Ch01 Ppt Mckeown

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Chapter 1

Pow erPoint presentat ion byLindsay Cow ling

Holmesglen I nst itut e

© 2011 John Wiley & Sons Aust ral ia,Lt d



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 timeframes:

– 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 theseobjectives

• Has its roots in life cycle theory of

consumption and saving




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





• 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





Increasing Numbers in

Older Age Groups

• This is due to:

– Falling birth rates

– Falling death rates – Lower rates of immigration

• Significant feature of the Australianpopulation is the size of the ‘babyboomers’ group (born 1945-60)



Increasing Numbers in Older

Age Groups continued

• By 2050, it is expected that Australia willhave 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 expectancywas 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 forregular 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 asencouragement for self-employed

people to also contribute towards theirown retirement

• Recent legislative changes have furtherincreased attractiveness of

accumulating a higher superannuationbalance 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 arepaid

• 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 haschanged 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 financialdecisions



Role of Financial Counsellor

• Financial Counsellor provides range of free

public services

• Seeks to contribute to communityeducation 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 relevantfinancial information

• Operates in partnership with industry,

education bodies and communityorganisations



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 reconsidercurrent interest rates

– Market volatility

• When fixed-rate investments are sold the

full value of investment may not berealised – this will occur if market interestrates rise during the holding period

Understanding Risk continued



4. Market risk

– All markets have ups and downs

– Some markets are more volatile thanothers over a specified time frame

5. Market timing risk

– Very difficult to choose when to enter andexit the market in order to maximise

returns




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




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 termdeposits, debentures, mortgages andbonds




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’sprevious decision




11. Gearing risk

– If an investor borrows money to invest,

the loan must be repaid regardless if theunderlying investment decreases in price

– Regular loan repayments not tied to returnsprovided by the investment


F f h E i



• The business cycle – recession, recovery, boom,

expansion

•

Greater economic volatility pre 1990, sustainedexpansion 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 policyand Chinese demand for our resources…

Features of the Economic

Environment

F f h E i




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

F f h E i





3. Recession

– High unemployment

– Low (and possibly negative) economicgrowth

4. Recovery

– Unemployment begins to fall – Economic growth starts to rise

F t f th E i





• Both monetary and fiscal policy to‘manage’ the local economy

•Monetary policy is conducted viacontrolling the money supply which inturn impacts on interest rates

• Fiscal policy involves governmentintervention in the economy via taxationand spending policies

f h l



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

Hi t f th Fi i l




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

Hi t f th Fi i l



• 2001

– ‘Attribution rules’ for pensioners commenced

•

2004 – Allocated pensions introduced

– Reduction in calculation of assets under socialsecurity asset test for age pensions

• 2005 – Member choice of superannuation fund

introduced



Hi t f th Fi i l



• 2006

– Announcement of ‘Simple Super’ rules toapply from July 2007 including transition rules

having effect prior to July 2007• 2007

– Focus of introduced ‘Simple Super’ rules toencourage self reliance and maximise

accumulated superannuation benefits – Further relaxation of social security

asset / income test provisions for age pensions



Hi t f th Fi i l



Economic Changes

• 1987 share market crash

• 1990 property trust freeze

• 1991 Pyramid Building Society closure

• 1992 Japan share market crash

• 1994 bond market crash






Economic Changes

• 1997 Asian crisis

• 1998 Ralph Report

• April 2000 share market jitters

•1 July 2000 Goods & Services Tax

• 2001 World Trade Center disaster






Economic Changes

• 2001-02 corporate collapses

• 2002 falls in world market shares

• 2004 share markets rebound

• 2004-05 tsunami impact






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



Origins of the Global Financial



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 widerange regulations and controls. The table below lists the mainlegal 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 FinancialServices 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 productsand financial services advice industry

which defines the capacity in which aperson 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 makeevery 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




• 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


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





(FSRA) 2001 continued

• Objectives are to:

– Promote confident and informed decision

making by consumers of financial products andservices

– Reduce systematic risk and provide fair and

effective clearing and settling facilities

• Various licensing regimes including

Australian Financial Services Licence (AFSL)




