Lecture 1-5 Notes

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Queensland University of Technology

LECTURE 1 – INTRODUCTION TO PERSONAL FINANCIAL PLANNING What is financial planning?  FP = holistic process whereby a client’s total position, both financial and non-financial, is examined and a set of actions or a plan is put in place which, once implemented, will assist in meeting the client’s ultimate goals and objectives. o Non-financial = wills, insurance, goals o Holistic = sum of everything or total  Financial plan = statement of advice o Includes a range of recommendations to achieve goals over a specific time frame o Need to action recommendations What data is required?  Current position – what do they have now? o Assets, Liabilities, Income , Expenditure, Super, Insurance  Goals  Timeframe  What is their risk tolerance? o Type of investments  Assess risk v. volatility (uncertainly of the market) - Need to know tolerance to these o Self risk – insurance needs  What is the client’s level of knowledge, understanding, care factor, fears? Why the need for Financial Planning?  Emphasis on the client and personal financial planning – holistic, not just transaction based  Economic environment of 1980s and substantive changes in government policy  Declining birth rate  Ageing population – baby boomers  Poor levels of domestic saving o 1980’s – high interest rates + high inflation o Credit card problem Macro Environment Advisors need an awareness of the impact of economic environment & global economy:  Interest rates  Social indicators  Inflation  Market volatility  Unemployment rates  Government regulation Business Cycle Economies are cyclical in nature and essentially the business cycle is divided into 4 phases:  Boom (peak) - high employment and economic growth, increase in inflationary conditions  Contraction (downswing) - economic growth starts to slow, level of unemployment begins to rise, falling retail sales  Recession (trough or depression) - high unemployment, low economic growth  Recovery (expansion) - unemployment begins to fall and economic growth begins to rise Australia’s Poor Savings Record  Australia’s savings rate has been in decline since 1960’s.  Household saving ratio (amount households save as proportion of their disposable income) fallen sharply from 15% in mid 1970’s to less than 1% currently (having fallen into negative territory in 2002.) Why poor savings?  Baby boomers (1947-1964) – “she’ll be right” attitude  Period of sharp rise in asset prices leads to perception of feeling wealthier, hence less need to save  Increase in social security payments & eligibility, hence reduced need to save for retirement or medical expenditure in old age. o Savings levels higher in Asia where little or no Gov’t support for the aged  Sharp rise in real wages  Easier availability of credit – late 1990’s household debt increased from 50 -90% of disposable income  Distortions to the after-tax return to saving – double taxation (tax on income, then tax on savings income)  Negative gearing – borrowing for an investment purpose. Occurs when interest paid is higher than income on borrowings. o Low interest rates o Easy credit  Compulsory super – need approximately 20%, not 9%  Technology = speed = increased expectation = I want it now society => easy credit, low interest rates  Lack of education on financial matters The Financial Planning Profession  There is one industry body – Financial Planning Association (FPA) o Must be authorised by this body to provide advice Roles of Professional Associations  Establish knowledge base jurisdiction (eg CFP)  Ensure educational qualifications for entry are at a high level  Delineating between different levels of competence & knowledge by granting members who attain a higher level of competence an increased level of membership  Build a strong public image – respectability & trust  Ensuring professional unity through codes of conduct & ethics  Achieving self-regulation Features of Professional Associations  Autonomous & free from Gov’t interference  Constructs mechanisms for monitoring & evaluating its members  Represents views of members to key decision makers (incl Gov’t & media)  Promotes members services to consumers + education  Establishes & monitors high standards of ethics & professional behaviour  Provides specialised education (e.g CFP) Financial Planning Environment There are three main parties:  Regulator (Government) o General public need to have a sense of confidence that a profession is regulated.  This needs to be done by an independent body o Consumer needs to feel that financial markets & associated services are run fairly and efficiently o Rules are required for uniformity & discipline and are there for consumer protection & investor confidence to allow consumers to make “informed decisions”  Clients  Financial Advisor/Planner Licensing and Prudential Regime  APRA – regulator of banking, super, insurance  ASIC – enforces laws that govern the way financial services businesses deal with individuals  RBA – monetary policy  ACCC – administer the Trade Practices Act  ATO – taxation law, self managed super funds Why do you need to be licensed?  