Financial planning involves analyzing a client's current financial situation, setting goals and objectives, identifying any issues, preparing a financial plan to meet goals, implementing the plan, and reviewing it over time. The key steps in the financial planning process are gathering data, setting goals and objectives, identifying financial issues, preparing the plan, implementing it, and reviewing it. Financial planning aims to help clients smooth consumption over their lifetime in line with the life cycle hypothesis. Proper retirement planning is important given demographic trends toward an aging population.

1. Topic 9: Part 2
Financial Planning
HBC242N
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2. Demographic Trends
• The proportion of the Australian older population is
increasing rapidly. Low fertility rates and continuous
increases in life expectancy have contributed to a
decrease in the number of workers supporting retirees.
• The predictions are that by the year 2030, two people in
the working age group will support one retired person and
this number will fall to 1.4 by 2050.
• Today, the dependency ratio is 3.5 workers for every
retired person.
Source: Australian Bureau of Statistics
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3. Macroeconomic implications of
ageing population
• Due to low fertility rates, the labour force participation rate is predicted
to fall. Smaller number of workers will produce less products and
services. Thus, the shrinking workforce will negatively affect GDP
growth.
• The shrinking workforce combined with the growing number of older
Australians, will put pressure on Australian fiscal sustainability.
• As it is more costly to support an aged person than a young person,
total expenditure associated with ageing is anticipated to rise in the
future, creating a budgetary gap.
• The workforce will also experience ageing, with an increase of
workers aged 65 and over by around 50%.
Source: Productivity Commission 2005.
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4. Government initiatives to improve
fiscal sustainability
• An introduction of the Superannuation Guarantee Charge -
9% of Gross earnings (contributions will be slowly
increased to 12% starting from the year 2013) paid by
employers to designated superannuation funds, and its
reforms such as: 15% tax charged only at the point of
entry and on earnings, no tax charged on withdrawals
whether lump sums or pensions for people retiring at the
age of 60 and over. Further, abolishment of RBL, ability of
drawing on super while still at work, allowable deductions
for employers on contributions paid to employees aged up
to 70. Raising the accessibility age to draw super from 55
years to 60.
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5. Government initiatives to improve
fiscal sustainability (continued)
• Keeping fiscal expenses as low as possible by
providing pensions at the equivalent of 1/3 of the
average male salary which are means/asset tested.
• Encouraging people to stay longer at work by the
introduction of tax incentives for people staying at
work beyond the ‘normal’ age of retirement (currently
being 65 for men).
• Increasing of the “normal” retirement age for women
to 65 by 2014 and men to 67 by 2024.
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6. Life Cycle Hypotheses
Financial planning has its roots in the “life cycle” theory of
consumption
and saving ( Modigliani and Brumberg 1954, Friedman 1957) and
considers paths of expenditure and income over a lifetime.
• Friedman & Modigliani and Brumberg assumed that households
save for future consumption.
• According to Friedman (1957), households will save more and
consume less if the level of income they currently earn is
temporarily. However, they will save less and consume more if the
level of income they earn is permanent, hence the term “permanent
income theory”.
• In the Modigliani-Brumberg model, the planning period is finite:
people save only for themselves, hence consumption and saving
patterns reflect an individual’s stage in the life cycle with saving for
retirement being a primary motive for deferred consumption
(Modigliani and Brumberg 1954; Ando and Modigliani 1963).
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7. The graphical depiction of the Modigliani’s
and Brumberg’s model of the LCH
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8. The proposition of the Modigliani’s
and Bloomerg’s model of the LCH
• People depend on others to expend money on their
behalf (e.g. children being dependent on their
parents, young people obtaining loans) while they are
in their infancy or at the beginning of their adult lives.
• Later, during their working lives, people generate
sufficient income to meet their current expenditure
and to provide some savings for future expenditure at
retirement.
• At retirement, people draw on their savings when
salaries and wages are no longer available.
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9. What is Financial Planning ?
• Financial planning is a process that helps to set
objectives and arranging financial means to satisfy
those objectives.
• Financial means are achieved by analysing financial
and non-financial position and working out a suitable
investment plan which is consistent with risk-return
preferences.
