Unit 2 : Financial Capability for the Medium and Long Term Flashcards
As people move from childhood into adulthood and then grow older, according to what do their needs and wants change?
- Their lifestyle
- The prevailing culture of the society in which they live
- The size of their family
- Their ability to afford products
What are the 5 main long-term financial products?
- Medium and longer term savings
- Investments
- Pensions
- Longer-term borrowing
- Insurance
Why do people invest?
To save for a longer term want or aspiration. It is different from a long-term savings product because it is more risky but can bring a higher return.
Give 2 examples of longer-term borrowing products.
- Mortgage: a loan secured on the value of the property being purchased
- Hire Purchase: secured consumer credit to finance items such as cars and furniture
What is a decision to buy a financial product influenced by?
Internal and external factors
What is the key internal factor that affects someone’s choices?
Their own personal set of values, beliefs and attitudes - these will affect the way people manage their money
What are the 5 internal factors that influence a decision to satisfy a need or want and therefore to buy a financial product?
- Values
- Beliefs
- Attitudes
- Perceptions
- Preferences
What are values?
General feelings or beliefs about desirable behaviour and goals. They involve the concepts of ‘good’ and ‘bad’ and how people think things ought to be.
What are beliefs?
Beliefs are more specific and detailed than values, they are less about the way people think things ought to be and more about the way they think they are.
What can beliefs be?
Religious, free speech, enterprise and fairness
What are attitudes?
Attitudes refer to how, at a given time and place, people think they feel about another person, event or issue.
What are perceptions?
People’s perceptions represent their understanding of the world around them. Their perceptions affect the way they feel about the financial products that they are surrounded with.
What are preferences?
People have certain preferences for particular products, and these will depend on their values, beliefs and attitudes.
What are external factors?
Those that are not within your control, but are imposed from outside
What are the 3 external factors that influence a decision to satisfy a need or want and therefore to buy a financial product?
- Marketing and advertising
- Peer pressure
- Trends, fashions and role models
What is marketing?
The activities associated with buying and selling a product or service, i.e. everything a company does to acquire customers and maintain a relationship with them
What does marketing include?
Advertising, selling and delivering products to people
What can marketing be subdivided into?
Promotion and Public Relations
What does promotion refer to?
Paid-for marketing activities, including advertising
What does promotion include?
All activities that aim to:
- Communicate with people
- Inform them of goods and services
- Persuade them to buy
What is advertising part of?
Promotion - it is used to inform and persuade
What can advertising carry?
Explicit (overt buy me now! message) and implicit messages (lifestyle and fashion message)
Who uses advertisements?
The media (television and radio - broadcast media, newspapers and magazines - print media, online - electronic and social media, cinema, hoardings, posters and billboards - other media) as well as banks, building societies and insurers
Give 7 examples of other promotional media.
- Carrying out product trials
- Offering money off
- Bogof
- Running customer competitions
- Sponsoring teams or events
- Special credit terms
- A bank may offer cash back to customers who use its credit card
Why should people be careful when choosing a financial product?
There is always a lot of ‘small print’ - that is terms and conditions. Sometimes a bonus or discount may be available only in certain circumstances and customers should be aware of this before choosing the product so they are not misled.
What is PR?
Public Relations - advertising that is not paid for directly but which keeps a business’s product in the public eye
What is PR part of?
Promotion, where the entire message is implicit
What does product placement and sponsorship do?
These type of activities cost money buy they contribute to the general reputation of a business and are not directly related to the brands that the business sells
What do we form from our peers?
Our perception of what is the norm - the acceptable behaviour within our particular group, and often we want to fit in, to be one of the crowd
Give an example of where trends can be found.
In financial services
In what 3 ways can trends influence the choices people make regarding financial services?
- The way in which people pay for goods and services, i.e. card or cash
- People’s attitudes to savings
- How people view using credit
Give an example of a trend in financial services?
People’s attitude to borrowing money - many years ago it was deemed ‘low class’ to buy goods on credit because it showed that people could not afford to pay otherwise. The trend reversed after the invention of the credit card as it became desirable to fund a ‘high class’ lifestyle on credit.
What is culture about?
Norms - about behaviour and attitudes across social groups, what society thinks is acceptable and unacceptable
Why are financial services providers very interested in culture?
