6. Financial Planning + Infomed Choices

Question 1

How long can a short term plan be?

Answer 1

• might run over just one year - e.g. a plan to have enough money available every year for a summer holiday
• might be a monthly or weekly plan - e.g. have enough money from the monthly or weekly income to pay bills over that period

Question 2

How do short term impact medium/long term?

Question 3

How long are medium term plans?

Answer 3

• can be achieved fate a few years - e.g. someone saving up for a car might put money aside over three years + then plan is achieved
• but most likely the person will start saving up for something else so there will be a new medium term plan, or might begin before the end of the first plan

Question 4

When do people use medium term plans?

Answer 4

• for different wants and different stages of their life cycle
• E.g. when they are young they might be saving for a college course/uni
• Middle age - saving up to build a house extension
• Late middle age - saving for a holiday

Question 5

How long can long term plans be?

Answer 5

• longer period of years
• E.g. buying a home + saving for retirement

Question 6

Mortgage as a long term plan

Answer 6

• paying back a mortgage - normally 25 year period + borrowers have to meet repayment obligations every month
• This obligation affects their short term + medium term saving since the mortgage payments leave them with less money to save or spend on something else
• This plan spans from young adulthood up to early or late middle age

Question 7

Saving for retirement

Answer 7

• very long term plan + could span working life of 40-50 years
• People therefore budget for this at all stages of their working life
• If someone is paying into a personal pension plan, they must make sure they have enough money each month to meet the instalment
• If they are paying into an occupational pension via their employer, then this pension contribution will be deducted from their monthly salary + they will receive their income net of this payment - don’t have a budget but it does mean they have less to spend on other things or to save for short term

Question 8

How should someone make an informed choice?

Answer 8

• look carefully at their wants + aspirations
• At their position of risk/reward spectrum
• Risk/reward spectrum of product
• Take financial advice if possible before proceeding

Question 9

Importance of knowing wants and aspirations

Answer 9

• topic 1
• Customer needs to consider why + to what extent they want to buy a financial product - their wants + aspirations

Question 10

How does the risk/reward spectrum of the customer affect choice?

Answer 10

• depends on their personality, their financial position, and their age
• May vary according to the stage they have reached in the life cycle
• Also differ according to nature of a life event - e.g. someone who needs money quickly in an emergency is less likely to consider the risk of borrowing funds

Question 11

How can a person identify risk?

Answer 11

• impact, severity + probability - topic 4
• Calculated by looking at the joint effect of the probability of the risk happening + the impact + severity of the that risk of it does occur
• They can then choose a product that carries the amount of risk appropriate to their attitude + situation

Question 12

What causes people to get into financial trouble?

Answer 12

• one of the reasons is that they are not aware of the impact a particular loss might have on their financial position + are therefore unable to manage that loss if it happens

Question 13

What can impact how much a person is prepared to risk?

Answer 13

• closely linked to how much they are prepared to lose
• Someone who chooses a savings account in a trusted bank knows they will receive a low interest rate but this is balanced in their mind by their belief that their money is safe - they give up a higher return for peace of mind
• Someone who chooses a riskier investment has a different view on balance between risk and reward - they do not want to lose their money but are prepared to take a higher risk for a chance of a higher reward

Question 14

Spectrum of willingness

Answer 14

• people who want safety + accept low return at one end
• people who want to earn a high reward + accept a high risk at the other end

Question 15

What determines where someone is on the spectrum of willingness?

Answer 15

• their personality - some people are natural risk takers + others have a more cautious approach to life
• The amount of money that have in disposal - some with very little money can’t afford to lose any of it - more likely to be risk averse, someone who is very rich might be prepared to risk a certain amount of money for the chance of a high return - the amount might not mean they mich to them
• Stage of the life cycle they are in - other things being equal, young people are more willing to take a risk + older people are more risk averse

Question 16

Why does life cycle have an impact on choice?(young)

Answer 16

• young single person with no dependents might be willing to take quite a big risk in order to have the chance of gaining big rewards - depending on their personality, as they have more time at their disposal to build up their capital if they make a loss
• They also have more time to give an investment product a chance to make a gain - if the stock market falls after they buy the product but they are willing to hold onto it, the market may rise again + they can recoup their original loss

Question 17

Why does life cycle have an impact on choice? (Middle aged)

Answer 17

• Middle aged married people with dependent children
• and have a large mortgage would be more concerned about sustaining a loss
• would probably choose a less risky form of long term saving

Question 18

How does risk attitude impact insurance?