To provide personal advice to someone else relating to a financial product (as defined in the Corporations Act), then they need to be licensed or be an authorised representative of an AFSL holder.  You do not need to be licensed or an authorised representative to give general advice or incidental advice. Who’s who? Licensee (Dealer Groups)  Apply to ASIC for AFS Licence  Licence outlines the approved financial product areas  Professional indemnity insurance mandatory  Types – single, small-large, institution, bank o Authorises people to represent the dealer group to interface with clients o Monitors & controls actions to ensure compliance & receives fee or share of advisors remuneration  Business services o Business management – actual running of the business eg office, equipment, software, staffing, record keeping o Business development – new clients, client retention eg newsletters, seminars, advertisements, signage  Compliance management Management Responsibilities They must ensure that:  the compliance system reflects their values  they provide the necessary resources to support the system  they make business decisions within the compliance system framework, and  they support disciplinary outcomes from the system  there also needs to be a comprehensive and ongoing education and training program for all employees, not just financial advisors Financial Planners/Advisors  Role is to advise the client, NOT make the decision for them  After analysing a client’s circumstances, provide clients with recommendations to meet their goals & objectives, along with any supporting data, research or information that will allow the client to make an informed decision. Issues for Financial Advisors  Macro level o statutory law reform — business management o common law precedents o taxation rules o superannuation rules o social security rules o product manufacturers, and o markets  Micro level o licensee o systems technology o client personal situation, and o client financial situation  Legislative changes  Technology  Professional indemnity insurance  Fee for service vs commissions  Projections and goal achievement  Monitoring and review  Use of support staff  Mentoring and apprenticeship  Paternalism and informed consent  Community vs client responsibilities LECTURE 2 – ETHICS AND COMPLIANCE Ethics and Morals  Ethics – knowledge of right & wrong; should or should not  Morals – behaviour or actions – does or does not o “For the Financial Services industry, the expected ethical stance and compliance regulations are about putting the needs of clients first. However, it is the actions of the individuals that define the character of the company and the industry.” Compliance – Core Regulatory Framework  Corporations Law (inc FSRA – “the planners life support system”)  Common Law  FPA Code of Ethics, Standards & Rules of Professional Conduct Strict Adherence to written law  Licensee obliged to provide a Financial Services Guide (FSG): o Financial planners must give to all clients o Licensee needs to check that planners do this o Clients sign & acknowledge that they received FSG Adherence to common law legal principals  Professional duty of care o Higher training => higher care => clients rely & act on advice Attributes of a professional Relationship  Confidentiality  Underlying values and principles of both the  Recognition of special education & training client and professional requirements  Diligence  A relationship based on trust Actions that advisors can take  Disregard  Compliance  Avoidance  Best practice  Minimal compliance Minimalist v Professional best practice  Is the minimum level of compliance good enough?  Have you satisfied the “Know your client” rule? o Clients must be able to trust their advisor and know the advisor is putting their needs first and is working for them with diligence and care and is providing them with appropriate advice so that they can make important financial decisions Financial Planning Association (FPA)  Professional organisation representing the financial planning sector o Strive to improve the financial wellbeing of all Australians  Provides the leadership and professional framework that enables members to deliver quality financial advice to their clients.  