Because it influences financial behaviour and indicates to them what financial products will be successful
What is there a strong culture of in the UK?
Home ownership - providers make mortgage loans available to people so they can buy they homes and pay back over a long period (often 20-25 years)
Among whom are mortgages normal?
People that work, and many people aspire to buy their own home one day - so people in the UK are likely to need to save for a deposit and then take out a mortgage
What risk do people take with mortgages?
The risk that they may not be able to keep up with repayments and that their home may be repossessed
What is the situation once people have paid off their mortgage?
The property belongs to them and they do not have to make any more payments; thus nobody can ask them to leave their home, even in retirement
Since the financial crisis in 2007 what has happened with regards to mortgages?
It has become a little harder to obtain a mortgage, but the culture of home ownership remains strong
Why are more young people renting rather than buying property?
Because of high deposits on houses
Where is the culture of home ownership not present?
In Germany, for example, because the norm is to rent property - only 43% of Germans decide to buy their house. The other 57% do not need to save for a deposit, but to pay a few months’ rent in advance.
What is the risk with renting?
Tenants could be asked to leave the property is they do not pay the rent or if the lease runs out and the landlord wants the property back
What is the feedback effect?
People’s feelings affect how they behave. The links between thoughts, feelings and behaviour is clear, and can be traced back to attitudes and so our personal values.
What is the feedback effect linked to?
Expectations - what people expect is going to happen
What are expectations?
Self-fulfilling - in that people’s attitudes mean that they affect the outcome of events
Give 3 examples of self-fulfilling expectations.
- If people expect a share price to fall, they will start to sell shares; if enough people see them the share price will fall
- If interest rates are expected to rise, people will save more money and borrow less; this means providers will have to pay out more interest on savings and gain less from lending. They may choose to increase the interest rates on lending, to maintain their income.
- If people expect increased unemployment, they may save more for the future or delay spending. Businesses will need to produce less goods and services, they then need fewer workers and so unemployment does rise.
What are the 2 influences of personal values on financial decisions?
- Ethical investing: involves someone choosing to save in a way that means money will be used for what the individual considers to be a good purpose. Ethics are a set of ideas about what people believe is right - the moral code that they aim to live by - so one person’s opinion about what is ethical will differ from that of someone else.
- Religious beliefs: Islamic Law (Sharia Law) prohibits the payment of interest on a debt and so Muslims are not allowed to borrow money. All major banks now provide Sharia-compliant financial products.
When someone buys a financial product, what are they entering in to?
A relationship with the provider that has implications for a specified time period (short, medium or long-term) - so buying a financial services product is not the same as buying something that is quickly consumed
Why must the customer be aware of the implications of a relationship with the financial service provider?
They bring with them responsibilities and the customer must be able to meet their obligations
What is the affordability implication of borrowing?
In the case of short-term borrowing, a person can know with a good deal of certainty whether they can afford to pay the money back. In the case of a medium or long-term loan, they cannot be so certain as their circumstances may change (e.g. they may lose their job).
What are the affordability implications of buying an insurance policy?
- Home and Travel insurance, are not very expensive. However, Motor insurance for young people can be very costly. Since motor insurance is compulsory, there is no point buying a car and then finding out you cannot afford to insure it.
- Another issue is whether people are buying too much insurance. Policies such as payment protection insurance, pet insurance, mobile phone insurance are not essential and people have to decide if they can afford them or not.
What is the affordability implication of saving?
People have to decide if they can afford to save and which account to use.
What is the affordability implication of setting priorities?
Since nobody can afford to buy everything they need, want aspire to have, they need to choose between alternatives. This means they must decide on their priorities = OPPORTUNITY COST.
What is the affordability implication of attitudes to risk?
Some people are risk averse and others risk tolerant, but the majority of people are somewhere in between. So, they will insure the most important items they possess but are not over-insured.
What is considered as medium and long-term?
3 months to many decades
Why do people save for long periods?
Because they make a decision now to save out of their current income to finance a future medium or long term need, want or aspiration. These future needs, wants and aspirations will require a significant amount of money and so people need to save for longer to achieve them.
What is hoped for with long-term savings and investments?