Answer 18

• insurance is a type of risk transfer
• a persons willingness to insure their financial risk also depends on how they feel about risk

Question 19

Risk averse with insurance?

Answer 19

• Those who are risk averse + can afford it will buy as many insurance policies as possible to cover a range of eventualities

Question 20

Risk tolerant with insurance

Answer 20

• Those who are risk tolerant might only buy insurance that they are legally required to have - e.g. motor insurance or they might only insure large items
• E.g. someone who takes out a mortgage might be required by the lender to take out buildings insurance but might vhoose not to buy a payment protection policy to cover the mortgage payments
• They hope they will not become ill or unemployed + have problems making payments - but if they do, they will deal with that situation when it comes

Question 21

What is self insurance?

Answer 21

• they do not ignore the risk entirely but don’t pay for insurance cover from a provider
• instead they save some money so as to have something to fall back on in case the risk does arise

Question 22

What affects the extent to which people practice self-insurance?

Answer 22

• whether there is a legal or operational obligation to insure the risk - e.g. it is illegal to not insure your motor vehicle with third-party insurance
• the cost of the insurance when balanced with risk
• the perception of the degree of the risk
• the ability to access insurance

Question 23

How risky is saving?

Answer 23

• saving is not a risky exercise - it is considered a sensible thing to do as it helps someone to reduce future risk by ensuring they have a lump sum which they can draw on in an amergency
• they will also have a sufficient income when they retired
• some people might consider saving too much is risky because it leaves less money for current consumption

Question 24

What is risk of savings based on?

Answer 24

• based on the fact that a saver has to hand over money to a provider to look after it for them
• they hope they will make a return but there is always a risk that the provider might fail + they might lose their uninsured deposits (if there is over £85,000 covered by the FSCS)

Question 25

Risk of investment products

Answer 25

• greater risk of not earning a return compared to savings + of losing the capita sum altogether but there is also the chance to earn a higher return
• they need to decide what they want from the product - capital growth or income

Question 26

Risk of inflation

Answer 26

• risk that the nominal sum of money saved will be eroded by inflation over the years
• this means the ‘real’ value of the money will fall

Question 27

Risk of borrowing

Answer 27

• always risky because the borrower has to commit to repaying out of their future income, but they can not be sure that they will have enough income over the repayment term to be able to settle the debt

Question 28

Why does the risk of loan products vary?

Answer 28

Varies according to:
- the amount of interest charged
- the possibility of the interest rate rising during the loan period
- the number of years for repaying the loan
- and terms and conditions

Question 29

How to consider the provider’s risk profile

Answer 29

• how safe + stable the provider is
• the reputation it has for good + reliable service
• how it is regulated
• how it can be accessed

Question 30

How can a customer make an informed choice when choosing a product + provider?

Answer 30

1. Consider the strength of their want + aspiration - think about the benefit they will derive from fulfilling it
2. Look at their own risk profile (financial circumstances), consider risk profile of product, consider risk profile of the provider
3. Find out the charges + any penalties, how flexible it is, and the terms and conditions
4. Consider the extent to which it fits with their own values

Question 31

What should be considered to determine if a financial product is suitable?

Answer 31

• the intended purpose - e.g. achieving an aspiration or paying for a life event
• the time scale - medium term or long term
• affordability - taking into account the person’s income + other expenses
• attitude to risk + the risk profile of the product + brand
• how the product fits into overall product mix

Question 32

What is ‘derived demand’

Answer 32

• financial products are examples of ‘derived demand’
• they are not wants in themselves but people buy them because they enable them to achieve their wants
• someone doesn’t want a loan for its own sake but because it enables them to purchase something they cannot afford otherwise

Question 33

Why do people save + invest in the medium and long term?

Answer 33

• they are aiming to spend the money eventually on a particular item or life event
• they want to provide for their own or their children’s future

Question 34

What impacts the amount a person saves?