3 key groups: o Members o Consumers o External stakeholders  Government , Regulators, Media Rules of Professional Conduct  First layer: The Code of Ethics outlines the ethical principles for the profession;  Second layer: The Practice Standards describe expectations of practice for FPA Members;  Third layer: The Rules of Professional Conduct (‘the Rules’) establish detailed obligations attaching to FPA professional membership. Education and Training  Important in building a professional and competent service industry  Until now the education available for aspiring or existing financial advisors has been based on a minimum core curriculum established by education providers  Under the Financial Services Reform Act and RG146, education for financial advisors must be competency based and cover both minimum competency and specialist competencies ‘Know your Client’ Rule  Financial advisors are bound by a fiduciary relationship with their clients, regardless of whether there is a formalised agreement or contract between them. o The advisor must always put the client’s best interests first  Reasonable basis for advice o Investigation of client situation and goals o Recommendations must be based on information gathered o Client-centric, not product-centric nor remuneration-centric ‘Know your Product’ Rule  As part of their duty of care, an advisor must have a sufficient understanding of the products they recommend to ensure the suitability of the product to the client.  Financial advisors offer a large number of products and services, including: o development of a full financial plan o small business advice o asset allocation optimisation o DIY superannuation o fund manager and product selection o budgeting o stock selection o administration services o model portfolio development o referrals o lending o monitoring and review o insurance and estate planning o annual review services, and o salary packaging o educational services, eg seminars o Leasing  Research of products and concepts is mandatory. Investment Risk  Risk assessment – identifying various investment risks: o Products  Company  Type of investment (growth/income)  Likely term (short or long)  Redemption freeze o Concepts  Superannuation (locked away)  Gearing  TTR  Aged Care o Client attitude to risks  Conservative, moderate, high growth Disclosures and Disclaimers  If a financial advisor makes a recommendation which leads to the transaction of a security and the client might rely upon the advice, Section 942 of the Corporations Act requires the financial advisor to disclose: o any commission, fee, or other benefit or advantage, whether pecuniary or not, direct or indirect, that the securities advisor may receive in connection with the recommendation and o any other pecuniary or other interests, whether direct or indirect, of the advisor that may be capable of influencing him or her when making the recommendation  Recommendations must be written Other Issues  Ongoing Review (annually at least)  Complaint and Dispute Resolution o Internal + External & FOS (formerly FICS)  Insurance Regulation, Product and Advice o Now covered by FSRA o Product replacement statement (13 months clause)  Privacy o The Commonwealth Privacy Act of 1988 introduced the process of more closely ensuring that customers’ privacy is honoured. Client-Advisor Relationship  Information explosion o Impact on client o Quality and reliability of information o Impact on the advisor o Technological communication methods  Websites  Email o Role of the internet  Advisor must concentrate on building a strong relationship with client o First meeting crucial – build rapport  Demonstrate interpersonal skills  Good communicator  Better listener  Respectful  Supportive o Explain roles and what to expect o Build trust – no trust, no client  Lack of trust can be caused by: o Body language o Overuse of jargon or technical terms o Attitude (patronising, condescending) o Tone of voice (gruff, intolerant) o Eye contact (or lack thereof) o Poor listening skills What you do before meeting client for first time is equally important in establishing a good relationship:  First contact (first impression)  Initial information kit  Ask re preferred delivery method (hard or soft)  Room set up for first meeting, receptionist The Financial Planning Process Process-driven — six steps - holistic:  Step 1 — Data Gathering o Collect and assess the financial data of the client – including the client’s tolerance of financial risks o Data collection critical first step  Advise client of importance of revealing all  Know your dcf!  Quantitative and qualitative data  Instruments are many and varied  Information collected in instrument includes:  Personal details  Current situation & Financial position o Assets o Liabilities o Income o Expenditure  Current Insurances  Current Investments  Superannuation and retirement  Risk tolerance/profiling (scientific or common sense) o Attitudes o Experiences o Likes & dislikes o Establish investor type  Conservative  Moderately conservative  Balanced  Growth  High Growth or Aggressive Growth  Social security  Estate planning  Step 2 – Identify Goals and Objectives o Determine the objectives and goals of the client o Assist client to identify what their goals are and (crucially) what timeframes are involved. o Break up into short term, medium term and longer term. o Assist client to rank the importance of each goal.  