AFAS200 Principles of Financial Literacy and Management

1.Advise the 3 couples on the need for budgeting and financial planning to help meet their goals and objectives. In your answer also address the benefits of appropriate budgeting and planning and the risks of not budgeting and or planning. Be specific, relate to each of the couple personal circumstances

2.Discuss and explain the different investment strategies below highlighting their key advantages and disadvantages. Comment specifically on the suitability of each of these investments strategies to each of the clients above. Clearly explain and justify your answer.

3.Explain the concept of risk management as an important financial planning consideration and how insurance can be used in managing key personal risks. In you answer List 1personal and 1 general insurance recommendations to each of the 3 couples and explain why they should be (you need to list and explain 2 recommendations for each of the couples, 6 in total)

4.Explain why it’s important to consider superannuation as part of saving for retirement and retirement palming. List and explain 2 possible superannuation/pension recommendations or strategy and explain why they would be considered by each of the 3 couples (you need to list and explain 2 recommendations for each of the couples, 6 in total)

5.Explain why it’s important to consider having a valid will and an appropriate power of attorney as part of the couples’ estate planning highlighting the benefits and risks as applicable. In your answer relate specifically to each of the 3 couples individual circumstances.

Introduction

This report addresses five questions on various crucial aspects of financial management and investment strategies. The aspects of financial management and investment strategies have been discussed in relation to the information provided about three couples. In the first question, the report takes on discussion on budgeting and financial planning. In this connection, the need and objectives of budgeting and financial planning, along with the risk of not having adequate budgeting process, have been discussed (Ang, 2014). Further, the second question discusses different investment strategies such as mutual funds, managed funds, government and corporate bonds, and gold. In this question, the advantages and disadvantages of the aforementioned investment strategies have been discussed along with the use gearing.

Further, the question three discusses about the risk management which is an important ingredient of the financial management process. Further, the suggestions in regards to the risk management strategies have been given to three couples based on the analysis of their particulars in regards to age and income. The question four takes discussion on the investment in superannuation and recommendations have also been given to all three couples for having a suitable superannuation investment plan. The last question is the fifth one which takes discussion on validity of will or appropriateness of power of attorney. In this question, the discussion has been linked to the particular circumstances of each individual.

Question-1

The financial planning and budgeting is essential not only for a business but also in the personal life of a human. In the context of personal life of a human, the financial planning and budgeting implies preparing plans for the future savings and expenses that one expects over the period of life. The budgeting, planning and forecasting is applied in steps to achieve the set targets of a business or personal life of a human. Thus, the budgeting and planning is necessary to achieve the goals and objectives (Berman et al., 2015). The plans are prepared to draw a road map to provide appropriate direction to the activities. Further, the budgets are prepared to estimate the amount of income and expenses expected to be earned and incurred over a definite period of time (Berman et al., 2015).

A proper financial plan is prepared keeping the personal circumstances, objectives and risk tolerance of an individual in mind. The planning keeps the activities within control and hence it is must to ensure that the objectives are achieved. There are various advantages of planning and budgeting as detailed below:

• Planning leads to allocation of the funds in the right areas and for right purpose. The earnings of an individual who plans well will be utilized more beneficially than the earnings of an individual who goes recklessly (Berman et al., 2015).
• Budgeting helps to control the expenditure. Preparing budget keeps the amount of expenditure within limits set out at the initial level (Berman et al., 2015). For instance, in the current case, couple-1 has estimated household income to be $135,000 for the year. Now, the spending of this couple would not exceed the amount of $135,000 in the normal circumstances.
• Preparing the budgets also facilitates evaluation of the performance and comparison against the actual figures. The comparison of actual figures with the budgeted figures is necessary to find out the gaps and conduct an analysis to figures out the reasons for such gaps (Berman et al., 2015).
• Further, budgeting assists in taking future decisions in regards to change in the investment strategies if the same are not working as per budgeted targets (Berman et al., 2015).