• AFSL required by people who provide

financial services

• Representatives act under the licenceof the principal

• ASIC issues regulatory guides as basis

for interpretation of the legislation






• Licensees must adequately train their

representatives according to ASIC

training standards• Training levels set at Tier 1 or Tier 2

depending on activities of staff

representing licensee






• FSRA requirements of principals: – Monitor and supervise competent and trained

representatives

– Sufficient financial, technological and humanresources

– Possess relevant competence, skills andexpertise

– ASIC-approved dispute resolution processes – Adequate risk management systems and

compliance measures






• FSRA disclosure requirements

– Three statements

•

Product disclosure statement (PDS)• Financial services guide (FSG)

• Statement of advice (SOA)

– Additional information provided on request

– Confirmation of transactions – Advice of material changes and significant events

– Periodical statement of investment products





Other Relevant Legislation

• Common Law

• Superannuation Industry (Supervision)

Act 1993• Life Insurance Act 1995

• Insurance Act 1973

•

Australian Securities and InvestmentsCommission Act 2001

Statutory Complaints




Resolution Schemes

• Structures which regulate complaints andpotential disputes with clients are:

•

Internal complaints-handling mechanisms forsuperannuation funds

• The Superannuation Complaints Tribunal

• The Life Insurance Complaints Service

• The Financial Industry Complaints Service(FICS)




• FICS acts as an external dispute handling body

for specified complaint types (including

monetary limitations)


Resolution Schemes continued



The Role of ASIC

• ASIC is Australia’s corporate, markets and financial services

regulator

• ASIC contributes to Australia’s economic reputation and

wellbeing by ensuring that Australia’s financial markets are

fair and transparent, supported by confident and informedinvestors and consumers

• ASIC is an independent Commonwealth Government body.

ASIC is set up under and administer the Australian Securities

and Investments Commission Act (ASIC Act), and it carries outmost of its work under the Corporations Act



The Australian Securities and Investments Commission Act 2001

requires ASIC to:

• maintain, facilitate and improve the performance of the

financial system and entities in it

• promote confident and informed participation by investors

and consumers in the financial system

• administer the law effectively and with minimal procedural

requirements

• enforce and give effect to the law

• receive, process and store, efficiently and quickly, information

that is given to us …

The Role of ASIC continued

Lessons for Investors and



Lessons for Investors and

Financial Planners

• Be aware of:

– market cycles

– risks accompanying high returns – benefits of diversification

– underlying portfolio of investment products

– scams

– the need to review investments



Summary

• Personal financial planning is aboutsetting in place some personal objectivesand arranging financial means to satisfythose objectives

• Need to prepare personal budgets, oftenutilising services of financial counsellors

to assess current financial position and toplan for future personal financialobjectives



Summary continued

• Both financial planners and investors

need to understand the risks involved

and the economic and legislativeenvironment



Appendix

• Financial Planning Association – The Financial Planning association (FPA) is the peak professional body

for financial planning in Australia, representing approximately 12,000

individuals and businesses. Over 9,000 of its 12,000 members are

practising financial planners. The stated aim of the FPA and itsmembers is to strive to improve the financial wellbeing of all

Australians - see FPA web site: www.fpa.asn.au

– FPA members include financial planners from a variety of backgrounds

and disciplines, including over 5,500 Certified Financial Planners (TM).

All FPA practitioner members are bound by a code of ethics, highprofessional standards and must meet continuing professional

education requirements.

http://www.fpa.asn.au/

http://www.fpa.asn.au/



FPA Priorities

• Key FPA priorities are:

1. Growing professional membership

2. Effective external relationships

3. Social and community responsibility

4. Sound operations, technology and finance

5. Good governance

d f h



FPA Code of Ethics

• Principle 1: Client First

• Principle 2: Integrity

• Principle 3: Objectivity

• Principle 4: Fairness

• Principle 5: Professionalism

• Principle 6: Competence

•

Principle 7: Confidentiality • Principle 8: Diligence

– http://www.fpa.asn.au/default.asp?action=article&ID=21847

&KeyWords=code%2Cof%2Cethics

FPA Rules of professional

http://www.fpa.asn.au/default.asp?action=article&ID=21847&KeyWords=code%2Cof%2Cethics






FPA Rules of professional

conduct deal with:

• General conduct

• Disclosure statements to prospective clients

• Financial plan preparation

•

Explanation of financial plan• Financial plan implementation

• Client service

• Complaints

• Document administration

• FPA reporting requirements

• Minimum education competencies

• Supervision



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