancialcapital.
Therearetwotypesofactivities,whichinvolvecapital:investingandfinancing.
Investmentisdefinedasthesacrificeofpresentconsumptionforfutureuncertain
benefits.Thiswell-knownexplanationcontainsthreeimportantcomponents:
1.Trade-offbetweenconsumptionandsavings.
Thismeansthatahouseholdmakesdecisionsaboutdistributionofconsumption
intimeunits.Thishasimpactontherealizationtheofhousehold’sgoals.
2.Futurebenefits.
Thisactuallyexplainstheroleoftimeandthefundamentalstatement:
postponingtheconsumptionbydecidingtoinvest,shouldberewarded.
3.Uncertainbenefits.
Thisbringsaboutthekeycategoryoffinance,alsoofpersonalfinance,i.e.
risk.Itisalsothekeycategoryaddressedinthisbook.InChapter2theway
inwhichtheterm“risk”maybeunderstoodisdiscussedinmoredetail.For
now,itissufficienttodefineriskasthepossibilitythatexpectedbenefitswill
benotachieved.Anaturalconsequenceofthispropertyisthattakingrisk
shouldberewardedinaway1.
Investmentcanbeconductedbythehouseholdusingallthreetypesofassets.
Realassets,likerealestateandsometypesofcommodities,aswellasfinancial
assets,likestocks,bondsandbankdeposits,allarecommontypesofhousehold
investments.Humancapitalinvestments-mainlyeducation-areofparticular
importanceinpersonalfinance,sincetheyhavesubstantialinfluenceonthe
household’sincome.
Cashflowismoneytransferredbetweenthehouseholdandtheotherentity.This
cashflowisamonetaryreflectionofthecurrentactivitiesofthehousehold(like
purchaseofgoodsandservices)andsomeofitscontracts(likeloans,insurance
payments,investinginstocks).Clearly,therearetwotypesofcashflows:
•
Inflow-positivecashflow,cashreceivedbythehousehold;
•
Outflow-negativecashflow,moneyspentbythehousehold.
Thedifferencebetweentheinflowandtheoutflowiscalledthenetcashflow.
Cashflowsareconsideredineachmomentintime(period).Wecancallthisconcept
thetermstructureofcashflow.
Thisschemeisaverycommonframeworkofanalysisinpersonalfinance,with
relationtoinvestingandfinancingactivities.Ininvestment,typicaltermstructureof
1Otherwisemostdecisionmakerswouldmakeonlyriskfreeinvestmentswhenevertheywould
haveachoicebetweenriskyandrisk-freeones.Benefitsfromriskydecisions,whentheriskdoesnot
realize,shouldatleastcompensateforthebenefitsthatarenotachievedinthecasesofriskrealization.
Thisis,infact,anecessarybutstillaninsufficientminimumrequirement.Ifonlythisformof
compensationwasavailable,theriskydecisionwouldonaveragegivenoadvantageovertherisk-free
one.Tomaketheriskydecisionattractive,itshouldactuallyonaveragebringhigherbenefitsthanthe
risk-freeone.