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Stanford CS 007-05 (2021): Personal Finance for Engineers / Assets & Net Worth

Adam Nash
Adam Nash

These are the slides from the 5th session of the Stanford University class, CS 007 "Personal Finance for Engineers" taught on October 19, 2021. This seminar focuses on liquidity, emergency funds, assets & liabilities, and net worth.

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PERSONAL
FINANCE FOR
ENGINEERS
CS 007: SESSION 5
ASSETS &
NET WORTH
CS 007
LIQUIDITY
access to money when you need it
WHAT IS LIQUIDITY?
• How quickly can you get access to
cash when you need it?


• Market liquidity refers to the extent
a marketplace allows assets to be
bought & sold at stable prices.


• Accounting liquidity measures the
ease an individual or company can
meet their financial obligations with
the liquid assets available to them.


• Don’t underestimate the value of
liquidity. Liquidity matters.
WHY DOES LIQUIDITY MATTER?
• Liquidity is the only thing
that matters when you
need to pay for
something.


• Liquidity is the power to
take advantage of
investment opportunities.
LIQUIDITY & RETURNS
• Liquidity is typically inversely
correlated with returns


• Examples


• Cash is very liquid


• Private Equity is very illiquid


• Safety ≠ Liquidity


• 5 Year CD is safe,


but illiquid


• Tesla stock is liquid, but
volatile!

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Stanford CS 007-05 (2021): Personal Finance for Engineers / Assets & Net Worth

  • 3. LIQUIDITY access to money when you need it
  • 4. WHAT IS LIQUIDITY? • How quickly can you get access to cash when you need it? • Market liquidity refers to the extent a marketplace allows assets to be bought & sold at stable prices. • Accounting liquidity measures the ease an individual or company can meet their financial obligations with the liquid assets available to them. • Don’t underestimate the value of liquidity. Liquidity matters.
  • 5. WHY DOES LIQUIDITY MATTER? • Liquidity is the only thing that matters when you need to pay for something. • Liquidity is the power to take advantage of investment opportunities.
  • 6. LIQUIDITY & RETURNS • Liquidity is typically inversely correlated with returns • Examples • Cash is very liquid • Private Equity is very illiquid • Safety ≠ Liquidity • 5 Year CD is safe, 
 but illiquid • Tesla stock is liquid, but volatile!
  • 7. EMERGENCY FUNDS a financial buffer to protect your goals
  • 8. 8: WHAT % OF AMERICANS HAVE $400 FOR EMERGENCIES? • Commonly misquoted statistic. • US Federal Reserve reported in 2017 that 40% of Americans do not have sufficient savings to cover a $400 emergency expense. • Actual survey question reveals the number is 12% that self-reported that they could cover the emergency. • Liquidity means having access to money when you need it. • Don’t underestimate the value of liquidity. Liquidity matters.
  • 9. WHY EMERGENCY FUNDS? • Practical outcome of need for liquidity • Example of “mental accounting” used for financial health • Goal is to protect your long term assets / plans from unexpected short term needs.
  • 10. HOW LARGE SHOULD AN EMERGENCY FUND BE? • Standard recommendation is at least 3 months of living expenses in cash or cash- equivalents • Calculated based on impact of losing employment • National average is 3-6 months to find a job of equal pay. • Time increases in recession & based on your seniority.
  • 11. COMMON MISTAKES WITH EMERGENCY FUNDS • Don’t focus on investment return or opportunity cost. • Think of it as a buffer, or as insurance. Not as an asset. • First on the list to fill, first to refill if tapped for emergency. • Do not tap it for frivolous needs. It is for emergencies.
  • 12. ASSETS & LIABILITIES what you own & what you owe
  • 13. WHAT IS AN ASSET? • Any resource with economic value • Financial assets are investments in cash, bonds, stocks, etc. • Real assets are investments in real estate, collectibles, commodities, etc.
  • 14. DIFFERENT TYPES OF ASSETS • Liquid vs. Illiquid • Financial vs. Real • Appreciating vs. Depreciating • Tangible vs. Intangible • Debt owed to you * https://www.wealthfront.com/plan
  • 15. WHAT ABOUT HUMAN CAPITAL? • Easy to argue that your skills & capabilities are the largest asset you have. • Don’t ignore “intangible assets” - sometimes they are the best investments. • Do remember that human capital varies significantly in liquidity. * https://www.wealthfront.com/plan
  • 16. WHAT ARE LIABILITIES? • A liability is a financial obligation, typically debt. • Most common personal liability is a loan. • Common types • Mortgage • Auto Loan • Student Loan • Credit Cards • Tax Liability
  • 17. DIFFERENT TYPES OF LIABILITY • Short term vs. Long term • Secured vs. Unsecured • Tax Liability
  • 18. CREDIT SCORES • Lenders report to 3 major centralized credit agencies when you apply for debt, receive debt, and when you pay off debt. • Building a good credit score is essential for qualifying for most loans. It can affect other services too, as it is used for identity verification. • Issues that affect credit score: length of history, on time payment, percent of capacity utilized, new applications for debt, bankruptcy. • Credit Karma 💯 
 http://www.creditkarma.com
  • 19. IS DEBT A BAD THING? • Modigliani-Miller 
 market value is determined by earning power & risk of underlying assets, not by the method of financing. • Assumes no taxes, transaction costs, bankruptcy costs • Tradeoff Theory of Leverage 
 There is an optimal capital structure.
  • 20. SHOULD I PAY OFF ALL OF MY DEBT? • More debt = more risk • Not all debt is the same • Compounding is not your friend with debt, especially high interest debt. • Some debt is subsidized (e.g. Mortgage, Student Loans) • Paying off debt can be emotionally satisfying, but financially irrational. • Paying off debt can improve savings rates over time.
  • 22. WHAT IS YOUR NET WORTH? • Assets - Liabilities • Total net worth includes all assets. • Liquid net worth excludes illiquid assets & primary home (and related liabilities) • Do not confuse with cash flow. Very different. * https://www.census.gov/data/tables/2018/demo/wealth/wealth-asset-ownership.html
  • 23. WHAT IS A BALANCE SHEET? • A balance sheet is a financial statement that summarizes a companies assets, liabilities & shareholders’ equity. • Assets = Liabilities + Equity 
 (see, it has to balance) • Common ratios • Cash Ratio • Quick Ratio • Debt to Equity • Asset Turnover • ROA (Return on Assets) * http://www.investopedia.com/articles/04/031004.asp?ad=dirN&qo=investopediaSiteSearch&qsrc=0&o=40186
  • 24. CREATING YOUR PERSONAL BALANCE SHEET • Very simple summary of a personal balance sheet • Some recommend excluding primary residence (and related mortgage) • Very different than income statement, but useful for evaluating progress (excluding primary residence)
  • 26. WEEK 6: CREDIT & DEBT. DIGGING OUT. • Different types of Debt: 
 Student Loans, Auto, Credit Cards, Mortgage • Secured vs. Unsecured Loans • Loans & Rates • Credit Scores • Compounding in Reverse