Financial planning is often claimed to be a new profession Starting point is preparation of personal financial statements Next is identification of financial goals and relative time frames All investors must have an understanding of risk and how this impacts on financial objectives
•The financial means to satisfy personal objectives •Useful to consider objectives in 3 time frames: –Short: within one year –Medium: up to 5 years –Long: up to 40 or even more years
•Main reasons include: –Increasing numbers in older age groups –Increase in longevity –Expected restrictions to accessing old age pension –Introduction of compulsory superannuation –Greater range of superannuation choices –Anticipated changes to government fiscal policy
Slide 1 Chapter 1 PowerPoint presentation by Lindsay Cowling Holmesglen Institute ©2011 John Wiley & Sons Australia, Ltd Introduction Financial planning is often claimed to be a new profession Starting point is preparation of personal financial statements Next is identification of financial goals and relative time frames All investors must have an understanding of risk and how this impacts on financial objectives What is Personal Financial Planning? The financial means to satisfy personal objectives Useful to consider objectives in 3 time frames: Short: within one year Medium: up to 5 years Long: up to 40 or even more years What is Personal Financial Planning? continued To be realistic a goal needs 2 components Specific or quantifiable Referenced to a specified time frame Why is Personal Financial Planning Important? It enables people to set in place personal objectives and arrange financial means to satisfy these objectives Has its roots in life cycle theory of consumption and saving Why is Personal Financial Planning Important? continued Life cycle theory provides a framework to meet short, medium and long-term objectives While consumption is relatively smooth over a person’s life cycle, lifetime income is quite uneven Income and expenditure Why is Personal Financial Planning Important? continued Main reasons include: Increasing numbers in older age groups Increase in longevity Expected restrictions to accessing old age pension Introduction of compulsory superannuation Greater range of superannuation choices Anticipated changes to government fiscal policy Why is Personal Financial Planning Important? continued Increasing Numbers in Older Age Groups This is due to: Falling birth rates Falling death rates Lower rates of immigration Significant feature of the Australian population is the size of the ‘baby boomers’ group (born 1945-60) Increasing Numbers in Older Age Groups continued By 2050, it is expected that Australia will have 2.7 people in the working age group for every retired person Currently the ratio is approximately 5 workers for every retired person …implications for: the governments ability to pay aged pensions more reliance upon superannuation Increase in Longevity In the early 1900s, average life expectancy was 55 for men and 59 for women In a recent survey, average life expectancy had risen to 79 for men and 84 for women By 2050 it is expected that life expectancy will increase to 88 for men and 91 for women Reasons include: Vast improvements in medical science Changes in dietary habits Awareness of health issues and the need for regular exercise Restricted Access to Age Pension In recent years, modifications have been made to eligibility for age pension Age of entitlement for women rising to match that of men (currently 65) Some countries seeking to increase entitlement age beyond 65 in the future Pension age to be raised to 67 (progressively) from 2017 Government offers incentives to encourage people of pension age to defer taking it up beyond retirement age Work bonus scheme Compulsory Superannuation Contributions Compulsory employer superannuation contributions first introduced in 1992 at 3% of employee’s remuneration From 2003, employers have had to contribute 9% of employee’s remuneration Government presently contemplating an increase to 12% Compulsory Superannuation Contributions continued Tax deduction offered as encouragement for self-employed people to also contribute towards their own retirement Recent legislative changes have further increased attractiveness of accumulating a higher superannuation balance prior to retirement Choice of Superannuation Fund From 1 July 2005, most employees have been able to choose the fund into which their employer superannuation contributions are paid This has encouraged funds to offer larger range of portfolio mixes Competition between funds is expected to force underlying member fees to be reduced over time Retirement Benefits Provided by Many Employers Form of superannuation benefits has changed from defined benefits to a defined contribution or accumulation fund This has meant a transfer of investment risk from employer to employee Retirement Benefits Provided by Many Employers continued Means that: Members must take responsibility for their own retirement Planning must start at an early age to maximise retirement benefits Complexity of products, rules and decision making requires members to become better educated regarding personal financial decisions Role of Financial Counsellor Financial Counsellor provides range of free public services Seeks to contribute to community education and development of financial issues Specific tasks provided may include: Financial advocacy Restructuring debt facilities Budgeting Financial Literacy Foundation Established by the government in 2005 – now the responsibility of ASIC Seeks to improve public access to relevant financial information Operates in partnership with industry, education bodies and community organisations Financial Literacy Foundation continued Foundation to date has promoted its activities via: Media campaigns Interactive website Education programs Conducting research Understanding Risk Risk can be interpreted in a number of ways including: 1. Mismatch risk Mismatching of a person’s objectives, investments and time frame 2. Inflation risk Real value of investments are eroded over time 3. Interest rate risk Reinvestment risk When fixed assets mature, must reconsider current interest rates Market volatility When fixed-rate investments are sold the full value of investment may not be realised – this will occur if market interest rates rise during the holding period Understanding Risk continued 4. Market risk All markets have ups and downs Some markets are more volatile than others over a specified time frame 5. Market timing risk Very difficult to choose when to enter and exit the market in order to maximise returns Understanding Risk continued 6. Lack of diversification risk Diversification reduces the overall risk of an investment portfolio Investment portfolio should be diversified across a range of asset classes Understanding Risk continued 7. Currency risk Applies if investments are