Thus, it could be observed that the budgeting is an essential process. The absence of budgeting and planning, whether in the personal affairs or business affairs, would lead to problems in the attainment of objectives and goals (Berman et al., 2015). For instance, in the case of couple-1, the goals and objectives set for the year are paying off debt, saving for deposits, and going on a skiing holiday. In the absence of proper planning and budgeting process, the attainment of these objectives would be difficult. Further, there is possibility that the expenses for the year might be exceptionally high leading to shortage in savings. The situation may be verse and it may lead to serious financial crisis if the affairs go unplanned and without budgeting (Hagin, 2004).

Question-2

There are different investment options available in the market such as investment via mutual fund/ managed fund, government and corporate bonds, using of gearing, and investment in gold bullion. The advantages and disadvantages of different investment options are different and the circumstances of a particular case may indicate suitability of a particular investment option (Hagin, 2004). For example, the low risk taking individuals may invest in gold bullion and government bonds while the high risk taking investors may choose mutual funds. Thus, it is risk and return profile of each investment option which dominates the decision of the investor. Every investor wants to keep the risk as low as possible while keeping the return as high as possible. However, it is normal tendency that the return increases with the increase in risk. This implies that the investment option which has high risk would provide high return; on the other hand the investment option with low risk would provide low return (Hagin, 2004). The analysis of advantages and disadvantages of investment in mutual funds, government/ corporate bonds, gold bullion, and use of gearing is presented as below:

Investment via Mutual Funds/ Managed Funds

The investment through mutual funds is an indirect method of investing in securities and other forms of investments. The mutual funds are established to invest money in the securities of the companies and other avenues like fixed deposits, government bonds, properties etc. (Wankhade, 2016). The mutual funds collect money from the public and invest that money in the shares, bonds, fixed deposits and properties. The investors are issues units on which they earn return in the form of dividend and capital appreciations. There are different schemes being offered by the mutual funds. The most crucial advantage of investing through mutual funds is that the investor is relieved of management of the invested amount. Further, the mutual funds also provide opportunity to accumulate funds by investing in small amounts (Haslem, 2009). Apart from this, the diversification to the overall risk of the investor is automatically effected by investing in mutual funds because the mutual fund invests in different avenues. Due to the increased diversification, the overall risk of the investors is also reduced. Further, the equity oriented mutual funds also provide tax advantages to the investors. The disadvantage of investing in mutual funds is that the returns may be lower due to high management expenses of mutual funds. Further, mutual funds are considered riskier than the fixed deposits and government bonds (Haslem, 2009).

Government and Corporate Bonds

The corporate bond is the debt instrument issued by the companies while the government bond is the debt instrument issued by the government for raising money from the public. The government and corporate bond both are low risk investment options; however, the government bond is even less risky (Larimore, Lindauer, and LeBoeuf, 2006). The issuer pays periodical interest to the subscribers of bonds. Further, the subscribers also get the principal amount paid back at the end of the specified terms of period. The most crucial advantages of investing in the government bonds is that the principal sum is guaranteed by the government, thus, the default risk is negligible. Further, as compared to the investment in stocks, the corporate bonds carry low volatility. The disadvantage of investment in bonds is that the return in the form of interest is low. Further, generally the bonds are redeemed at par, thus, the investor looses an opportunity to earn return in the form of capital appreciations (Larimore, Lindauer, and LeBoeuf, 2006).

Using of Gearing

Taking money on credit to invest is unconventional way of investing. This form is investment is common among the portfolio investors. Mainly, the portfolio investors invest by borrowing money to take advantage of gearing. Investing by borrowing money increases the risk of investor. Thus, the portfolios which comprise assets with low risk can afford to make investment by borrowing money (Kohler, 2011). Investing in this way will increase the beta of portfolio and it can be used to bring the risk to an optimal level. However, it should be noted that use of gearing is beneficial only when the market is rising. When the market rises, the high geared portfolios earn high returns but when the market declines, the loss are enormous. Thus, the using gearing can result in boosting returns but at the same time is also highly risky also because the losses can be devastating (Kohler, 2011).