Answer 34

• income - strong r/ship between income + savings - someone who has a low income is unlikely to be able to save
• amount of current consumption (spending) in their short term plan - since saving means giving up current consumption, the more people consume in the short term, the less they can save in the long term
• the necessity of saving - someone who is desperate to buy an expensive item + cannot access a loan is forced to save up for it over a number of years
• people’s attitudes to saving - some people save over a long period of time because they feel it is a sensible thing to do - for some people this is an attitude + habit learned in their childhood

Question 35

When does someone not need a payment protection scheme?

Answer 35

• if a person is only saving + not borrowing
• they are neither repaying existing debt nor planning to take on a new debt
• but they might use saving schemes

Question 36

Why do people borrow in the medium and long term?

Answer 36

• to finance an item of expenditure that is too large for them to afford now
• or because it would take too long to save up for it + they want to have it now

Question 37

What impacts the amount someone borrows?

Answer 37

• income - determines amount they are able to repay over a given period + also determines the amount a provider is willing to give them
• other expenditure (especially mandatory + necessary items) - the more someone spends on other items, the less they can afford to borrow
• time period of loan - longer the period = more they can borrow + repay
• necessity of borrowing - depends on cost of items relative to their income + the extent to which borrowing is seen as a necessity depends on the nature of the life event or aspirations it is used for
• people’s attitudes to borrowing - some people don’t like the idea of being in debt while others are not concerned about it

Question 38

How does necessity of borrowing impact the amount borrowed?

Answer 38

• depends on cost of items relative to their income e.g. most people cannot afford to buy a home unless they can get a mortgage
• the extent to which borrowing is seen as a necessity depends on the nature of the life event or aspirations it is used for - e.g. financing an operation in a private hospital, or funding a big wedding

Question 39

Why do some only borrow and not save?

Answer 39

• only borrowing + not saving suggests that their monthly income is only just enough to cover their normal expenditure + the repayments on their long term loans
• likely someone that is borrowing has also bought one or more insurance policies - e.g. bought a house or flat with a mortgage, probably have purchased a mortgage protection insurance policy
• may have purchased payment protection as well if they become unemployed or ill
• will certainly have to insure their house + contents too

Question 40

Saving and borrowing at the same time

Answer 40

• many people save + borrow at the same time - therefore have a more complex product portfolio
• they need to achieve a balance between the amount they save + the amount they have to repay on their loans
• if they get into financial trouble, they will give priority to paying the loans so to not lose their property or get a poor credit score

Question 41

What is joint demand?

Answer 41

• means two products are bought together because they are complementary
• the purchase of one product necessitates the purchase of another product

Question 42

Examples of joint demand?

Answer 42

• personal loan to buy a car + motor insurance - demand for personal loan is derived from demand for the car + the law requires the owner to have a third party motor insurance
• fixed term savings bond + instant access savings account - the saver has agreed to leave money in the bond for a fixed number of years but they may also retain a certain amount of money in an instant access account so there are funds they can draw out in emergencies
• interest only mortgage + investment product to cover the payment in capital - customer will pay only interest throughout the term of mortgage but must at the same time buy a long term investment product that is designed to grow + can be used to pay capital sum owed at the end of mortgage
• mortgage to buy a home + personal loan to buy furniture to put in home - having paid the deposit they might not be able to afford the other products unless they take out a personal loan as well - alternatively they might buy these items using a hire purchase or on their credit card

Question 43

Do people use the same provider for joint demand products?

Answer 43

• not necessarily - research might point them towards a different provider
• an individual financial adviser who knows the range of products available on the market might suggest different providers for the various products
• their recommendations won’t only relate to price but also the suitability of product features to the customer

Question 44

What is competitive demand?

Answer 44

• situation in which two or more products fulfil the same need or want + therefore are in competition with each other for customers money
• the purchase of one products excludes the purchase of another

Question 45

How are savings + borrowing products competitive demand?

Answer 45

• may appear to be different product types + therefore have no relationship but there actually a negative relationship
• based on the fact that every product competes for limited resources of consumers
• a person who is intent on saving in the medium or long term has earmarked a certain amount of money to put away each month - the same money can not be used to repay a loan
• the equal + opposite also applies + someone who is repaying a loan can not save money spend this way

Question 46

Competitive demand of different types of products under the same product heading

Answer 46

• the difference between products can be large or small
• e.g. some are saving + some are investments - they therefore have different levels of risk + different time periods
• the products have different maturity dates, interest rates, terms and conditions
• providers try to increase the amount of competition between products by means of product differentiation- they find ways of making one brand look different from others
• some financial products have ‘add-ons’ to make the product look more attractive

Question 47

How are different product brands under the same product heading being offered for sale by different providers?