• Financial planning involves managing the portfolio to
evaluate its actual behaviour in relation to expected
performance.
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10. How a $1000 investment grows
over time
50000
45000 45259
40000
35000
30000
8% rate of return
25000
21725 10% rate of return
20000
17449
15000
10000 10063
5000 6727
4661
2594
2159
0 1000
0 10 20 30 40
• Source: Gitman, LJ.
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11. Reasons for seeking financial advice
• Changes in personal circumstances such as:
- marriage or divorce;
- birth of a child;
- buying a home;
- changing jobs;
- death or illness of a family member.
• Investment of a windfall gain such as an inheritance,
compensation payment or redundancy payment.
• Saving for retirement.
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12. Why retirement financial planning?
• Retired people will no longer be able to rely on the
government to provide financial support.
• As a rule, most of people do not start thinking about
retirement until well into their 40s or 50s, which results in
a substantially reduced level of retirement income.
• People do not save adequately. The introduction of
compulsory super should help but we still have to wait to
see its full impact.
• The sooner retirement saving starts (coupled with
compounded interest and salary sacrifice arrangements),
the better off retirees will be.
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13. Attitudes towards retirement planning
• Comments of some planners regarding financial
understanding of retirement issues in the community.
For example, their clients:
- were surprised at how low the Age Pension is;
- generally had poor funding for retirement;
- thought that a lump sum of $50,000 to $60,000
constituted ‘substantial’ funds in super; and
- under estimated the cost of what they want to do in
retirement.
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14. Will the projected superannuation payout
on retirement be sufficient to meet
lifestyle requirements?
• According to government estimates, saving of 12% of
annual income for the 40 years of working life would
give an income equal to 40% of pre-retirement salary.
However, 60-80% is preferred.
• According to the LCH, people want to smooth their
consumption over their life cycle (keep the same life
style before and after retirement), thus 40% of pre-
retirement salary might not be enough.
• People usually need more savings to support them in
retirement than they anticipate. The outcome of under-
provision is to retire later or work part-time after
retirement.
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15. Six Steps Financial Planning
Process
• Step 1: Gathering data
• Step 2: Setting goals and objectives
• Step 3: Identifying any financial issues
• Step 4: Preparing a financial plan
• Step 5: Implementing the financial plan
• Step 6: Reviewing the financial plan
(Source: “Good Advice – for Peace of Mind”, Financial Planning Association of
Australia, 2006.)
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16. Step 1: Gathering data
• Personal details
• Details of children/dependants
• Employment details
• Income from all sources and expenditure details
(including investment income or other such as
distribution from a trust)
• Asset and liabilities schedule
• Superannuation details
• Details of existing insurance and information of
further insurance needs
• Tax rates
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17. Step 2: Setting goals and objectives
• Goals can be short (<1 year), medium term (2-5
years) and long term (>5 years).
• Establishing financials goals and objectives which will
determine the types of investments made:
– saving for major expenditures;
– accumulating retirement funds;
– being free of personal debt in retirement;
– non-specific goals such as: utilise surplus income
to accelerate investment capital without sacrificing
the current life style.
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18. Life cycle requirements or life strategies
• Consumption phase - young single people and
married couples with a desire to save for the future
consumption.
• Wealth accumulation phase - people with
established careers and with no or small mortgages
seeking to establish well structured retirement plans.
• Approaching retirement phase - people at the age
55 - 65 seeking to maximise their retirement funds.
• Post-retirement phase - people with desire to
provide satisfactory income during their retirement
and seeking to preserve their savings for the long life
expectancy.
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19. Step 2: Setting goals and objectives
(continues)
• Other issues: accessibility and liquidity
As circumstances change throughout a life,
liquidity and accessibility of investments need
to be considered. Investing a small proportion
of portfolio (around 5% of the total holding) in
easy accessible investment vehicles such as
term deposits should be recommended.