valued in a foreign currency Value of investment may rise or fall due to exchange rate fluctuations Understanding Risk conintued 8. Liquidity risk Always important to have access to cash for emergency purposes Redeeming investments to realise cash may be an expensive alternative 9. Credit risk Applies to investments such as term deposits, debentures, mortgages and bonds Understanding Risk continued 10. Legislative risk Governments can make changes to current laws and regulations Change in legislation may have either a favourable or unfavourable effect on investor’s previous decision Understanding Risk continued 11. Gearing risk If an investor borrows money to invest, the loan must be repaid regardless if the underlying investment decreases in price Regular loan repayments not tied to returns provided by the investment Understanding Risk continued The business cycle – recession, recovery, boom, expansion Greater economic volatility pre 1990, sustained expansion of Australian economy from 1992 to the onset of the GFC in 2008 Recovery since thanks to RBA monetary policy and a ‘healthy’ dose of government fiscal policy and Chinese demand for our resources… Features of the Economic Environment Features of the Economic Environment continued Four Stages in the Business Cycle 1. Boom or expansion Employment and economic growth are high Increase in inflation is cause for concern 2. Contraction Economic growth starts to slow Sales begin to fall Unemployment starts to rise Features of the Economic Environment continued 3. Recession High unemployment Low (and possibly negative) economic growth 4. Recovery Unemployment begins to fall Economic growth starts to rise Features of the Economic Environment continued Both monetary and fiscal policy to ‘manage’ the local economy Monetary policy is conducted via controlling the money supply which in turn impacts on interest rates Fiscal policy involves government intervention in the economy via taxation and spending policies History of the Financial Planning Industry Historical Developments 1980–83 5% tax on superannuation payouts Double dipping: pension plus lump sum 1983 Rollover funds introduced 1985 Capital gains tax (CGT) introduced 1986 Fringe benefits tax (FBT) introduced History of the Financial Planning Industry continued 1987 Double taxation ceased with the introduction of dividend imputation and franking credits 1990 Simplifications to reasonable benefit limit (RBL) rules 1993 Superannuation guarantee introduced 1998 Life expectancy policies introduced 2001 ‘Attribution rules’ for pensioners commenced 2004 Allocated pensions introduced Reduction in calculation of assets under social security asset test for age pensions 2005 Member choice of superannuation fund introduced History of the Financial Planning Industry continued 2006 Announcement of ‘Simple Super’ rules to apply from July 2007 including transition rules having effect prior to July 2007 2007 Focus of introduced ‘Simple Super’ rules to encourage self reliance and maximise accumulated superannuation benefits Further relaxation of social security asset / income test provisions for age pensions History of the Financial Planning Industry continued Economic Changes 1987 share market crash 1990 property trust freeze 1991 Pyramid Building Society closure 1992 Japan share market crash 1994 bond market crash History of the Financial Planning Industry continued Economic Changes 1997 Asian crisis 1998 Ralph Report April 2000 share market jitters 1 July 2000 Goods & Services Tax 2001 World Trade Center disaster History of the Financial Planning Industry continued Economic Changes 2001-02 corporate collapses 2002 falls in world market shares 2004 share markets rebound 2004-05 tsunami impact History of the Financial Planning Industry continued Economic Changes 2006 collapse of a number of property related managed investment schemes 2007-08 housing affordability crisis and US sub-prime fallout 2010 European sovereign debt crisis History of the Financial Planning Industry continued Origins of the Global Financial Crisis US banks mispriced risk, lending standards fell US merchant banks parcelled up mortgages into Collateralised Debt Obligations (CDO’s) and sold them world wide only to see them fail as US house prices plummeted and mortgagees walked away from their obligations Questions asked of Rating Agencies? Institutional lending froze as institutions failed and others were afraid to deal with counterparties Share markets halved in value Australia relatively unaffected despite one quarter of negative economic growth Confidence in the financial planning industry fell… Current proposed financial planning reforms designed to restore confidence by removing perceived conflicts of interest and improving transparency… Regulatory Framework As with any profession, financial planners are subject to a wide range regulations and controls. The table below lists the main legal and regulatory provisions that establish the legal framework of the financial planning industry. Regulatory Framework continued Significant regulatory reform of the financial services industry followed from the 1997 Wallis Inquiry Reform was implemented via wholesale changes to the Corporations Act 2001 and the introduction of the Financial Services Reform Act 2001 Corporations Act 2001 Licensee’s obligation to monitor and supervise representatives to ensure compliance Representatives must be adequately trained and competent ASIC RG 36 Corporations Act 2001 continued Licensing regime in the financial products and financial services advice industry which defines the capacity in which a person can provide advice Authorised representatives: Principals must hold an Australian financial services licence (AFSL) issued by ASIC Principals must keep a register of their authorised representatives ‘Know Your Client’ Rule Before a financial planner is able to give specific advice on an investment, the Corporations Act requires the planner to make every effort to understand the client’s investment objectives, financial situation and particular needs. Guidance provided to advisers regarding considerations that should be made prior to making recommendations Definition of financial product critical for application of legislation Includes definitions of when a financial service is being provided Clear distinction is made between retail and wholesale clients Corporations Act 2001 continued Financial services guide (FSG) Must be given to a retail client in relation to provision of services Must have clear, concise and effective wording Should be given prior to service provision Corporations Act 2001 continued Financial Services Reform Act (FSRA) 2001 Provides single regulatory regime for: Financial services Financial products Financial markets Clearing and settling facilities Administered by ASIC Incorporated as Chapter 7 of the Corporations Act 2001 Financial Services Reform Act (FSRA) 2001 continued