Financial
Planning (PFP)
LEARNING OUTCOMES
By the end of this topic, you should be able to:
1.
2.
3.
4.
X INTRODUCTION
Personal financial planning is very important for everyone. Personal financial
planning is a process of setting objectives, assessing assets and resources,
estimating future financial needs, and making plans to achieve your personal
financial goals. It plays a crucial role in helping you to get the most out of your
money. However, many of us do not pay sufficient attention towards personal
financial planning. Some may even ignore it at all costs and assume that talking
about money matters is not acceptable, even going so far as to label people who
do so as being money-minded.
In this topic, we will discuss the importance of proper personal financial
planning, the five steps of personal financial planning and how life events have
an impact on financial planning.
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7.1
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There is a saying by writer Alan Lakein that nobody plans to fail, they just fail to
plan.
The effect of having and implementing a proper financial plan will only be seen
in the long run. Consider the following case:
Mr. A, aged 35 years old, is a professional engineer who graduated from a top
notch UK university, earns a very good salary and is married with two children.
His net savings amount to around RM3,000 to RM5,000 (adjusted for inflation) a
month on average after deducting all expenses. He places all his savings into a
fixed deposit account, earning an average of 2.5% return. He put all of his efforts
into being the best engineer in his field, which earns him a very respectable
salary and has secured him a job until his retirement at the age of 60 years old.
His brother, Mr. B, is 33 years old and is a plumber, earning about half of his
brothers salary. Mr. B is also married with two children. He only manages to
save between RM1,500 and RM2,000 (adjusted for inflation) a month on average.
He invests the savings in properties and shares. He continually sharpens his
investment skills while keeping his plumbing job. He plans and works on his
finances carefully to meet his financial goals.
Guess who will be better off financially, assuming all other things remain equal?
Both brothers eventually retire and achieve financial freedom. However, Mr. B
became financially free at the age of 45 years old when he accumulated sufficient
financial assets to finance his familys expenses including his childrens
education. Meanwhile, Mr. A had to depend on his job until the age of 55 years
after both of his sons graduated from university.
Now, can you see the impact and importance of financial planning? If you were
to choose one, would you want to be in the situation of Mr. A or Mr. B?
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(g) Have better personal relationships with people around us, because we are
happy with our lives and do not need to borrow money to make ends meet
or expect handouts from others; and
(h) Have a sense of freedom from financial worries because we have planned
for the future, anticipated our expenses and achieved our personal goals in
life.
This is an introductory topic to personal financial planning where you will be
exposed to the basics of financial planning. Hopefully, it will spark your interest
in personal financial planning.
ACTIVITY 7.1
Do you think you need proper personal financial planning to succeed
financially in life? Why?
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7.2
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Many people think that being wealthy means earning a high income or having a
lot of assets or a large inheritance. In fact, wealth is very closely related to your
ability to understand trade-offs and to make decisions that generate wealth for
you.
A trade-off means sacrificing current consumption to generate future
consumption.
Success is defined by the individual or family that seeks it. It is not defined by
others, but by you. Therefore, it would be a futile exercise if you begin to
compare your wealth with that of others. Financial success means different
things for different people. There is no absolute definition of it. It all depends on
your values, which translate into what you value most in life.
To some people, financial success is being able to actually live according to ones
desired standard of living and not the standard of living imposed by parents,
friends or society. To others, it means financial security, which provides the
comfortable feeling that your financial resources will be adequate to fulfil any
needs you have as well as most of your wants. Please note that it is quite
impossible to fulfil all your wants due to the fact that you have unlimited wants
but limited resources. Some people want to be wealthy and have an abundance
of money, property, investments and other financial resources. Ultimately, the
decision is yours. Remember, there is always a trade-off in achieving your
financial success, for example, sacrificing something to get something in life. The
fundamental truth of personal finance is that you cannot build financial security
or wealth unless you spend less than you are earning and live below your means.
Put your savings to work, i.e., invest your savings wisely.
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ACTIVITY 7.2
What do you understand by the terms wealth and financial
success? In your own words, compare these two terms.
7.3
What is financial happiness? It encompasses a lot more than just making more
money. It is about the satisfaction you feel about your financial matters. People
who are happy with their finances are likely to be in control of their money, and
this happiness spills over in a powerful and positive way to feelings about their
overall enjoyment of life. So, how can you be happier as far as personal financial
matters are concerned? Let us look at the five steps of personal financial
planning.