Investment in Gold Bullion

The investment in gold is the safest way of investing money. The investor needs to purchase physical gold in the form of gold bars or biscuits. The price of gold bears perfect negative correlation with the stock market. Thus, investing in gold with the investment in stock market could be used to optimize the risk and returns of the portfolio. The advantage of investing in gold is that it could be used as the best mechanism to hedge the risk of investment in stock market (Epstein, 2012). However, the investment in gold could be costly due to its high cost of maintaining and holding. Further, to make investment in gold, the investor needs to have large amount of money; so, this is also one of the disadvantage of investing in gold (Epstein, 2012).

Suitability of Investment Strategy for Each Couple

The suitability of investment depends upon the risk and return preferences of the investor. An investor wanting higher returns may be willing to take high risks and thus, the investment in stock market could be preferred. Further, there are some other factors such as amount available for investment, period of investment, regularity of income which also dominates the decision of investment. The relevant facts and figures in the case of three couples given in the current study are presented as below:

It could be observed that couple-1 is a new married couple with no dependents yet. They want high growth and they have got longer time period to invest because they are at young age as of now. However, the net assets of the couple are low only $115,500 and the income available for investment each year is also low at $20,000. Thus, having regards to the circumstances of the case, it could be inferred that the investment alternative which offers them high growth in future and the investment in which could be made with small amounts on monthly/quarterly/ yearly basis would be preferable. Therefore, it seems that investment in a scheme of mutual fund would be the best choice for the couple-1.

The couple-2 is near the retirement age. They have got high income sources and save after meeting the living expenses a sum of $130,000 each year. Further, time period of investment could be assumed to be moderate for them. This couple has already got investment in shares and managed funds. Thus, now it would be recommendable for them to invest in less risky avenues like corporate and government bonds. The investment in corporate and government bond would require large amount, which they can afford as their income is quite sufficient. Further, the investment in bonds would provide stability and regularity in the income and at the same time it would optimize the risk also.

Further, the net assets value of couple-2 is $3,585,000 which is quite high; therefore, they can also use gearing to boost up the returns. The loan would be easily available for them due to high net assets and yearly income. Further, the investment in gold and bullion is also a good choice to hedge against the loss on investment in stocks. In regards to couple-3, it has been observed that they are retirees. They already have investments in shares and managed funds. The investment in government bond is the best option available for couple-3 because it will provide stability in the income. They should resist investing in shares. The holding in shares should be sold by them and the money realized should be used in investing in government bonds.

Question-3

The risk management refers to the process of analyzing the factors giving rise to risk and taking reasonable steps to reduce the risk. In financial terms risk refers to the possibility of monetary losses which may due to different factors. For example, in business the risk may be to lose demand in the market due to lower quality (Brown, 2015). Further, the firm operating at the international level bears the risk of foreign exchange. The adverse changes in the rates of foreign currency may cause severe losses to the firm. In regards to the investment in shares, the risk is the loss that may be caused due to adverse price changes in the shares. In order to ensure stability in the earnings, it is crucial to maintain the risk at the tolerable level through various risk mitigation and reduction strategies. Thus, the objective of risk management is to keep the risk within the risk appetite of the investor (Brown, 2015).

There are various tools and techniques being used to reduce the risk in the business. The nature of risk mitigation strategies would depend upon the type of risk and the nature of factors giving rise to the risk. For example, in order to reduce the risk of foreign exchange, the firm may enter into a forward contact with the bank or the foreign exchange dealer to exchange the foreign currency at some future date at the rate agreed in the contract (Brown, 2015). The management of risk is essential to save the business from collapsing down in a quick succession. In the same way, the risk management is also crucial in the personal life of an individual. The future is uncertain and therefore, the individual should be prepared with the adequate risk management strategies to control and manage the risk. In this regards, insurance can be used as the conventional way to manage and control the risk. The insurer provides guarantee to indemnify the insured in the event of loss. The insurance can be taken on one’s life which is called life insurance and it can also be taken for assets, which is called general insurance (Koh, 2012).