Step 3 — Identify any financial problems Need to determine: o Current cash flow situation — excess savings capacity o Net worth — Statement of assets and liabilities o Are goals achievable? o Any problems evident? (eg under insured, health issues, too much credit, close to a cut off date)  Step 4 — Prepare a written Statement of Advice (SoA) which contains alternatives and recommendations o Statement of Advice as a comprehensive document with explicit recommendations to meet client goals based on data gathered. o Insurance and estate planning considerations must be dealt with o Adequacy of retirement savings program reviewed o Client asset allocation needs to be determined — consistent with client risk profile o Selection of investment vehicles o Selection of investment products o Must contains alternatives and recommendations  Step 5 — Implementation of recommendations o Critically important phase o Cements future relationship with client o Implementation schedule designed o Client service agreement signed o Summary of client-advisor agreement — confirms actions as specified in written SOA  Step 6 — Ongoing review of the plan o Initiates ongoing relationship with client o Necessary for currency and appropriateness of plan for client needs o Completes the planning process o Frequency of review depends on many factors — eg how often, size of portfolio, market changes. Generally annual reviews are recommended Financial Statements  Income statement (cash flow) — essentially a statement of cash availability  Balance sheet — Total Assets minus total liabilities = Net Worth  What items are included as assets  What items are included as liabilities Reviewing Performance  Importance of good record-keeping  Monitoring the financial process  Use of financial ratios in reviewing performance o Solvency ratio o Liquidity ratio o Savings ratio o Debt service ratio Financial Goals  Goals can be divided into — o Short term: usually < 12 months o Medium term: usually 1–5 years o Long term: usually > 5 years  Understanding the time value of money (Refer Appendix A) Planning and Controlling Cash  Estimating income  Estimating expenditure  Preparation of a cash budget  Comparison of actual to budget LECTURE 3 – TAXATION AND FINANCIAL PLANNING Taxation and Financial Planning  From a financial planning perspective, assisting clients to legally manage their personal tax liabilities and to obtain receipt of legitimate transfer payments is an important role.  Key questions when managing a client’s tax situation include: o What techniques should be used to reduce tax liability? o What structures should the client use and what assets should be held in those structures? The Tax Equation  Taxable income = Assessable Income – Allowable Deductions  Determination of tax payable: 1. Apply tax rate(s) to taxable income 2. Deduct tax offsets 3. Add Medicare Levy = Tax payable Ordinary Income  Ordinary income is normally subject to income tax; i.e. it is assessable income.  Ordinary income includes: o Income from personal exertion ( e.g. wages, salary, professional income) o Business Income o Income from property ( e.g. rent, dividends) o Interest from a bank account Exempt Income  Certain types of income are made exempt by special provisions of the income tax law  Conversely, some receipts that are not ordinary income are made assessable by the legislation (Statutory income) e.g. capital gains  Exempt income is income that is made exempt by a specific provision of the legislation  ≠ non-assessable income which is outside the scope of taxation (eg lotto win) ( see discussion text p 347)  Income can be exempt because:  It is derived by exempt entities ( e.g. non-profit organisation)  It is deemed exempt by a special provision( eg. Child care benefit) Statutory Income  Where the statute determines a receipt is income, it becomes assessable. Examples are: o Fringe Benefits Tax o Capital Gains Tax o Superannuation benefit o Employment termination payments Income from Government  Certain payments may be exempt o Carer payments o Baby bonus o Disability support pension (if < age pension age) o Child care benefits o Family tax benefit o Remote area allowance  Some payments may be assessable o Austudy o Unemployment benefits o Aged pension payments o Sole parent payments Income from Property  Income must be generated by the property  Must not be characteristically personal exertion income o Dividends o Rent o Interest o Royalties Income from Shares  Franking credits may reduce tax payable on franked dividends  Shares are a capital purchase unless the buyer is a share trader  Gains realized on