7.3.1
Before you can begin setting goals and developing strategies to achieve them, it is
important to understand where you are today. The first step in creating your
personal financial plan is assessing your current financial situation. Having a
detailed analysis and understanding of your current financial situation is the
basis of formulating realistic, relevant and well-informed financial goals.
A useful way to gain insight into your current financial situation is to calculate
your current net worth. Net worth is defined as a persons total assets minus
their total liabilities. This gives you an idea of your financial position on a given
date.
Utilising the chart in Figure 7.1, calculate your current net worth.
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7.3.2
Your values are the fundamental beliefs about what is important, desirable and
worthwhile in your life. They serve as the basis for your goals. Every one of us
may differ in the ways we value cars, houses, education, spiritual life, health,
loans, family life, holidays, and other items or aspects of our life. I am sure you
know someone who is a car enthusiast and is willing to buy a car worth more
than RM300,000, even though the instalment will cost him around 50% percent of
his monthly income. Personal financial goals should be derived from your
values. You express your values, to a certain extent, by the ways you spend, save
and invest your money. For instance, parents who value education would spend
a lot or almost all their savings on their childrens education.
Thus, it is very crucial for you to specify your values explicitly before setting
your financial goals. Once you have identified your values and evaluated your
current financial situation, you are ready to move to the next step in the financial
planning process: developing your financial goals. Setting goals will give you a
direction for your plan and a destination toward where you want to head.
Knowing your goals will drive you toward strategising the proper plan to
achieve them. A well-defined financial goal should have the following criteria.
(a)
(ii)
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(b)
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(c)
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Goal
Total Cost
Duration
Monthly
Cost
Target Date
Monthly
Cost
Target Date
Monthly
Cost
Target Date
Goal
Total Cost
Duration
Goal
Total Cost
Duration
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The next step of the financial planning process involves identifying and
evaluating alternative courses of action to achieve your goals. Good and practical
strategies must be developed to bridge the gap between your desired and the
current financial situation within a targeted time.
For example, you, a senior manager in a multinational company, are planning to
buy a BMW 328i at RM280,000 in three years time. You want to ensure you will
be able to pay all related expenses on the car, including road tax, tyre
replacement, maintenance cost, insurance, petrol, tolls, polish, etc. That will come
to RM1,200 per month. The monthly instalment would be around RM2,500 for a
nine year loan tenure, with the down payment of RM100,000. Thus, total
expenses for the car would be RM3,700 a month. Lets assume that your current
take home pay is RM10,000 and your net saving is RM3,000.
So what are your options for changing your current situation to make this goal a
reality? In this particular case, you have to either plan to increase your income or
reduce your monthly expenses. Of course, it is always better to increase your
income level should you have the means to do so. You may take up a part-time
teaching job or get involved in direct marketing to earn extra income or even
invest your savings more aggressively to achieve higher rates of return. Besides,
you could decrease allocations to various expenses and shift more of your
monthly income to savings for your car purchase fund. For instance, you may
also reduce eating out to two times a month instead of eight times a month, limit
purchases of new clothes and delay other short-term goals such as buying a 55
TV and sofa set.
You may use the following form to evaluate your alternatives. For each financial
goal, you may identify and evaluate up to three strategies. So, which action is the
best for you? The answer is: it depends on an individuals situation and the effort
one is willing to invest in order to achieve his/her goals. Adequately evaluating
each of your options can help to ensure you select the best course of action to
accomplish your financial goals. Table 7.4 shows the goal strategies worksheet
which can help you with this.
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Monthly Cost:
Strategy 1:
Pros:
Cons:
Strategy 2:
Pros:
7.3.4
Cons:
Formulating your financial plan will require you to make decisions as to which
goals to pursue and the most appropriate strategy to achieve them. The decisions
must be weighed in terms of your current financial situation and practical
projection of your future financial needs and situation. Without these, your
financial goals will be unrealistic and may not be attainable in the desired time.
In particular, developing the plan should cover various areas, such as insurance
plan, retirement plan, debt plan, saving and investment plan, education fund
plan, tax plan and many others, according to your financial goals and strategies
set in the previous step.
