Principles of Financial Literacy - Coursework Example

Principles of Financial Literacy By student’s name Course code+ name Professor’s name University name City, state Date of submission Table of Contents Part 1 3 Budgeting and Financial Planning 3 Part 2 5 Investment Strategies 5 a.Investment via Mutual Trust/Managed Funds 5 b.Investment in Government and Corporate Bonds 6 c.Use of Gearing 7 d.Investment in Gold Bullion 8 Part 3 8 Risk Management and Insurance 8 Part 4 10 Superannuation 10 Part 5 12 The Importance of a Will and a Power of Attorney 12 References 14 Part 1 Budgeting and Financial Planning Budgeting refers to the planning of the acquisition of resources and their use or allocation to an organization or a person’s life over a specific period. It refers to the process of allocating the financial resources of an organization or an individual to their activities or investments (Pintea et al. 164). Budgeting helps an individual to keep track of their income and expenditure by ensuring that the resources acquired are utilized properly. Financial planning, on the other hand, refers to the process of gathering and analyzing financial data with the aim being to develop strategies to help an individual in achieving their goals and objectives in life (Kapoor 3). It is the process where a person manages their money to achieve personal economic satisfaction. Budgeting differs from financial planning in that it involves tracking your income and expenditure to ensure that your expenses are not more or equal to your income. It helps in prioritizing on where your money will be directed by prioritizing on the most important things. Financial planning, on the other hand, means making a plan that involves setting life goals and objectives and ensuring that every financial activity is geared towards meeting these goals. It involves planning not only for your present but also for a person’s future needs and goals (Kapoor 3). Budgeting for a family is important because it helps the family to control their income and expenditure. Budgeting helps people understand how they are spending their money. Financial planning helps the couples and families to understand how their money can be used or applied in meeting their future needs and objectives. Money is a scarce resource. Budgeting is, therefore, important to help people control their income and expenditure, establish priorities as well as set targets and also to monitor their financial performance. Financial planning has several benefits such as improving efficiency in obtaining, using and securing financial resources during a person’s lifetime, increasing control over a person’s affairs such as debts and dependence on others and also improved relationships in the family due to well-planned and communicated financial decisions (Kapoor 10). The lack of budgeting and financial planning means excessive debts, bankruptcy, failure to attain an individual’s life goals, family problems due to mismanagement of money, dependence on others and also a life of poverty and dissatisfaction. In the case study, the three couples can benefit greatly from budgeting and financial planning. For Couple 1, they are starting a life together which means that they need a plan to achieve their set goals. They have an income of $155,000 and their expenditure stands at $135,000. This means that they are only left with $20,000 which has to be used to pay their debts which amount to $135,000 as well as saving. One benefit of budgeting for them is to be able to reduce their living expenses by budgeting for only those things that are important. Budgeting will help them reduce their expenses drastically to create enough money that can be invested to pay their loans and meet their objectives (Pintea et al. 166). Financial planning for the couple involves looking at their income and making a plan on how their finances can be used to meet their goals and objectives. Their goal is to pay their debts, buy a house and go on holiday to Japan. To achieve this, financial planning is important to see how their resources can be manipulated and applied towards meeting these future goals. The lack of a financial plan or budgeting for the couple means more debts and a failure in their objectives. For Couple 2, budgeting and financial planning is also important for them. They have a few years before retirement which means they need to save as much as possible and invest to ensure that they pay off their loans, pay private school for their kids and have enough for their retirement. Financial planning for them means allocating their resources in a way that helps meet their goals and objectives. Budgeting will help them to improve their financial performance in terms of their expenses. They need to increase their assets and significantly reduce their liabilities to ensure that even in retirement they can still meet their goals (Walther and Skousen 45). Budgeting and financial planning will help them achieve these goals. For couple three budgeting and financial planning is important for them to ensure that they do not acquire any liabilities but rather increase their assets. Financial planning will enable them to see how their finances can be used to pay for their trip to Africa and still start a sinking fund for their grandchildren. Part 2 Investment Strategies a. Investment via Mutual Trust/Managed Funds Mutual trust or managed funds is an investment strategy that allows an individual to pool money together with other investors for the purpose of investing in assets that would otherwise be out of reach (AM Capital 3). A person who invests in a managed fund becomes a unit holder because they have acquired