What Should Every
Student Know?
A Review Essay
What should every student
know about financial counseling and planning? To some extent, the minimum
requirement is determined by accreditation and certification program requirements,
such as the Accredited Financial Counselor program and the Certified Financial
Planner (CFP) program. In particular, undergraduate programs in financial
planning are influenced by the comprehensive CFP test. However, only a
minority of those getting jobs in the financial services industry will
obtain the CFP certification. Furthermore, such testing tends to reflect
what current practitioners are expected to know, rather than the underlying
concepts that ideally should be understood.
When financial counseling
is added to financial planning, the range of possible topics to cover is
enormous. This essay will not attempt to cover much even within the areas
of financial planning, although readers are encouraged to contribute relevant
essays to this journal. There are two recent texts that may help fill some
gaps in preparation of students for long careers in financial services.
One text is The Mathematics of Personal Finance: Using Calculators and
Computers(1) attempts to cover a
range of mathematical techniques. Since I wrote one of the chapters, I
will not review the book, but you can find out more about the book including
the table of contents, at the web site
www.damepub.com. The book is especially clear in its treatment of the
time value of money by tables, financial calculators, and spreadsheets,
and the way this treatment is carried throughout most of the chapters.
The approach makes the book more useful than the typical personal finance
book to students outside of the United States. My own contribution involves
an approach to household accounting for financial planning. This book will
become more valuable to teachers if users of the book provide feedback
to the editors and chapter authors.
Undergraduate financial
planning students and graduate students interested in financial management
typically take courses in finance, which may focus on corporate finance.
While many of the topics of introductory finance courses are relevant to
household financial decisions, some finance textbooks give little attention
to topics of importance to moderate and middle income households. The new
textbook Finance(2) provides much more coverage
of topics relevant to financial planning than does the typical finance
textbook, and in a way that should provide better long term understanding
of concepts. The authors are eminent, with Merton sharing the 1997 Nobel
Prize in Economics for his work in options pricing.
<Finance provides an
excellent explanation of the difference between the real rate of return
and the nominal rate of return. On most personal finance topics, the discussion
is clear and appropriate. For instance, the discussion of index mutual
funds is very good. The treatment of human capital as part of total household
wealth is excellent, including a nice graph by age (p. 130). The authors
state:
“In making lifetime saving/consumption
decisions:
1. Try to do the analysis
in real terms (constant dollars) to simplify the calculations and to avoid
having to forecast inflation.
2. Start by computing
the present value of your lifetime resources. The present value of your
lifetime spending cannot exceed this amount.” (p. 131).
This is the approach I
have used with the Life Cycle Savings program (Hanna, Chang & Fan,
1995) in my classes, so it is nice to have validation in this textbook.
I take issue with the
treatment of risk tolerance, which is similar to the financial planning
approach rather than economic approach I would expect from two MIT- trained
economists. “When we refer to a person’s risk tolerance, we do not distinguish
between a capacity to bear risk and attitude toward risk.” (p. 271). This
is fuzzy thinking, which Chen and I try to address in an article in this
issue (Hanna & Chen, 1997).
Nevertheless, I will probably
use Finance as a supplementary text in a graduate course, as it covers
the essence of enough fundamental concepts to make it essential reading
graduate students. For graduate students with limited time, I would prefer
that they master Bodie and Merton’s Finance rather than an investments
textbook. Investments will change form over the years, but many of the
concepts covered in this textbook will still be relevant through the next
millennium.
Sherman Hanna
References
Hanna, S. & Chen,
P. (1997). Subjective and objective risk tolerance: Implications for optimal
portfolios. Financial Counseling and Planning, 8(2), 17-25.
Hanna, S., Fan, X.J. &
Y. R. Chang (1995). Optimal life cycle savings, Financial Counseling and
Planning, 6, 1-15.
1.
E. Thomas Garman and Jing J. Xiao (eds.) The
Mathematics of Personal Finance. Houston, TX: Dame Publications, $46.95
(ISBN 0-87393-533-0 ). (800) 364-9757.
2. Zvi
Bodie and Robert C. Merton, Finance. Upper Saddle River, NJ: Prentice
Hall. Preliminary edition of paperback edition, $36.87. (ISBN: 0137813457).