People hope that their savings and investments will grow over a period to give them a good return. However, if the economy performs badly, they may not get as good a return as they had hoped, and with some types of investment they may get back less than they actually put in.
What are the 2 main ways in which people can use their savings or investment fund when it matures in the future?
- They can hope for capital growth, i.e. the market value of the investment is greater when sold than the amount they paid for it. So, when they cash it in, they can use the lump sum to finance a planned project.
- They can use their fund for income: the investment will pay out a regular amount that they can use as part of their monthly income, e.g. dividends.
What can many investments provide?
A mixture of both growth and income
What are the 9 features of savings products?
- Lower risk
- Savings accounts are held at financial providers
- Savers deposit money and earn interest
- The capital sum the deposit is NOT at risk
- The saver will get back the money that they put in
- Deposits of up to £85,000 are protected by the FSCS, should a provider fail
- Savings accounts do not pay very high interest
- Medium-term savings accounts will pay less interest than long-term savings accounts, but savers will usually need to give the provider notice before they can withdraw money, from the long-term accounts
- If notice is not given, interest is lost
What is a portfolio?
Many investors use a variety of different long-term savings and investment products when saving for a large item or for retirement - this combination is known as their portfolio
What are the 4 providers of long-term savings and investment products?
- Banks, building societies, NS&I and post office (all offer long-term savings and investment products)
- Friendly societies (mutual organisations that offer long-term savings and investments, life insurance, pensions and annuities)
- Insurance companies (provide long-term savings and investments, including life insurance, investment products and pensions)
- Investment companies (offer a wide range of product types. These products are divided into those that aim to grow money over time (capital growth), and those that provide regular income from the money invested).
What is capital growth?
An increase in the market value of an investment, over and above the amount the investor paid for it or paid into it.
Why might someone want capital growth?
People with small children may want a sum of money to be available in 15 years’ time when their child goes to university, or someone else may want a sum of money for retirement. They do not want to take income from their investment now.
Why might someone want an income from an investment?
- They may be using a sum of money that they have accumulated to give them an annual return that could be regarded as part of their household income.
- They may have inherited some money, so they place the money in a fund that will give them an income. They sacrifice growth in order to take the income out and spend it.
- Another example is a retired person who wants to use their money to buy them an income in their old age. They buy an annuity, which means that they hand their sum of money over to an insurance company and, in return, they are paid an income for the rest of their lives.
What is an annuity?
A financial product that pays a regular guaranteed income, in return for a lump sum paid to the financial provider. It is used by people when they retire.
What will investment companies help people to do?
Invest their money, taking into account their attitude to risk, the amount to be invested and the length of time they can invest it
What are the 3 investment companies?
- Fund companies: offer packaged accounts that can be tailored for the private investor (unit trusts, OEIC’s and investment trusts, which pool money for investors.
- Portfolio managers: look after a portfolio of investment products such as shares and bonds on behalf of customers who have a sizeable sum to invest. They make decisions on behalf of the investor in order to meet an agreed investment objective.
- Stockbrokers: carry out deals for people who want to buy and sell shares, bonds and other investments.
What are the 2 long-term savings products?
- Savings Bonds
- NS&I
What is the withdrawal policy of savings bonds?
The holder can only make a limited number of withdrawals or none at all, during the period without incurring a penalty
What is a savings bond?
A savings product held for a fixed period, e.g. 2 years (maturity period)
Give an example of a savings bond.
Fixed rate e-bond, by Virgin Money - an online account paying AER of 3% gross per annum and matures in 3 years. Minimum investment is £1 and maximum £100,000, no withdrawals and you are unable to cancel or close the account once it has been opened.
Who do savings accounts suit?
People who need to accumulate a medium-sized lump sum but need the discipline of a product that does not allow them to spend the money in the meantime.
What savings bond do NS&I currently offer?
A Children’s Bond. They can be bought for a child under 16, they pay a tax free interest, which is guaranteed for a fixed period.
What are the investment minimum and maximum of a NS&I children’s bond?
Minimum £25, maximum £3000
Can children’s bonds be cashed in early?
Yes, but with a penalty equivalent to 90 days interest
Who are children’s bonds suitable for?