The life insurance provides guarantee to indemnify in the event of death of the insured, thus, it guides the dependents of the individual against the financial crisis in the event of his death. In the case of three couples, the recommendation for general and life insurance are given as below:

• The couple- is new married, thus, they both should take life insurance policies on each other’s life. This will provide safeguard against the financial crisis in the event death of either person. They have got a car, thus, they should take out a general insurance policy to provide safeguard against the loss of car by theft or in accident (Koh, 2012).
• The couple-2 should also take life insurance policies on their lives to provide safeguard against the financial crisis for their children in the event of their death. Further, they have got one car which is needed to be insured under the general insurance policy (Koh, 2012).
• The couple-3 has surpassed the age of retirement, thus, they should take life insurance policies on the lives of their children. Further, a general insurance policy should also be taken on car to provide safeguard against the risk of loss of car (Koh, 2012).

Question-4

Superannuation is a fund set up by a company or the government to provide an opportunity to the employees to save for their retirement. The employees make contribution to the superannuation fund each year from their salary earnings and a part of contribution also made by the employer (ATO, 2017). The superannuation fund invests the amount of contributions made in the account of an employee and then the income generated through those investments is again invested. The contributions are made by the employee and employer till the date of requirement of the employee. After the retirement, the employee can withdraw the amount accumulated in the fund either in lump sum or he may take out an annuity plan wherein the payments are made periodically. The accumulation of funds through superannuation funds also provides tax advantages to the employees (ATO, 2017). Therefore, the superannuation is considered as the most popular way savings for retirement. In the cases of three couples, the superannuation recommendations/ strategies are given as below:

Question-5

It is important to have a valid Will and appropriate power of attorney to prepare for the future of one’s family. As part of the estate planning, the individuals need to be prepared with the valid Will and the power of attorney. The estate plan includes among other things, a valid will and the power of attorney which provides directions and instructions in regards to the use of individuals assets in the event of his becoming incapable of taking decisions (ASIC, 2017). The Will contains nominations of the people who will participate in the estate of the individual after his death and proportions in which they will share the estate of the deceased. The Will takes effect only on the death of the person making will. Thus, having a Will is crucial to avoid any dispute among the legal representatives of the deceased regarding the ownership of the estates of the deceased (ASIC, 2017).

Further, the power of attorney is important to give someone the powers to take decisions in regard to the use of assets in the event of an individual becoming physically or mentally incapable of being taking decisions. Thus, the power of attorney extends the powers to perform certain functions on behalf of the owner (ASIC, 2017). The power of attorney is the necessary document to make decisions in regards to sales or dispose of the estate of the person who has fallen incapable of signing the deeds and documents. In the case of Couple-1, the husband and wife both should prepare a Will for each other. Further, in the case of Couple-2, the Will prepared by the parents should provide for the proportions in which the estates will be distributed among the children in the event of death of the parents. Further, they also should appoint an attorney holder who will be acting on behalf of the couple to dispose off or acquire the properties and investments. The couple-3 has crossed the age of 65 years hence in their case it is more crucial to prepare the Will and power of attorney (ASIC, 2017).

Conclusion

This report presents discussion on the management of personal finance of the individuals. From the discussion in this report, it could be articulated that the budgeting and financial planning plays a crucial role in the management of finances. If the planning is not proper, the achievement of objectives is difficult. Further, it has been observed that the decision to invest money depends upon various factors and the primary among them are the risk and return preferences, period of time, and the amount available for investment. There are different investment alternatives such as shares, bonds, mutual funds, and gold and bullion. The choice of investment alternative would depend upon the specific needs of the investor in regards to the return and his appetite to take risk. Further, report takes on discussion on the risk management and the use of insurance as a risk management strategy. In this regards, it has been observed that the insurance is an important measure to control and manage the risk. An individual can control and manage the risk by taking life insurance or general insurance. In addition to the above discussion, the report also highlights the characteristics of superannuation plan along with the importance of a valid Will and power of attorney.

References

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