Personal Financial Management

Time value of money

$1 today is worth more than $1 in the future, because it can be invested to earn a return.

With interest rate $r$ per period and $n$ periods:

$\text{Future value: } FV = PV(1 + r)^n \qquad \text{Present value: } PV = \frac{FV}{(1 + r)^n}$

Net present value (NPV) = present value of future cash inflows − initial investment. Accept an investment if NPV > 0.

Nominal and effective rates of return

If a nominal annual rate $r$ is compounded $m$ times a year:

$\text{Effective rate of return} = \left(1 + \frac{r}{m}\right)^m - 1$

The more often interest is compounded, the higher the effective rate. It equals the nominal rate only when interest is compounded once a year. Compare investment plans by their effective rates.

Consumer credit

	Credit card	Overdraft	Personal loan
How it works	Buy now, pay by the due date; pay the minimum to roll over the rest	Withdraw more than the account balance, up to a limit	Borrow a fixed sum, repay in instalments
Cost	No interest if paid in full by the due date; very high interest on any unpaid balance	Interest on the amount overdrawn	Interest over the loan period

A personal credit record of repayment history is kept by a credit reference agency. A poor record makes future borrowing harder and more expensive.

Risk and return

• Return = income (interest, dividends, rent) + capital gain or loss.
• Risk = the uncertainty of the return.
• Risk-return trade-off: a higher expected return usually comes with higher risk.

Product	Risk	Expected return
Savings and time deposits	Very low	Low
Bonds	Low to medium	Medium
Unit trusts and mutual funds	Medium	Medium
Stocks	High	High

Diversification: spreading money over different investments reduces risk.

Personal financial planning: the life-cycle approach

Financial needs change with life stages, e.g. a young worker can take more risk for long-term growth, while someone close to retirement should choose lower-risk investments.

The MPF System

Employers and employees each normally contribute 5% of the employee's relevant income, subject to minimum and maximum relevant income levels. Self-employed persons must also contribute. Members can choose their own funds, so they should review their investments regularly.

Stock trading

• Stock prices are affected by macro-economic factors (interest rates, economic growth), industry factors, firm-specific factors (profit, management) and speculation.
• The Hang Seng Index reflects the overall price movement of major stocks listed in Hong Kong.