units in the fund. In a managed fund, the value of the investment rises or falls depending on the market value of the assets hence the value of the investment may vary from time to time. Some of the benefits of this investment strategy include access to investment opportunities that would normally be out of reach, regular returns and diversification, that is, investments made across different assets (AM Capital 3). Some of the disadvantages of managed funds include the risk of loss of income and principal invested, market risks which may affect the total returns and the value of the investment may vary based on the market. Based on the risk profiles of the couples, this investment strategy would more appropriate for Couple 1 and Couple 2. It is, however, less appropriate for couple 3. This is because Couple 1 has a high growth risk profile which means that they are ready to take higher risks for potentially great returns hence they can invest in managed funds. They also have a greater need for growth in capital and they also have time on their side due to their ages. Couple 2 has a growth risk profile meaning they are also willing to take high-risk investments for capital growth. Couple 3, however, has a balanced risk profile meaning they can only take calculated risks (Mutual Capital Ltd 8). Due to their age, they do not have time to recover in the event of market downturn hence the strategy is not appropriate for them. b. Investment in Government and Corporate Bonds Governments normally issue bonds as a way to help them raise the money needed for operations and programs. Governments sell bonds and other securities as a way to fund its activities and services and to finance the national debt. A corporate bond is also a way for companies to raise money from investors which is meant to finance their business activities (ASIC 6). The government or the company promises to pay interest on the money and to pay back the money at a certain date. Investing in government or corporate bonds is a way of lending money to the government or a company. Some of the advantages of government and corporate bonds the fact that they are a fixed term investment meaning that the government or the company concerned will pay back the money at some point. There are also regular interest repayments and it is also a low-risk investment since the government or the company will pay back (ASIC 8). The disadvantages include low-interest rates, hard to get access for small investors, for corporate bonds and there is also a risk of loss in the case a company becomes insolvent. The investment strategy would be more appropriate for Couple 3 because their balanced risk profile means that they would prefer low-risk investments. They would also be appropriate for Couple 2 because the periodic interest payments will increase their capital while still preserving the invested amount. The strategy would not be appropriate for Couple 3 because they seek after high-risk investments. c. Use of Gearing Gearing simply refers to the investment method that involves borrowing money so that one can invest. Such investment can be through buying shares, managed funds or property (National Wealth Management 3). This investment strategy can be used to speed up the process of wealth creation by allowing the investor to make a large investment than would normally be possible. Gearing is of three types namely positive, neutral and negative gearing. Positive gearing is when the income you get from the investment is higher than the investment costs incurred. Neutral gearing is when the investment costs are equal to the income received from the investment while negative gearing is when the investment costs exceed the income received from the investments. Some of the benefits of gearing include tax savings associated with gearing and the potential for increased capital gains as well as diversification (National Wealth Management 4). The disadvantages include reduced cash flow in the case of negative gearing and timing mismatch, that is, the investment income may be irregular hence making it hard to meet the interest rates for the loan or money borrowed. Gearing is more appropriate for people with an aggressive risk profile and an investment time-frame of more than seven years. Due to these factors, this investment strategy may be appropriate for Couple 1 and 2 due to their aggressive risk profile. Further, they may be more willing to invest in a long-term investment because for couple 1 they have the time and for couple 2 it is appropriate for their children’s education even after their retirement. d. Investment in Gold Bullion Investment in gold bullion means buying bulk quantity of gold as an investment strategy. Buying gold is a lucrative investment strategy as well as a good way to diversify the risks involved. The demand for gold remains strong even today and has continued to increase. Such increase in the demand means that the rate of returns when selling is also high (ABC Bullion 4). Some of the advantages or benefits of investing in gold bullion include capital growth returns and the method provides the chance to diversify away from the traditional investments such as shares and bonds. Investment in gold is also immune from economic uncertainty and inflation hence protecting the investor. The disadvantages include securing safe transport and storage for the gold, insurance for the gold and transaction costs are also high which further adds to the cost of the investment. The investment strategy is appropriate for all the couples due to its great returns. However, it is more appropriate for Couple 3 due to the low risks involved. It may also be