A child if they don’t need to access the money (so not suitable if the child might need it sooner)
Why are children’s bonds by NS&I less risky?
As they are guaranteed by the government
What are the 4 investment products (assets)?
- Stocks and shares
- Stocks and shares ISA
- Corporate and Government Bonds
- Property
Why is the fact that people can invest money themselves by choosing to buy specific assets (such as shares or property) not a good option for many small investors?
As they do not have enough money to allow them to spread their risk over a well-diversified range of assets. Also they are unlikely to have the knowledge or time to select suitable shares and track their progress.
What are the features of stocks and shares?
- Known as equities
- Each share represents the part ownership in a company
- Someone who buys shares will pay the market value at the time, but this price will change subsequently and may rise/fall
- It is possible for someone to sell their shares if they need the cash back, but they take they risk that they may be selling when the share value has fallen
- In addition to capital growth, shareholders hope to receive a dividend, which is a share of the annual profits made by the company.
- Quite high risk investment give capital growth and income, but if the company does badly, there will be no dividends and the share price may fall
- The FTSE 100 (Financial Times Stock Exchange Index) shows the movements in the value of the shares in the hundred biggest companies listed on the stock exchange
What does a stocks and shares ISA allow people to do?
Put money into different types of investment on a tax-efficient basis
What was the ISA allowance in the UK for 2013/14?
£11,520
If you were to split between investing in both a cash ISA and stocks and shares ISA, what is the limit for a cash ISA?
£5,760 (half the allowance), and the rest in stocks and shares
When are people advised to use a stocks and shares ISA?
Only if they are willing to tie their money up for at least 5 years, as the value of the ISA will fluctuate with changes in market values
What are stocks and shares ISAs free of?
Income tax and capital gains tax, but investors have to pay charges to their financial advisors and fund managers
What is capital gains tax?
The tax payable on profit (gain) made when you sell or give away an asset, like property or shares
What is the tax-free allowance on capital gains for 2013/14?
£10,900
What is the tax rate charged on capital gains above the tax-free allowance?
18% up to £32,012
What is the tax rate charged on capital gains above the first band?
28%
How do corporate and government bonds work?
Companies and governments need to borrow money, so they issue bonds. Investors lend their money to the issuer by buying the bonds. They are lending money to the company or government and so are creditors and not part-owners - as shareholders are.
Why are corporate and government bonds different from Savings Bonds?
Their value can fluctuate as they are traded on the financial market
For how long are corporate and government bonds normally issued for?
A specific period of time, and at the end of the period the bond matures and the issuing company repays the capital value
What do holders of corporate and government bonds receive?
Income in the form of interest, usually at a fixed rate
How can holders of corporate and governments get their money back?
There is a market for bonds and so holders can sell them
What are the best known corporate/government bonds?
Gilts
Why are gilts the best-known bonds?
They are issued by the government and are regarded as very safe
Why is property seen as a good investment?
As property prices tend to move upwards in the long-term
Why is property investment quite risky?
Because prices can fall in an economic downturn and it is not easy to sell an asset in such time
What do people see property as?
Part of their long-term investment portfolio
What can people do with property investment upon retiring?
They can sell it and downsize and use the cash surplus to give them an income
How do people use a buy-to-let mortgage?
People can rent out the properties to give them an income, which they hope will cover the mortgage repayment, and benefit from any increase in the capital value of the properties - this is seen as quite risky
What can property also be?
Assets like gold and silver and works of art, antiques and fine wines. These can offer the potential for high rewards but are very risky and are only suitable for the very wealthy, who are experienced in these areas.
How can people look after investments without having to manage their own portfolios?
Using investment funds
Who offer investment fund products?
Banks, building societies, friendly societies and insurance companies
What will people who want to invest over the long-term but do not have the knowledge do?
Turn to the general financial providers and buy ready-made investment products
How can people discuss their needs for an investment fund?
With a CRM, by telephone or by visiting the website
What will investment fund providers make clear to investors?
That investments are more risky than savings and that the value of the fund can fall as well as rise
Give 2 examples of investment fund providers.
- Barclays Funds (Foundation Funds and Investors’ Choice Funds)
- Nationwide Share dealing service
What are collective investments?
Money contributed by many people that is put into a common pool and investments are made out of that money
What is the pool of money from a collective investment used to invest in?