Answer 47

• some of these products may be very similar + in some cases identical - in terms of interest rates, time period + conditions
• providers sometimes add on extra features to differentiate them but the most important difference is brand
• the brand name (provider) inspires loyalty + therefore is effective when people don’t have time or the inclination to shop around
• nowadays all providers give specific names to their products so that customers can ask for them specifically

Question 48

Competitive demand for different product brands under the same product heading being offered by the same provider

Answer 48

• large providers offer different brands with different features + aim them at different market segments
• each market segment contains people who are similar in terms of income, age, attitude to risk + lifestyle
• e.g. a range of mortgage products - some with discounts to suit young professionals on low incomes who expect an income increase in the future, some with higher interest rates for those who cannot provide a high deposit, and others for people buying to rent

Question 49

What are internal factors?

Answer 49

• those which originate in a person themselves
• personal priorities, health, state of mind etc,
• they are factors which only affect that person + their family

Question 50

What are external factors

Answer 50

• those which originate from outside a person + they come from the external environment in which everyone lives
• beyond the control of an individual + they are factors which affect many people
• e.g. a period of low economic growth will result in many people losing their job + being unable to pay bills

Question 51

Impacts of external factors?

Answer 51

• affect peoples wants + aspirations, their plans, and their ability to succeed in those plans
• they make a difference to financial planning but people do not have control over them
• many of these factors are economic ones, but there are also legal + social influences

Question 52

What is inflation?

Answer 52

A gradual increase in the general level of prices in an economy over a period of time + it reduces the purchasing power of money

Question 53

What is the main impact of inflation?

Answer 53

• individual’s income can not keep pace with price increases
• if their income lags behind, they might find themselves unable to fulfill savings or spending plans or to make loan repayments

Question 54

How does inflation affect savers?

Answer 54

• depends on the difference between inflation rate + interest rate being received
• savers money loses value as prices rise + their position depends on whether the interest rate they are reciievibg covers the rate of inflation
• since 2077-08 interest rates have been very low c most savings accounts do not receive enough money in interest to compensate savers for rising prices of the goods they want to buy with their savings
• they are losing in ‘real’ terms because the purchasing power of their money is falling + they can buy less real goods + services with their money

Question 55

How does inflation affect borrowers?

Answer 55

• depends on the difference between inflation rate + interest rate being paid
• money borrowed loses value + borrowers gain to this extent
• but they pay interest + the interest rate will almost certainly be higher than the rate of inflation

Question 56

How does inflation impact a persons financial choice?

Answer 56

• affects the decision of whether to finance a purchase through saving up for item or borrowing the money
• someone who decides to save for it faces the risk that the price of the item will rise by the time they are able to afford it, even taking interest receipts into account
• it might be better to borrow the money + to buy of today’s price
• the final decision will depend on the interest rate in each product

Question 57

How do interest rates change?

Answer 57

• change according to the economic + financial condition of the country
• the Bank of England makes changes in its bank rate according to whether it wants to slow down or speed up the economy - that is whether they want to encourage people save or to spend
• bank rate affects other interest rates i.e. the rates that providers pay on savings + charge on loans

Question 58

How will interest rates affect savers + borrowers?

Answer 58

• saving + borrowing decisions will depend on the current level of interest rates + also on how people expect interest rates to change in the future
• interest rates are closely connected with the rate of inflation

Question 59

How is unemployment caused?

