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Personal Financial Planning of a Common Citizen - Essay Example

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This essay "Personal Financial Planning of a Common Citizen" deals with the concept of financial planning. As the author puts it, the proper financial planning from the right age would also assist a person in fulfilling his other dreams and commitments…
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Personal Financial Planning of a Common Citizen
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Personal Financial Planning Table of Contents Introduction 2 The Scenario 3 Requirements 4 Investment Avenues 4 Financial Planning 7 Conclusions 11 References 12 Bibliography 13 Introduction People work hard all his life to live better. The definition of better living can vary from person to person. For some it might be the social status, for others it might be holidaying at world famous sites or partying with near and dear ones. There are innumerable such options. The one common thing among all the options is that to experience one or the other, the person needs money. This is the basic reason why people work so hard. Such requirements are felt more when the person is old enough to take the professional load he used to take in his youth. As he would not have any regular inflow of money as with age he would retire from the profession he was into, he needs to save and plan for future, which would take care of his old age. Though at the old age citizens are entitled to state sponsored pensions still having own money would definitely help them with greater mental assurance to fight the diseases and illnesses which invariable comes with age. Also, the proper financial planning from the right age would also assist a person in fulfilling his other dreams and commitments like those of education of family members and purchasing of house, etc. The Scenario Jeff, aged 55, works at building trade sites for last 39 years. He started to work at the age of 16 and has earned enough to pay off his mortgages. Jeff is married to Amy, a home maker. The couple has two children. The first child of Jeff and Amy is Kylie (29) who is married (to Jake) and has two children, of three years and eighteen months old. The other child of Jeff and Amy, named Phil is 26 years old and is still single. Jeff earns a decent sum of £ 24,000 per annum for last five years. The standard of living of the couple is much simpler and only major indulgence of the aged pair is that they smoke around 20 cigarettes per day. Jeff had been trying his luck by purchasing lottery tickets for last ten years or so but without any fruit. But at last luck supported the man and he have own a considerable amount of £ 750,000. The cheque has just reached him and he wants to have proper financial planning for future with the sum he has received as the winner of the lottery. The few of the major considerations for Jeff in his financial planning are as follows: Pension plan Investment for the purpose of education of his grandchildren Contribution towards children Savings and family holiday Requirements Jeff hopes the amount that he have own in the lottery would be able to take care of his needs. The objectives of Jeff includes to receive a decent sum of pension during his period of retirement (approximately around £ 25,000 per annum and that should also be inflation proof) and to make contributions towards the education of the children of their daughter. Also, the couple wanted to make some contribution towards their children. Jeff has further plans to visit and holiday in Disneyland once Phil is married and has children. To meet all the requirements, Jeff has to divide and allocate his resources in such a way that all these requirements are successfully taken care of. There are many avenues and channels of investment. The chosen avenue for Jeff should supplement his need efficiently so that his requirements are met and purpose served. Investment Avenues There are various channels of investments where a person can invest to secure his future. Some of them include: Shares – One of the strongest avenues that have come up in the recent time for investors is the capital market. The reason of huge popularity for the capital market investments is because of the regulations and transparencies in transactions in the stock exchanges of modern times. Till recently the stock market has been huge revenue generating avenue for the investors but with credit crunch taking the toll of the financial health of the world, it is no more the most preferred avenue for investments. Also, the capital market as produces very high return to the investors, similarly on the flip side, is also very risky in nature. Bonds – Bonds are long term loans that the investors provide to the companies for a certain rate of interest. The individual investors provide loan to the companies and there fore it is less volatile than the capital market as the companies commit to pay interest at a particular rate of interest. Also there are many bond rating agencies like Standard & Poor’s, Moody’s and many others which provide rating to the bonds with respect to its credibility and paying back probabilities. Debentures – One can also use debentures as the medium to invest. Debentures are a type of debt instrument which does not have any collateral attached with it. The