As to the insurance planning, many people believe that insurance policies should
be purchased as soon as possible and the higher the coverage, the better it is.
However, this is not always the case. Earlier and higher insurance coverage will
cost you a higher premium, where the money should be invested to generate
more passive income. The ideal situation is where you only take up an insurance
policy that you really need and can afford to pay for. The time and coverage
should depend on your need. Therefore, needs analysis for insurance products
must be done according to your current and near future financial situation before
purchasing the insurance policy.
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7.3.5
Financial planning is a dynamic and on-going process. It does not end after
implementing a particular strategy. You have to regularly assess your financial
decisions. You should do a complete review of your finances at least once a year
to identify the root cause of deviations and take necessary follow up actions.
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Your financial goals may change over the years to reflect changes in your lifestyle
or events, such as an inheritance, birth, death, marriage, divorce, house purchase,
investment and change of job status. As a result, your plan may not be sufficient
to achieve the new goal and may require adjustment to assist you in meeting the
new goals. While owning a car may not be a priority now, it may be a goal you
have later. As current goals wane from your list of priorities and you develop
new goals, your plan will have to change to help lead you towards achieving
your new objectives.
Additionally, no matter how carefully you strategise and implement each of the
steps in formulating a financial plan, or no matter how perfect your plan is,
unforeseen circumstances will still occur. Changes in the stock market, inflation
rate and interest rates may also affect your income and expenses, which in turn
alter financial planning results. All these circumstances may prompt you to
revise your plan to achieve financial goals.
Remember, be objective when reviewing and revising your plan from time to
time to ensure you are on the right path towards achieving financial success.
In the preceding sections we have discussed the five steps in devising an effective
personal financial plan. Though it is easier said than done the key to your success
is perseverance. You have to plan and take action as early as possible to ensure
you reap good financial rewards. It is also never too early to start financial
planning.
SELF-CHECK 7.1
What is the keyword you would use to remind yourself to implement
all the five steps of personal financial planning effectively?
7.4
Living your life is essentially about making smart choices, whether it is choosing
a career, or buying a car or house. Making smart choices requires that you plan
ahead, be informed about what is available in the market and avoid impulsive
decisions. You would have gained a lot of ideas about planning your finances
and managing your money in the earlier parts of this topic. You will need to
practice these steps in living your life.
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Your Career
Like most people, you will need a job after you graduate. This job will be the first
of many work experiences you will have that eventually shape your career.
Irrespective of what you choose todo in life, develop an interest inyour field
and make sureyou love and enjoy your job. It is better if what you do at work is
something for which you have the necessary aptitude or talent. If you dislike
mathematics, do not force yourself into a career in accounting. If you enjoy
dealing with people, maybe a career in sales and marketing is for you.
(a)
(b)
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If you do not pay back your student loan, it may hamper your chances of
working for a good employer. You may also have a problem in getting
financing from financial institutions later. This could potentially delay you
from achieving your life and financial goals.
(c)
(ii)
Commissions;
(iii) Bonus;
(iv) Gratuity;
(v)
7.4.2
Buying a Car
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Assuming that you have decided to buy a car, you then need to decide whether
to buy a new or used car. People often think that it is better to buy a new car
because the maintenance costs would be lower than a used car. That may be true
but a new car can also have its problems and the depreciation of a new car is
higher.
In order for you not to overstretch your financial resources, buy a used car that is
in a good condition or a new car with an affordable repayment amount. After all,
you only want to get from A to B conveniently, safely and in comfort. More often
than not, you do not need to have a flashy or expensive car to impress others.
You can buy your dream car later when you can afford to pay for it. Thus, a
financial plan plays an important role in buying a car.
The following are some useful tips in buying car:
(a)
Shop around for a car that is reliable. You must be aware that some car
makers focus on building cars that are fun to drive and performance
oriented. Others stress on reliability and fuel efficiency. Thus, you have to
study the strengths and weaknesses of your targeted or preferred car
makers before deciding on the brand and model. You should choose a
reliable car because it is normally more cost effective in the long run. If you
decide to buy a used car, get a trusted mechanic to examine the car first.
(b)
Work out the budget based on your monthly salary. Take into account the
monthly car instalments, monthly running costs such as petrol, toll and
parking fees, annual expenses including road tax, insurance and regular
service, as well as unexpected expenses to cover any repairs to the car in
case of a breakdown or an accident.