appropriate for Couple 1 and 2 since it is a long-term investment strategy. Part 3 Risk Management and Insurance Risk management is a tool for management that can be used by organizations as well as individuals to minimize the adverse effects of accidental loss that has financial recursions. Basically, risk management is a continuous process or effort by a person or an organization to control the risk of losses to which such person or organization is exposed to and how to finance the losses when they occur (Williams 3). Risk management is an important part of financial planning. This is because of the many types of risks such as those caused by a decline in stock markets, death, economic instability, loss of income, damage to assets among others. These unforeseen events have the potential to cause devastating financial effects to an individual’s finances and, consequently, altering the financial plan. Risk management is the process where a person conducts an assessment to identify these risks and prevent them or cushion against their devastating effects when they occur (Williams 5). The most common method of managing risks is through insurance. Insurance is based on the principle or concept of indemnity, that is, it exists as a way to provide protection against loss. This means that once a person has insured against a certain risk, in the event that such a risk has happened, the insurance company compensates the person for the loss suffered (Houghton Muffin Company Ltd 5). For the three couples, risk management must be a key point to consider when doing their financial planning. They must identify the risks associated with their financial plans and make plans on how to manage such risks. For Couple 1, they have a desire to get a deposit for a house and also travel to Japan for skiing. There are risks involved in their long-term goals and objectives. There is the chance that the house may burn or get damaged for one reason or the other. As such they will need to take a general insurance against fire on the house once they purchase to minimize the risk of loss. Even as they travel to Japan, it is important to prepare by taking personal insurance against any accident that may occur while skiing. This will protect them from unexpected health costs in the case of an accident. For Couple 2, they have assets which are growing as they invest more. As a result, such assets such as their house ought to be insured. They can also take up health insurance for the whole family including the children to protect against any unexpected illnesses. Jeff may also need to take up liability insurance in the event any of his clients sues him due to the legal services offered (Callan Capital 1). Couple 3 also needs to make certain decisions such as taking up life insurance to protect either spouse from the costs that may arise in case of the death of the other. They can also insure their assets for the sake of their children and grandchildren. They can also take up travel insurance for their planned travel to Africa, and a health and accidents cover to protect themselves from any loss or costs that may arise from accidents that may occur during the trip. Part 4 Superannuation Superannuation is a way of saving for one’s retirement. This amount is paid to a person upon retirement from employment. It is, therefore, a way of saving to ensure that one is financially stable even upon retirement (Australian Government 2). The money for superannuation generally comes from the contributions made into an employee’s super fund by the employer as well as any other amount that the employee may add or top up. Superannuation is important because it guarantees that once a person retires, they have money to invest or provide for their basic needs even without the need for a salary. It is also a way to provide financial benefits to one’s children in case of death before retirement. These savings also receive certain tax benefits from the government. This means that the government charges lower taxes for the money saved through superannuation. This method, therefore, provides for a way to save for retirement with better tax terms (Sentry Group 1). Contributions to superannuation are divided into two types namely concessional and non-concessional contributions. Concessional contributions are those contributions either made by individuals or for them that are taxable on the contributor. These contributions are part of the taxable part of superannuation benefits. The percentage tax for concessional contributions stands at 15% (National Wealth Management Holdings Ltd 5). Non-concessional contributions are those that are not taxed and include personal after-tax contributions as well as spousal contributions. They form part of the tax exempt component of one’s superannuation benefit. There are, however, limits to the amount of the non-concessional contributions that is not taxable. Once the amount being contributed has exceeded such an amount, then it is taxable. In regard to superannuation, Couple 1 can choose to have both employer related superannuation schemes and personal schemes. Employer related superannuation schemes are those schemes where the employer remits money for their employees. Personal schemes are those which involve individuals making contributions towards retirement savings independent of the contributions being made by the employer (Australian Government 4). Due to their age, these schemes will help the couple to prepare for their retirement. For the second couple, they are close to retiring. It would be wise for them to ensure that they withdraw their superannuation funds after the age of 60 to benefit from tax-free incentives