debenture holders provide the money to the debenture issuer i.e. the government or the company, as the case may be. The basic mechanism of the debenture often depends upon the reputation of the issuer as there is no collateral. Mutual Funds – With the boom of the capital market, another avenue that has gained huge popularity is that of mutual funds. Almost all big companies float mutual funds to raise capital from the market. There are several types of funds namely close ended and open-ended, etc. The funds might be based on equity or mid-cap or it might also be based on certain sectors. The individual investor purchases mutual funds on the basis of the net asset value of the fund. If the NAV goes up, he makes profit and if it goes down, it is his loss. In case of mutual funds, the investor can only choose the sector or the fund and the particular share is selected by the fund manager. In this way, the investor can leverage fund manager’s professional acumen and earn high returns. Fixed Deposits- Fixed deposits are another type of investment avenues which has a fixed maturity period. In the case of a fixed deposit, a certain sum of money is invested with an in plan which provides a specified rate of return at the end of the maturity period. The rates of interest attached with a fixed deposit plan are relatively lower as the money is assumed to be secured under this plan. Deposits in Post Offices – Deposit in post offices are often meant for the smaller investors or retail investors. One can also plan to use this channel as the investment option to increase his wealth. Life Insurance Schemes – Life insurance schemes are very popular as well as very efficient source of investments. Life insurance policy provides assurance for one’s life as well as assists him to maximise his wealth. Life assurance policies can be categorised in to two types namely the traditional and the unit linked insurance plans. The traditional plans generally have long maturity periods and lesser returns. Also the risk attached with such policies is less. On the other hand, the unit linked insurance policies are linked with the capital market. It is of recent nature. Though the probabilities of earning higher returns are there with ULIPs but simultaneously the returns the risk involved with such investments are also more as the money is invested in the capital market. Pension Schemes – As it often happens in case of the employees of private sector companies that there is no pension plans attached with the terms of employment (which often renders the employees without any steady inflow of monetary benefits), so there is emerging need of pension schemes apart from the social safety net provided by the government. To cater to the requirement many private financial players have come up with certain schemes which asks the customers to invest certain sum of amount for a certain period so that he is enabled to receive annual (or monthly as the case may be) amount as pension for the rest of his life. Financial Planning The award of £ 750,000 has compelled Jeff to think about the financial planning. Earlier, though Jeff earned a decent sum of remuneration, he did not prioritise to save regularly. To fulfil the dreams and the commitments of Jeff and also to receive the annual pension of £ 25,000 per annum, he needs to plan his windfall revenue wisely. To construct the financial plan for Jeff, it is assumed that his present annual income is spent as usual i.e. he does not bother to invest any amount out of it and spends normally. There fore the amount upon which financial planning is to be prepared is £ 750,000 that he has earned as the capital gain. According to the tax laws prevalent in United Kingdom for the purpose of capital gains, 40% is to be charged over and above £ 34,600. This calls for hefty amount as £ 286,160 is paid to the government as tax (HM Revenue & Customs, n.d.). The residents of United Kingdom are also entitled to receive state pensions. The age of being eligible for the state pension is 65. But as Jeff wants his pension to commence from 60 years of age, it is advised to him to invest with one or the other private financial players. As in the retired phase of his life he would not have any other stable cash inflow of funds, it would be better on his part to invest as more as possible. Though the exact amount to be invested to get the specified sum of pension can never be ascertained in absence of the time period or the rate of pension, etc, it would be wise for Mr. Jeff to invest more than the half of the available amount as one time contribution towards the pension fund. The rate of inflation of 2% should also be taken into consideration for the purpose as the pension amount that is to be received has to be inflation protected. So, even if not more at least one-half of the amount (i.e. £ 214,620) should be invested in the pension fund. The second objective of Jeff is to provide assistance for higher education to his grand children. It is a long term plan as his grand children are kids of three years and eighteen months. There fore, Jeff has approximately more fifteen to eighteen years before the money is required. Present expenditures of higher education in United Kingdom ranges in between £ 12,000 to £ 15,000 (UB Graduate School of Education, n.d.). It is expected to rise in future to at least three-fold to four-fold in the time frame of fifteen to