Chapter 1

PowerPoint presentation by Lindsay Cowling Holmesglen Institute 2011 John Wiley & Sons Australia, Ltd

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 time frames:
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 these objectives Has its roots in life cycle theory of consumption and saving

Why is Personal Financial Planning Important? continued

Life cycle theory provides a framework to meet short, medium and long-term objectives While consumption is relatively smooth over a persons life cycle, lifetime income is quite uneven

Why is Personal Financial Planning Important? continued

Income and expenditure

Why is Personal Financial Planning Important? continued

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 Australian population is the size of the baby boomers group (born 1945-60)

Increasing Numbers in Older Age Groups continued

By 2050, it is expected that Australia will have 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 expectancy was 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 for regular 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 employees remuneration From 2003, employers have had to contribute 9% of employees remuneration Government presently contemplating an increase to 12%

Compulsory Superannuation Contributions continued

Tax deduction offered as encouragement for self-employed people to also contribute towards their own retirement Recent legislative changes have further increased attractiveness of accumulating a higher superannuation balance 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 are paid 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 has changed 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 financial decisions

Role of Financial Counsellor

Financial Counsellor provides range of free public services Seeks to contribute to community education 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 relevant financial information Operates in partnership with industry, education bodies and community organisations

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 persons objectives, investments and time frame

2. Inflation risk
Real value of investments are eroded over time

Understanding Risk continued

3. Interest rate risk
Reinvestment risk
When fixed assets mature, must reconsider current interest rates

Market volatility
When fixed-rate investments are sold the full value of investment may not be realised this will occur if market interest rates rise during the holding period

Understanding Risk continued

4. Market risk
All markets have ups and downs Some markets are more volatile than others over a specified time frame

5. Market timing risk

Very difficult to choose when to enter and exit the market in order to maximise returns

Understanding Risk continued

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

Understanding Risk conintued

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 continued

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 term deposits, debentures, mortgages and bonds

Understanding Risk continued

10. Legislative risk
Governments can make changes to current laws and regulations Change in legislation may have either a favourable or unfavourable effect on investors previous decision

Understanding Risk continued

11. Gearing risk
If an investor borrows money to invest, the loan must be repaid regardless if the underlying investment decreases in price Regular loan repayments not tied to returns provided by the investment

Features of the Economic Environment

The business cycle recession, recovery, boom, expansion Greater economic volatility pre 1990, sustained expansion 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 policy and Chinese demand for our resources

Features of the Economic 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

Features of the Economic Environment continued

3. Recession
High unemployment Low (and possibly negative) economic growth

4. Recovery
Unemployment begins to fall Economic growth starts to rise

Features of the Economic Environment continued

Both monetary and fiscal policy to manage the local economy Monetary policy is conducted via controlling the money supply which in turn impacts on interest rates Fiscal policy involves government intervention in the economy via taxation and spending policies

History of the Financial Planning Industry

Historical Developments
198083 1983 1985 1986
5% tax on superannuation payouts Double dipping: pension plus lump sum Rollover funds introduced Capital gains tax (CGT) introduced Fringe benefits tax (FBT) introduced

History of the Financial Planning Industry continued

1987 1990 1993 1998
Double taxation ceased with the introduction of dividend imputation and franking credits Simplifications to reasonable benefit limit (RBL) rules Superannuation guarantee introduced Life expectancy policies introduced

History of the Financial Planning Industry continued

2001
Attribution rules for pensioners commenced

2004
Allocated pensions introduced Reduction in calculation of assets under social security asset test for age pensions

2005
Member choice of superannuation fund introduced

History of the Financial Planning Industry continued

2006 Announcement of Simple Super rules to apply from July 2007 including transition rules having effect prior to July 2007 2007 Focus of introduced Simple Super rules to encourage self reliance and maximise accumulated superannuation benefits Further relaxation of social security asset / income test provisions for age pensions

History of the Financial Planning Industry continued

Economic Changes
1987 share market crash 1990 property trust freeze 1991 Pyramid Building Society closure 1992 Japan share market crash 1994 bond market crash

History of the Financial Planning Industry continued

Economic Changes
1997 Asian crisis 1998 Ralph Report April 2000 share market jitters 1 July 2000 Goods & Services Tax 2001 World Trade Center disaster

History of the Financial Planning Industry continued

Economic Changes
2001-02 corporate collapses 2002 falls in world market shares 2004 share markets rebound 2004-05 tsunami impact

History of the Financial Planning Industry continued

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 Crisis

US banks mispriced risk, lending standards fell US merchant banks parcelled up mortgages into Collateralised Debt Obligations (CDOs) 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 wide range regulations and controls. The table below lists the main legal 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 Financial Services Reform Act 2001

Corporations Act 2001

Licensees 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 products and financial services advice industry which defines the capacity in which a person 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 make every effort to understand the clients investment objectives, financial situation and particular needs.

Corporations Act 2001 continued

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

Corporations Act 2001 continued

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

Financial Services Reform Act (FSRA) 2001 continued

Objectives are to:
Promote confident and informed decision making by consumers of financial products and services Reduce systematic risk and provide fair and effective clearing and settling facilities

Various licensing regimes including Australian Financial Services Licence (AFSL)

Financial Services Reform Act (FSRA) 2001 continued

AFSL required by people who provide financial services Representatives act under the licence of the principal ASIC issues regulatory guides as basis for interpretation of the legislation

Financial Services Reform Act (FSRA) 2001 continued

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

Financial Services Reform Act (FSRA) 2001 continued

FSRA requirements of principals:
Monitor and supervise competent and trained representatives Sufficient financial, technological and human resources Possess relevant competence, skills and expertise ASIC-approved dispute resolution processes Adequate risk management systems and compliance measures

Financial Services Reform Act (FSRA) 2001 continued

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 Investments Commission Act 2001

Statutory Complaints Resolution Schemes

Structures which regulate complaints and potential disputes with clients are: Internal complaints-handling mechanisms for superannuation funds The Superannuation Complaints Tribunal The Life Insurance Complaints Service The Financial Industry Complaints Service (FICS)

Statutory Complaints Resolution Schemes continued

FICS acts as an external dispute handling body for specified complaint types (including monetary limitations)

The Role of ASIC

ASIC is Australias corporate, markets and financial services regulator ASIC contributes to Australias economic reputation and wellbeing by ensuring that Australias financial markets are fair and transparent, supported by confident and informed investors 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 out most of its work under the Corporations Act

The Role of ASIC continued

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

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 about setting in place some personal objectives and arranging financial means to satisfy those objectives Need to prepare personal budgets, often utilising services of financial counsellors to assess current financial position and to plan for future personal financial objectives

Summary continued
Both financial planners and investors need to understand the risks involved and the economic and legislative environment

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 its members 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, high professional standards and must meet continuing professional education requirements.

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

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 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