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20. How financial goals change with a person’s life
situation
Personal Long term Intermediate- Short-term goals
Situation goals (5+ term goals (2-5 (1 year)
years) years)
1. University Repay Undertake Find a job
Student university student
and other exchange
loans program or travel
overseas
2. Single, Buy a home Save enough for Attend
mid 20s a deposit for a investment
home seminars
Travel overseas Begin to invest
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21. How financial goals change with a person’s life situation
(continued)
3. Married Build a Begin an Seek a financial
couple with substantial education fund planner advice
children diversified and begin to
investment invest
portfolio
Buy a larger Increase Implement tax
home superannuation minimisation
contribution strategies
(salary sacrifice)
4. Married Retire at age Travel overseas Shift investment
Couple with 62 portfolio into
grown growth securities
children, mid
50s Take long Reduce expenses
holiday
Increase
superannuation
contribution
(salary sacrifice)
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22. Step 3: Identifying any financial
issues
• Analyse financial position to determine the current net
worth, the current cash flow situation, and the saving
capacity now and in the future.
• Identify goals that are unattainable such as: a desire to
retire early but having insufficient funds to achieve this
goal.
• Categorise trade-offs e.g.: increase saving, accept
higher level of risk (invest in growth assets), retire later,
or accept lower accumulation of funds (lower income
at retirement).
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23. Risk profiling and asset allocation
1. Very conservative investors – defensive
investments such as cash and bonds (government or
carrying high credit ratings).
2. Conservative investors – aiming to reduce risk of
loss and therefore accepting a lower return over the
long term, mixed defensive and growth investments
such as blue chips but substantial higher weighting
(around 60-70%) is given to cash and bonds holdings
(capital stable).
3. Balanced investors – aiming to achieve reasonable
returns, but less than growth funds, equal exposure
to both growth (shares and property) and income
investments (cash and fixed interest).
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24. Risk profiling and asset allocation
(CONTINUE)
4. Growth investors – aiming for higher returns over
the long term but accepting a higher risk of losses
in bad years, mostly growth assets such as shares
and property with small proportion of portfolio
shifted towards defensive/income assets.
5. Aggressive investors – portfolio constructed from
growth and speculative assets such as futures,
options, warrants and other derivatives.
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25. Step 4: Preparing financial plan
After careful analysis of the information gathered, and
identifying goals and any issues, a financial plan will be
prepared outlining the current position, goals, and
recommended strategies and investments.
A good financial plan should recommend the most
appropriate strategies which will meet the client’s goals
without substantially sacrificing their current lifestyle.
A good financial plan should contain strategies that will defer
and minimise an individual’s level of taxes over the long run
e.g. negative gearing, salary sacrifice, income splitting.
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26. Step 5 and 6: Implementing and
reviewing financial plan
• The implementation occurs once the plan has been
presented to the client and subsequently agreed to.
• On at least an annual basis the plan should be
reviewed to ensure that recommendations remain
appropriate given changes to personal circumstances
and external factors (e.g. changes to legislation,
changes to economic conditions).
• Please note: for the purpose of this subject, we only discuss the
first 4 goals.
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27. What is a Statement of Advice?
• Under the Financial Services Reform Act 2004 (FSRA) a financial
plan/Statement of Advice (SOA) must be provided to a client whenever
personal advice has been given by the planner.
• The Australian Securities and Investments Commission (ASIC) views the
plan as a document that outlines to the client how their goals and
objectives can be met (suitable to their risk profile), while providing all
information required for any reasonable person to make a decision
regarding that advice. That is, not only should the plan outline the
recommended strategies and investments, but also explain to the client
why these have been recommended, any risks associated with the
recommendations, the costs of the advice/recommendations, and how
the planner/dealer group is remunerated for this advice.
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28. Statement of Advice (SOA)
1. Scope of advice – are there any limitations to the
advice?
2. Executive summary – what is recommended and
what is the outcome of the recommendations?
3. Existing position – personal and financial details,
current cash flow analysis.
4. Goals and objectives.
5. Investor risk profile – how should the client’s assets
be allocated given their tolerance to risk?
• Strategic recommendations – what are the
strategies recommended to meet the client’s goals
and objectives and why those strategies are
recommended?
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29. Statement of Advice (continued)
7. Investment recommendations – what are the
investments recommended to meet the client’s
goals and objectives?
8. Revised position – what are the changes to cash
flow after the recommendations, and what is the
projected capital due to the recommendations?
9. Services – what level of service does the planner
offer?