eighteen years. Jeff might use the children insurance plan for the purpose. This would enable to get the life of his grand children get assured and after completion of the maturity period. There are also other similar options available to Jeff. He can go for the money back schemes. In such schemes, the assured (or the proposer i.e. Jeff) pays premium annually. And after regular interval of certain specified time period (generally four – five years), the beneficiary receives certain sum of money from the issuer or the insurer. It helps to satisfy the needs of that time period. If Jeff is ready to undertake a bit risky venture, he would also opt for the close-ended mutual funds. As there is time span of around fifteen years when the money would be required, so Jeff can expect to fetch a considerable return from the mutual funds industry. With most probability, top funds like Fidelity or Prudential would not let him down. But then again mutual fund industry is subject to market risk and there is no surety to earn any specified return. It would be advisable for Mr Jeff to allocate 20% of the amount available to the purpose of the higher education of his grand children irrespective of the channel he prefers. Also Mr. Jeff has been planning to visit Disneyland with the entire family once the baby is born. Now it would take at least a few years to get Phil married and get the baby born. For the purpose of Disneyland, Jeff might allocate 15% of the available funds. Out of the allocated fund, Jeff can invest one-half in the stocks of the blue-chip companies. Investing in the capital market is risky but again it generally fetches higher return for the investor. Therefore, the other half of the allocated fund can be invested in the debt market or the bond market. In order to do so, Jeff can take maturity period to be 5 years. Such investment would help him to reduce the risk that he incurs by investing in the capital market. In addition to all these consideration, Jeff also plans to pay-off the mortgages of his children and assist them financially. He also has a certain sum to keep as his savings and cash at bank or cash in hand. After providing for the factors like pension, education of grand children and proposed tour to Disney, he has 15 % of the fund left. To pay off the mortgage of his children, Jeff can allocate 10% of the available funds. It is presumed that the children of Jeff would also earn a decent sum of money as their salary. Therefore, the amount that Jeff is willing to pay would purely be contributory and not obligation. The sum with most probability would augment the financial help to his children. It would be wise for Jeff to allocate certain sum of money for his immediate unforeseen needs. The need might arise because of certain medical problems of near and dear ones or it might be because of any other reasons also. To supplement such situations, Jeff should allocate at least 5% of the available fund (after deduction of tax). He should try and keep the money in his savings account as cash at bank so that he can withdraw the amount on urgency. Conclusions Financial planning is very crucial for the citizens whatever being his profession be it business or service. As it happens in case of service holders, they generally earn a specified amount of money at the end of a particular period. Financial planning is therefore important for the service holders as they do not have any extra source of income to supplement their needs. So they have to plan their resources efficiently. Similarly, in case of business persons or professionals also, financial planning holds supreme importance because they do not have any confirmed source of income for all the time so that they can maintain and improve their standard of living. Jeff has won a huge sum of money as windfall gain which was unforeseen. So the onus lies on Jeff to allocate and utilise the amount wisely so that he can fulfil his wishes of earning a decent sum of pension, contribute towards the higher education of his grand children and pay-off the mortgages of his children. Also, the dream of visiting Disneyland with the entire family would come true with financial planning. But as it happens in the external environment of finance and economy, always a certain degree of risk is attached with the expected returns. The change in rate of tax and inflation might change and jeopardise the planning. Still, financial planning is necessary and should be dealt with due importance. References HM Revenue & Customs, No Date. Capital Gains Tax rates and annual tax-free allowances. Capital Gains. [Online] Available at: http://www.hmrc.gov.uk/rates/cgt.htm [Accessed 1 July 2009]. UB Graduate School of Education, No Date. Higher Education Finance and Cost Sharing in the United Kingdom. The State University of New York [Pdf] Available at: http://www.gse.buffalo.edu/org/IntHigherEdFinance/files/Country_Profiles/Europe/United_Kingdom.pdf [Accessed 1 July 2009]. Bibliography Inflation Report, No Date. Publications. Bank of England. [Online] Available at: http://www.bankofengland.co.uk/publications/inflationreport/index.htm [Accessed 1 July 2009]. State Pension, No Date. How Much Will I Get? The Pension Service. [Online] Available at: http://www.thepensionservice.gov.uk/state-pension/basic/how-much-will-i-get.asp [Accessed 1 July 2009]. Read More
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