(c)
If you decide to apply for a car loan, shop around for a package based on
affordability. It is always good to buy the car with cash if you have the cash
on hand and other important goals have been fulfilled and you cannot get
higher returns on the cash on hand with a reasonable risk level. However, if
using cash is too much of a burden, try saving more cash for the down
payment and apply for a smaller loan. Always ask about the interest rate.
Do not be impulsive when buying a car that would have long-term effects
on your financial health.
(d)
Do not use your credit card to pay for the down payment. You are not
being wise because you will be getting yourself into a loan with higher
interest rates. Effectively, you are spending your future money to pay the
hefty interest on it.
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(e)
Try to pay for petrol, annual road tax, insurance and car maintenance with
cash instead of using your credit card so that you can feel the price that you
are paying.
(f)
Avoid upgrading or modifying your car with a sound system, better tyres
or additional accessories. These will not add value to your car. It is always
wiser to invest your money to gain passive income instead of spending it
on unproductive matters.
Owning a car is not cheap. Before you buy one, make sure that you can afford to
own and maintain it!
SELF-CHECK 7.2
What is the key factor in determining your car purchase from the
personal financial perspective?
7.4.3
Buying a House
Buying a house ranks at the top of the financial decisions you will be making in
your adult life, mainly because of the costs involved. The first house that you buy
is usually for you to live in. Why should you buy a house instead of renting one?
By buying a house, you will increase your net worth as you pay down your
housing loan. Owning your own home will also bring a sense of pride and
accomplishment. Not only is there more freedom with house ownership, there is
also a greater sense of security in having a permanent roof over your head.
(a)
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(i)
(ii)
(iii) If you find that you are not thrilled with your new neighbourhood,
you may find yourself stuck until the value of your house increases
enough to get back your initial investment. This can be avoided if you
have done a proper study. For example, you can rent a unit in the
target housing area or condominium for a short period before
deciding to buy.
(iv) Once you become a home owner, anything can happen to
unexpectedly bring down the value of the house your area may be
prone to floods during the rainy season or a highway may be built
close by several years later. If you rent, you can just pack your bags
and move.
When you rent, you can have freedom of movement. However, when you
own a house, you will have a sense of financial freedom.
(b)
(ii)
Check the area for features that can add value to the house, such as
schools, shops, a park and playground, public transport and
surrounding businesses. Watch out for conditions that may make the
area economically disadvantaged.
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(ii)
Because property is not liquid (i.e., it cannot be sold quickly) will this
be a problem for you when there is a need for cash?
ACTIVITY 7.3
Do you prefer to own or rent a house for your own use considering
your current financial situation?
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7.4.4
Marriage is a big commitment and should be entered into only if you feel capable
of handling the responsibilities. With the romance come the real issues, including
finances.
(a)
The Wedding
Be realistic about your wedding expenses. You will be surprised at how
much gifts, ceremonies, dinners, clothes, shoes and wedding photos can
add up to.
Like in other aspects of your life, have a budget. List the things that are
necessary for the wedding. Discuss with your spouse-to-be on how much
money you can afford to spend. Get tips and advice from those who have
been through it all on how to spend wisely for this important occasion.
Do not try to live up to the expectations of other people by going to the
extent of borrowing from family members or friends, or even from the
bank, to pay for your wedding. In fact, you should have been saving for
your wedding as part of your overall financial plan. There have been many
cases of couples encountering problems due to the large debt incurred
during their wedding. Very often financial problems lead to other
difficulties.
(b)
(ii)
Decide on how to handle routine bills, paying for the family and
children, household budgeting, as well as savings and investment;
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(vi) Talk about each others investment style, including your respective
risk appetites and preferences. It is wise to have a common
investment portfolio to meet future financial goals, such as retiring
together and living a comfortable life. These investments are also
usually used to pay for your childrens living and education expenses;
and
(vii) You may need to increase your insurance coverage to include
different types of policies, such as life insurance, critical illness
insurance, medical insurance and personal accident insurance.