shares when the shares are sold are taxed as capital gains Fringe Benefits Tax (FBT)  Affect non-cash fringe benefits provided by an employer to an employee or associate  Paid by the employer not the employee o The employee does not pay tax on the value of the benefit received  FBT is paid at the highest marginal rate (i.e. 46.5%) on the grossed-up value of the benefit  Benefits may be provided through salary packaging Capital Gains Tax  Capital gains are statutory income  Capital gains (or losses) are determined after deducting the cost base from the disposal of the asset  Capital gains tax (CGT) was introduced 21 Sept 1985  Where the asset is held for more than 12 months, individuals are entitled to a 50% discount  Residential property is exempt unless used for investment purposes  Capital losses can only be offset against other gains  Some assets are exempt ( e.g. cars, personal assets acquired for < $10,000) o Special rules for collectables Superannuation  Contributions from a contributor’s salary is taxed concessionally at 15%  Contributions above the cap($25,000 for individual under 50)are subject to an additional tax of 31.5%  Non concessional contributions are not deductible, i.e. they are effectively taxed at the contributor top marginal rate  Salary sacrifice: employees give up income to make a contribution which is taxed concessionally.  Superannuation benefits ( lump sum or income stream)  Tax free if paid out when member is over 60  Concessionally taxed if paid out when member is 55-59 Employment Termination Payments (ETP)  Concessionally taxed if genuine termination or early retirement  Tax treatment depends on the number of years in service Deductions  Deductions reduce assessable income and consequently tax payable.  Deductions are generally given for work related expenses, investment and business expenses, gifting deductions and anything further stipulated by the ITAA  A deduction is an outgoing or loss incurred in earning assessable income General Deductibility  Must satisfy the positive limbs: o Loss or outgoing is incurred in gaining or producing assessable income, or necessarily incurred in carrying on a business;  Must not fall in the negative limbs: o An outgoing or loss must not be for personal reasons, must not be a capital outgoing, must not be non assessable purposes or excluded by legislation.  Capital nature : repairs o Initial repairs o Improvement o Replacement or entirety  Private or domestic: o Travel from home to work o Clothing o Home office expenses o Mobile phone Interest  Interest incurred from a loan to secure an income producing asset is deductible. o Interest may be apportioned.  Interest is not deductible if the purchase is a capital acquisition for which there is no income producing activities currently or until sometime in the future.  ≠ borrowing costs which must be deducted over the duration of the loan Gearing  Borrowing to purchase income producing assets is known as gearing.  Gearing is tax beneficial as interest can be deducted against the income derived from the asset o Negative gearing: the interest is greater than income produced and this shortfall can be set off against other income. Specific Deductions  Those deductions actually listed and quantified in the legislation. o Substantiation: many deductions require proof or evidence. Some deductions must be recorded in a specific manner ( e.g. car expenses) o Travel Expenses: must be recorded. The ATO has guidelines and upper limits on some expenses. o Entertainment Expenses: are generally not deductible, unless the outgoing is directly related to the production of income, e.g overtime, as distinct from entertaining clients Capital Allowances (Depreciation)  A capital item can be ‘written off’ or deducted over the life of the asset.  Income producing assets other than business assets can be written off if worth less than $300.  Small Business taxpayers can write off assets of less than $1,000 under the diminishing value method o Small Business taxpayers can pool their assets and depreciate the pool at a set rate Asset Classification  Capital which depreciates, eg machinery, is deductible. o Capital items that do not wear out or decline in value are not deductible as capital allowances (  Buildings are not considered to be depreciating assets and therefore cannot be depreciated  Trading stock is not a depreciating asset Tax Offsets  A tax offset reduces the amount of tax payable directly (rather than indirectly by reducing income and consequently tax).  