from the government. This gives them access to more money for investment or use in other ways. They can also choose to have their superannuation transferred to an accumulation fund where their contributions will be accumulated to provide the maximum benefits for them (National Wealth Management Holdings Ltd 4). For Couple 3 since they are already enjoying their superannuation funds the best thing to do would to invest the funds for maximum benefits. They can invest the money in a defined benefit fund where the final benefits to receive from the fund are guaranteed. They could also invest their money in an accumulation fund where the benefits to be paid to them will be based on the amount accumulated. Part 5 The Importance of a Will and a Power of Attorney A will is a legal document made by a person during their lifetime where they outline how his or her property is to distributed upon their death. Although a will is made during a person’s lifetime, it only takes effect upon his or her death. This means that before the death of an individual they can change the will as much as they wish. The person making a will is called a testator while the people benefiting from the will are called beneficiaries. The testator is required by law to ensure that they appoint a person to administer the will and the property known as the executor (Women’s Legal Service 1). The executor is supposed to manage the property after the death of the testator by ensuring that all debts and liabilities are paid and that the assets or property of the deceased are distributed to the beneficiaries based on the specifications in the will. For a person to make a will they must be 18 years and above and also have the capacity to do so, that is, not be insane. They must understand the nature of the document they are making. A power of attorney is a document made by a person, the donor, giving another person, the donee, the power and authority to act on their behalf. A power of attorney can either be general or specific. A general power of attorney is one where the power of the donee is not limited (Women’s Legal Service 4). He or she can act in all matters on behalf of the donor. A specific power of attorney, on the other hand, is where the powers given to the donee are limited such as in relation to a particular transaction. A will is important for Couple 1 mainly to keep track of the assets and other property they own. It enables the couple to give instructions that the other partner is supposed to manage their property once they die. This ensures that the property is protected from mismanagement by other relatives. A power of attorney is important because at their age the couple is making a lot of financial decisions in order to ensure that they grow their income. A power of attorney enables either party to make decisions on behalf of both of them when the other one cannot do so (Student Legal Services of Edmonton 6). It is important for Couple 2 to have a will because it outlines all the properties they own. This ensures that none of the property may be lost in case of death. A power of attorney is also important to enable either of the couple to act for the benefit of the children in the event the other person is not capable of making such decisions. A power of attorney and a will are important for Couple 3 due to their advanced age. A valid will is necessary to show how they wish to have their property distributed upon their death. This helps protect the property from mismanagement. A power of attorney is also important to enable each of them to make take over financial decisions in case the other is incapacitated. References ABC Bullion, A beginners guide to investing in precious metals, ABC Bullion, 2016. AMP Capital Limited, Understanding managed funds, AMP Capital Investors Limited, 2014. Australian Government, What is superannuation? Australian Government, 2014. Australian Securities and Investments Commission, Investing in corporate bonds, Australian Securities and Investments Commission, 2016. Callan Capital, Essentials of financial planning, Part 2: Risk management, 2017, Web 15th April 2017. (http://callancapital.com/essentials-of-financial-planning-part-2-risk-management/) Houghton Muffin Company Ltd, Risk management and insurance, 2008, Web 15th April 2017. (http://college.cengage.com/business/phk/business/9e/assets/students/appendices/phk9_olappendix_b_c.pdf) Kapoor, Jack, Planning your personal finances, McGraw-Hill Education, 2015. Laurie, Williams, Risk management, 2011, Web 15th April 2017. (http://agile.csc.ncsu.edu/SEMaterials/RiskManagement.pdf) Mutual Capital Limited, Mutual trust cash fund, Mutual Capital Limited, 2016. National Wealth Management Holdings Ltd, Understanding superannuation, GWM Adviser Services Limited, 2017. National Wealth Management, Understanding gearing, GWM Adviser Services Limited, 2016. Pintea, Mirela-Oana, Lacatus, Viorel-Dorin and Deceanu, Liviu-Daniel, Purpose for budgeting- Literature review, 2014, Web 15th April 2017. (http://conferinta2013.academiacomerciala.ro/_VOLCONF2013PDF/volumconferinta/PURPOSE%20FOR%20BUDGETING%20-%20LITERATURE%20REVIEW_pintea.pdf) Sentry Group, Why is superannuation so important? 2017, Web 15th April 2017. (http://jpmfinancialplanning.com.au/wp-content/uploads/2015/03/Why-is-Superannuation-so-important-Final.pdf) Student Legal Services of Edmonton, Wills, personal directive and power of attorney, Student Legal Services of Edmonton, 2010. Walther, Larry and Skousen, Christopher, Budgeting and decision-making, Ventus Publishing, 1999. Women’s Legal Service, Wills, power of attorney and enduring guardianship, Women’s Legal Service, Tasmania, 2013. Read More