Many different investments such as a wide range of shares, bonds and other assets (like property, gold etc) - this means that each investor’s risk is spread or diversified across many different holdings
What do collective investments include?
Unit trusts, investment trusts and OEICs - they offer combinations of growth and income
What does OEIC stand for?
Open Ended Investment Companies
Who are unit trusts - the most common form of collective investment for?
They appeal to investors who want to buy shares buy who are too small or inexperienced to be able to invest on their own
What are the 4 advantages to the individual investor from using collective investments?
- The risk is reduced because the fund invests in a large number of different types of company. The risk is spread; a small investor cannot take much advantage of as they do not have enough money to buy the minimum amount of stocks and shares.
- The investor takes advantage of the expertise of the investment manager
- The cost of hiring the services of a skilled fund manager is shared amongst investors
- There is wide choice of investment funds and collectives which cater for all types of investors
What are 3 insurance-linked products?
- Term assurance: Life Cover
- Endowment policy
- Annuity
What is term assurance - life cover?
This is an insurance plan that runs for a fixed period of time and pays out a lump sum if the insured person dies within the term (not an investment policy)
What is an endowment policy?
A long term savings vehicle. They are often used to provide a lump sum to pay off a mortgage or other long-term debt, or fund an event in the future. They can be surrendered before maturity but the insured person is likely to lose quite a bit of money in doing so.
What is an annuity?
A product that provides an income for people when they retire. They take a lump sum they have already saved and buy an annuity. This gives them a guaranteed income for a fixed number of years or until the holder dies. Some annuities are index linked, which means they rise with inflation - but these cost more than the ones that are not.
What is a personal pension?
A type of investment fund, a long-term savings plan that is tax-efficient and is purchased by an individual throughout their working life in order to save for their retirement
What are the 2 types of pension plans?
- Occupational pensions
- Personal pensions
What are occupational pensions?
Operated by employers, who may also pay contributions into them for their employees
What are the 2 types of occupational pension?
- Final Salary Schemes
- Money Purchase Schemes
What are Final Salary Schemes?
Employees pay throughout their working lives, the scheme is invested to make the best return and agrees to pay the employee a pension based on the amount of years they have worked and linked to the last salary they earned before retirement. They are risky for an employer and so many firms are closing them down. (More common is the Average Salary Schemes)
What are Money Purchase Schemes?
Employees pay into the pension plan over their working life - the scheme is invested and provides the employee with the resulting lump sum on retirement. The amount the employee receives depends on how the scheme performed. The employee can then take the lump sum and invest it in an annuity to provide income on their retirement.
What are personal pension plans?
Long term money-purchase products provided by banks, insurance companies and other providers to help customers to build up a pot for retirement
What is a feature of personal pension plans?
They are tax efficient because of the tax relief at the basic rate of income tax on the payments made into the plan
What was the Pensions Act 2008 brought in to ensure?
That everyone was automatically enrolled by their employer into a workplace pension scheme; then they have the option to leave if they wish
What must the pension scheme chosen by an employer be?
The National Employment Savings Trust (NEST) or equivalent
What does the NEST set out?
The minimum benefits required
Why did the government introduce auto-enrolment?
Because they believe that people are not saving enough for their retirement - and so they do not have to rely solely on the state pension
What is the state pension?
A regular payment made by the government to people when they reach state pension age
What is the coalition government planning to introduce with regard to pensions?
A flat rate state pension for new pensioners from April 2016
How many levels of payment of state pensions are there currently?
2
What is the current pension age?
- 65 for men born before Dec 1953
- Between 60-65 for women born after April 1950 and before 1953
What does the state pension keep pace with?
Life expectancy
What will the increases in pension age be and when?
- From 66 to 67 between 2026 and 2028
- To 68 between 2044 and 2046
What is the main reason that people borrow over a prolonged number of years?
They need to fund a large expenditure
Give 5 examples of large expenditures that people need to borrow for a prolonged period of time to pay for.
- A house
- Study at university
- A consumer durable
- A car
- An emergency life event
Why do people need to repay a borrowed amount of money over a long period?
Because their monthly repayments need to be small enough to be affordable and fit into their personal budget
