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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
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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
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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
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What is Personal Financial
Planning? continued
• To be realistic a goal needs 2 components
– Specific or quantifiable
– Referenced to a specified time frame
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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
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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 person’s life cycle, lifetime
income is quite uneven
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Income and expenditure
Why is Personal Financial
Planning Important? continued
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• 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
Why is Personal Financial
Planning Important? continued
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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)
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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
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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
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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
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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%
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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
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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
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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
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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
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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
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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
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Financial Literacy
Foundation continued
• Foundation to date has promoted its
activities via:
– Media campaigns – Interactive website
– Education programs
– Conducting research
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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
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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
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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
Understanding Risk continued
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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 continued
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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
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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
Understanding Risk continued
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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
Understanding Risk continued
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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
Understanding Risk continued
F f h E i
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• 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
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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
F f h E i
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Features of the Economic
Environment continued
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
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Features of the Economic
Environment continued
• 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
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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
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History of the Financial
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
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• 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
History of the Financial
Planning Industry continued
Hi t f th Fi i l
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• 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
History of the Financial
Planning Industry continued
Hi t f th Fi i l
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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
History of the Financial
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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
History of the Financial
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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
History of the Financial
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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
History of the Financial
Planning Industry continued
Origins of the Global Financial
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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…
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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.
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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
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Corporations Act 2001
• Licensee’s obligation to monitor and
supervise representatives to ensure
compliance• Representatives must be adequately
trained and competent
• ASIC RG 36
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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
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‘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.
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• 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
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• 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
Corporations Act 2001 continued
Financial Services Reform Act
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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
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Financial Services Reform Act
(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)
Financial Services Reform Act
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• 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
Financial Services Reform Act
(FSRA) 2001 continued
Financial Services Reform Act
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• 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
Financial Services Reform Act
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• 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
Financial Services Reform Act
(FSRA) 2001 continued
Financial Services Reform Act
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• 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
Financial Services Reform Act
(FSRA) 2001 continued
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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
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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)
Statutory Complaints
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• FICS acts as an external dispute handling body
for specified complaint types (including
monetary limitations)
Statutory Complaints
Resolution Schemes continued
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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
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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
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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
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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
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Summary continued
• Both financial planners and investors
need to understand the risks involved
and the economic and legislativeenvironment
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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.
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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
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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
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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