10. Fees and interests – what is the cost of the advice,
and how is the planner compensated?
11. Disclaimer – what are the legal limitations of the
advice, and what should the client be aware of prior
to implementing the advice?
12. Appendices – usually include further information
relating to recommended strategies and
investments.
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30. Timing in the market
• Deciding what to invest when the world is heading for a
recession, or at least an economic slowdown, is difficult.
A financial planner in order to provide the best advice,
should be aware of the economic cycles and its impact
on investment.
• A tool which people could use to understand the likely
repercussions of a changing economy and how it might
impact them is called an economic clock.
(source:http://www.wealthtipsonline.com.au/innercircle/hotopic1.html)
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31. The Economic Clock
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32. What is the economic clock?
• The economic clock demonstrates that as an economy
moves through its economic cycle there is a time to buy
certain types of investments and possible a time not to
buy. That does not mean sell, because one of the most
important investment habits to develop is a long-term
investment horizon.
• The economic clock identifies that the return a particular
investment will generate depends on what time it is in
the economic cycle.
• The economic clock provides a guidance but there is no
guarantee that the economy will go through the whole
cycle.
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33. The Six O’clock Recession
• Recessions mark the peak of a downward swing in an economic
cycle.
• A recession is defined as a period of two or more successive
quarters of decreasing production. Production is usually measured
in terms of Gross Domestic Product (GDP), so in layman's terms,
any two consecutive periods of negative GDP will constitute a
recession.
• Recessions are characterised by high unemployment, caused by
employers shedding staff as production levels fall, cutting
profitability and the need for labour. With less employment comes a
drop in the average weekly earnings and with fewer dollars to
spend, consumers demand less, resulting in even lower
consumption.
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34. Recovery Till Midnight
• A recovery from recession begins with a fall of interest rates.
• It is an excellent time to invest in the stockmarket as companies are
well placed to obtain higher earnings from growth in target markets
resulting in higher share prices and bigger profit distributions.
• Share prices move through a period of gradual increases as the
hour hands pass between six o'clock until about eleven o'clock
when those who have missed out on the stockmarket gain start
buying leading to more aggressive market highs. A frenzy begins
which marks the beginning of the end of the recovery cycle, which
peaks when the economy is booming.
• Just before midnight a phenomenon known as 'the greater fool
theory' begins. The greater fool theory suggests that no matter what
price an investor pays for a share, someone (the greater fool), with
less education and less understanding of the market, will buy it at a
higher price. You know you are in the 'great fool' period when you
hear that investors with little or no knowledge of the fundamentals of
investing believe they can't lose.
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35. Midnight Boom Before The Impending
Correction
• Well before the clock strikes midnight the wise
investors have exited stocks and are looking for the
next opportunity. They have left because they
understand that there is likely to be a correction in the
market, since share prices cannot be justified by
traditional stock valuation methods.
• As investors leave the market, supply become higher
than demand triggering a sell off and a slump in share
prices. Investors who were too slow (or greedy) are
burned, particularly those that have leveraged (via
margin lending facilities) and the market is in a fall.
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36. Property 'Till Three O'Clock
• The smart investors that 'got out' at the top move into property with
reliable 'bricks and mortar'.
• Extra demand in property pushes demand above supply and results
in higher prices.
• This itself isn't a problem, except that the government sees the
economy is overheating and looks to introduce measures to enable
a 'soft landing' through increasing interest rates to flatten demand by
consumers.
• With higher interest rates comes less profit in real estate since most
investors have leveraged their property purchases. Rises in interest
rates continue until it is no longer viable for purchasers to continue
investing in property and soon there are more sellers than buyers.
Property prices, like share prices, correct.
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37. Decline Back To Six O'Clock
• Decline begins as business confidence begins to fall. Investors find
little value in either stocks or property and with impending trouble on
the horizon fixed interest securities become very popular again.
• Lower business confidence means that new capital ventures are
postponed.
• Less spending and higher interest rates result in lower demand,
which results in less production. With fewer sales there is a squeeze
on earnings, resulting in profit downgrades.
• The economy slows to the point where productivity stalls and then
declines. When this happens for two periods in a row, the economy
is said to be in a recession.
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