(c)
Financial Debts
This may sound harsh but do discuss with your intended spouse the debts
that you will bring into the marriage, if any. You should make a
commitment to settle personal debts within a period of time after the
wedding, if those debts cannot be paid off before getting married. Should it
become necessary to apply for a loan or even a credit card once you are
married, you will need to discuss your ability to pay for that new debt
commitment. Both of you must agree on the terms of payment and period
to settle the debt. You should not hide from each other the topic of debt.
Some marriages are reported to fail due to financial debts incurred by
spouses.
(d)
Financial Check-up
It is a healthy practice for a couple to prepare a monthly budget and
spending plan, and track spending at least once a weekusing a family cash
flow statement. The familys net worth (assets and liabilities) should then
be reviewed monthly.
You must review the household financial commitments and net worth
every month. Make it a monthly affair and a fun exercise to do together.
Talk about positive ways to improve the household financial commitments,
find creative ideas and reasons to grow more money for each other and
your family.
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7.4.5
Your Retirement
You are never too young or too old to plan for retirement. The earlier the better,
but it is also better late than never. Nonetheless, it is desirable to inculcate the
saving habit at a young age. In fact, saving should be part of your lifestyle. It is
wise not to rely solely on your EPF as your retirement fund because you may not
have enough in your account to provide you with a comfortable lifestyle after
retirement. This is becoming more common due to the high inflation rate.
Young adults normally do not think they are going to retire one day. Retirement
is difficult for people of all ages. Even people in their 40s do not want to face the
prospect of retirement. They have obligations, for example, the house, the
childrens education, the parents health care and 1,001 other things to take care
of first.
There is also the fear of the unknown. Not knowing what will happen to you
when you are old may sometimes prevent you from taking stock of your
financial welfare. You prefer to live for now rather than plan for the future.
Perhaps you are afraid of being told that you are not on track when you start to
plan for your retirement fund. You know that you have spent too much money,
your income-earning ability is not improving and you are not able to increase
your savings.
If you start saving as soon as possible, you will be in better shape than you might
expect. If you have been regularly saving some money and cultivating saving
habits, you will find it empowering for your personal self-worth. By saving early,
you may find that you have enough to enjoy some of your money even before
you actually retire.
ACTIVITY 7.4
When is the best time to plan for your retirement?
(a)
(ii)
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How many years do you have until retirement to earn your money?
After analysing your current assets and liabilities, estimate your spending
needs and adjust them for inflation. Then decide when you want to retire
at age 45, 55, 60 or 65? Calculate the monthly retirement income needed for
your desired retirement lifestyle. Your retirement planning should include
debt reduction, budgeting, diversifying investments and, believe it or not,
maintaining good health through diet and regular exercise.
The question of health is vital during old age. Health costs can be a major
expenditure and a drain on retirement savings. Even if you have medical
and life insurance which cover critical illness and disability, this may not
include all the procedures and prescriptions that you need to have.
Sometimes certain illness are only partially covered or not at all covered
under insurance benefits. Therefore, adequate retirement planning has to be
done for maintaining and living a healthy life.
(b)
Retirement Timeline
(i)
Sign up for EPF on your first day of work. However, due to inflation,
the money you will have in your EPF may not be enough for your
retirement. Create a personal retirement account by opening a savings
account with the bank and start saving at least 10% of your disposable
income.
(ii)
(iii) Ear mark a portion of each raise or yearly bonus to your retirement
savings. Make sure you provide in your monthly budget the amount
of savings meant for retirement.
(iv) While you are saving for retirement, review your investment portfolio
for retirement annually to ensure that your money is growing
according to your retirement plan.
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7.4.6
A Balanced Life
Personal financial planning is very important for every individual who wants
to achieve financial success in life.
There are five steps in devising an effective personal financial plan. Though it
is easier said than done, the key in achieving success is perseverance.
You need to have strategies for living your life with the help of personal
financial planning.
Career planning is important so that you can increase your incomegenerating capability.
Buying a house is a major financial decision. Weigh out the benefits of renting
versus buying a house.
You and your spouse must be willing to frankly discuss financial issues,
draw up a financial plan and achieve it together.
You are never too young or too old to plan for retirement.
Work towards having a balance in your life, where money is not the sole
reason for your existence in this world.
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Affordaability
Fin
nancial successs
Balanceed life
Neet worth
Career planning
p
Reetirement plan
nning
Financiial happiness
Weealthy
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Financiial planning