Tax offsets are targeted at certain groups. o Dependent rebate ( spouse housekeeper) o Senior Australian Tax Offset o Medical expenses rebate o Low Income Offset ($1,200 if earns less than $60,000 and then tapering off until $90,000) o Superannuation contribution spouse offset o Private Health insurance tax offset Tax Based Benefits  Family Tax Benefit: to assist low income families with children. Benefits are means tested and vary according to the number of children in the family ( now paid by Centrelink) o Part A benefits o Part B benefits  First Home Savers Account  Education Tax Offset Medicare Levy  Levied at 1.5 % o 1% Medicare levy surcharge for taxpayer with income > $77,000 ($154,000 for families) who do not have private health insurance Other Taxes  HELP - Higher Education Loan Programme (previously known as HECS)  Goods and Services Taxes (GST) o BAS  Stamp duty  Payroll Tax  Land Tax  Non Resident withholding tax Goods and Services Tax (GST)  Broad consumption tax eventually paid by the final consumer introduced in Australia on 1/7/2000  Levied at the rate of 10%  Limited range of exemptions: food, health care, education , exports, residential rent  Value added tax : i.e. registered business can claim GST paid on their input Stamp Duty  Imposed by the states on various transactions: o Transfers of real property o Transfers of marketable securities o Transfers of motor vehicles o Insurance o Lease and hiring arrangements o Loan securities (abolished in QLD since 1/7/2008)  Generally paid by the transferee  Rates increase with value Superannuation guarantee contributions (SCC)  Since 1/7/1992, all employers are required to provide specified employees with a minimum level of superannuation contributions (currently 9 % of salary).  There are a number of exemptions listed on p. 387 of the text)  The superannuation guarantee is payable on salary and wages, bonuses, shift loading, casual loading, pay for sick leave and long service leave taken, director fees etc.  Superannuation guarantee is not payable on reimbursement of expenses, overtime, benefits subject to fringe benefits tax, annual leave loading, redundancy payments, dividends, partnership and trust distributions, or payments for domestic or private work under 30 hours per week.  There is also a maximum superannuation guarantee contribution base. LECTURE 4 – INVESTMENTS IN SHARES, BONDS AND MANAGED FUNDS Risk  Probability of loss — chance  Level of loss — quantifying the amount of loss  Frequency of loss — how often it occurs Components of Risk  The risk of an investment consists of two parts: diversifiable and non-diversifiable risk o Diversifiable risk (Unsystematic risk) results from uncontrollable or random events, such as labour strikes, legal actions and regulatory actions  Such risk affects various investment products differently. It is called diversifiable because it represents the portion of an investment’s risk that can be eliminated through diversification o Non-diversifiable risk (systematic risk) is attributed to forces such as war, inflation and political events that affect all investments and thus are not unique to a particular investment  The sum of these two components of risk is called total risk: Total risk = Non-diversifiable risk + diversifiable risk Risk and Volatility  Risk = potential loss of capital but also the fact that the expected return may not eventuate  Volatility = movement or variance relating to investment markets or returns o Time is an important element when considering volatility as short-term volatility may hide longer-term growth Risk Management Classifications of risk: o Speculative risk – akin to gambling o Pure risk – probability of loss combined with level of loss and the frequency of the loss o Behavioural risk – client’s psychological disposition to risk (risk profile) Types of Investment Risk o Mismatch risk o Currency risk o Inflation risk o Liquidity risk o Interest rate risk o Credit risk o Market risk o Legislative risk o Market timing risk o Specific risk (lack of diversification) Risk Management Process There are four methods commonly used to minimise risk: 1. Elimination 2. Control 3. Transfer 4. Retention Concept of Return  Risk is present when an investor is uncertain as to the outcome that the investment will produce  Return is the reward for taking on a certain level of risk when investing, ie the profit from investing o Some investments guarantee a return while others do not o Components of return include dividends, interest and capital movements (not just appreciation) Risk and Return  If an investment has a high expected rate of return then it will have a high level of risk as well, and conversely if it has a low level of risk then it will usually have a low level of return o This is sometimes called the risk-return trade-off Diversification  Most investors rarely hold single assets in isolation  Diversification occurs where an investor creates a portfolio of assets across different asset classes Risk, Return and Diversification  Modern portfolio theory o By knowing the characteristics of different types of investment the investor can create a portfolio which
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