Answer 59

• when the level of economic activity in the country slows down, or if the country becomes less competitive in the exports market
• less demand for goods to be produced = fewer workers are needed
• some workers will be made redundant + fewer new recruits will be taken on

Question 60

Impact of unemployment (saving)

Answer 60

• those without a job become reliant on benefits, which are probably significantly less than the income they have been earning
• they will have to reduce their spending + are unlikely to be able to save
• if they are signed up to a savings scheme whereby they make a monthly deposit, they will be unable to keep this up + May lose interest
• they are now in a position to borrow money

Question 61

Impact of unemployment (borrowing)

Answer 61

• particular problem for anyone who already owes money - now they will have no income to meet the loan repayments
• people who have purchased payment protection insurance will be in a better position as their loan payments will be covered at least
• unemployed people may have to use their savings to pay their current expenses + their debts + will probably have to postpone any life events they were planning

Question 62

Impact of unemployment (long term)

Answer 62

• impact on pensions, especially if they were paying into an occupational scheme with their employer
• anyone who lays into a flexible personal pension is in a better position as they can put the scheme on hold until they find another job

Question 63

How do house prices fall?

Answer 63

• in a growing economy, there is a lot of demand + house prices will be buoyant
• if the economy slows down + there is uncertainty about the future, house prices might fall

Question 64

Impact of falling on house prices for first time buyers?

Answer 64

• good for first time buyers, as it makes it easier for them to get on ‘property ladder’
• but there is a greater risk of them losing their job + mortgages becoming harder to maintain if the economy is not performing well

Question 65

Impact on falling house prices for mortgage payers?

Answer 65

• not good for people who have already bought their home as its value will fall + May even less than they owe on their mortgage
• these people are in a situation of negative equity + it is a problem for someone who wants to move but knows that the proceeds of the sale of the house will not cover the debt still outstanding
• this person will either have to buy a cheaper property + ask the bank to finance any difference or wait till the market improves

Question 66

Impact of falling house prices on retirement plans?

Answer 66

• affects people who look on their property as an asset in their pension portfolio + it reduces their retirement savings

Question 67

Impacts of fall in price of financial assets?

Answer 67

• some people invest in stocks + shares as part of their portfolio + changes in prices of these financial assets will affect their financial position + their plans
• a fall in the stock market means that they will get less for their shares if they sell them - and if companies are not doing well, they will receive lower dividends
• if someone has made a long term plan to spend money at some point in the future + to finance this with shareholdings, they will have to adjust their plan

Question 68

Product mixes for a student loan

Answer 68

• take out a loan to pay for maintenance money e.g. £3,000 - can get products with an interest free period e.g 21 months
• get a part time job to meet commitment
• make a budget - cash flow forecast

Question 69

Product mixes for buying a car

Answer 69

• buying a car involves borrowing money (unless it can be paid for through savings)
• insuring it
• paying running costs e.g. annual car tax, maintenance and fuel

Question 70

Product mixes for buying a home

Answer 70

• mortgage
• payment protection insurance (expensive, not necessarily a priority)
• house + contents insurance
• risk of interest rates rising - opening an instant access savings account(e.g. Cash ISA) to provide a lump sum to protect from risk

Question 71

Product mixes for renting a home?

Answer 71

• deposit to landlord (can be a substantial sum - need to borrow the money e.g. 2 year personal loan
• don’t need to insure as it belongs to landlord - may insure own belongings using home contents insurance
• cheaper option to buying a home although the monthly rental might be similar to monthly mortgage payments - difference is a large deposit needs to be provided for a mortgage to prove they are creditworthy, therefore renting is a better alternative for someone on a low income

Question 72

Product mixes for having a family

Answer 72

• expensive + needs to be budgeted for
• buy items such as a pram, cot and car seat
• possibly upgrade to a family sized car - may need a loan for this
• how will you look after the child once maternity leave is over? - someone might have to work part time or give up work entirely-> this will mean a loss of earnings for an extended period
• if the couple decides to continue working full time they will have to budget the cost of childcare
• once child starts school - uniform , swimming lessons, music tuition - may want to send child to a private school = big expense for years + need to be able to cover this comfortably with their income
• provider for child in case anything happens to parents - mortgage guarantee protection, make a will, name a person as child’s guardian if they both died
• also open a savings account for the child
• t

Question 73

Product mixes for planning for retirement

Answer 73

• money purchase pension schemes with work - percentage of salary goes into pension scheme every month
• pay national insurance contribution to receive a state pension
• buying. A property relatively young e.g. 30 - will pay off 25 mortgage by 55 + will be a homeowner for retirement
• at retirement they can sell current home + move to cheaper, smaller property - therefore have money left over from the sale of their home to buy an annuity that will provide an income