Comprehensive Financial Planning - Case Study Example

Adults work hard for over thirty years to feed and sustain their families. When a person’s working journey ends he deserves to have the financial means to cover the living expenses and medical expenses of his family. People from all income levels can create their financial future by utilizing effective financial planning. Life is a never ending struggle and at the end of our battle against time one deserves to enjoy it without any financial worries. Thirty years ago working professionals had great confidence that the companies they work for would take care of their retirements needs after they finished their service. These workers had great confidence in the system and did not plan for their retirement because of it. Many of them suffer the consequences when corporation began to cut back on retirement benefits and started policies to lower costs. This population which we referred to as the baby boomers felt betrayed by the companies which they had work so hard for so many years. The financial future of many of the workers was compromised because of corporate profits. The later generations, gen. X and Y, realized that their retirement depended on the moves they made to make it happen. The new generations are in need of professional advice to guide them towards financial stability in their golden years. This paper will analyze the products in which individual can invest to secure their financial future. The risk of the different alternatives will be studied as well as the impact taxes have on investments. An analysis of the differences between the mindset between individual investors and institutions is provided. In order to visualize the impact financial planning has on individuals a financial planning analysis of a particular individual is performed utilizing sound financial planning techniques. Financial planning is a discipline that has gained great popularity among members of our society. Financial planning is a process in which individuals determine what their financial goals are and a professional creates a plan on how that person can achieve them (Prudential, 2006). One of the main aspects of the field is creating a retirement plan. Starting a retirement plan earlier in a person’s career has tremendous advantages. The power of compound interest creates greater the wealth the longer the money stays put in a portfolio. Analysis of financial instruments Purchasing equity in a corporation is a type of investment which can bring great returns for an investor. Equity in a corporation is usually purchased in the form of common or preferred stocks. In order for a corporation to be able to easily sell stocks to an investor it must become public. A public corporation in a company that is registered in a formal stock exchange such as the New York Stock Exchange or in an over the counter market such as NASDAQ. Companies sell stocks for the purpose of raising capital. Investors buy stocks to gain a return on their investment. When a person purchases a stock they become partial owners of the company. The stock owner benefits from the success of a company because he is eligible to receive dividends of the corporate earnings if the company chooses to declare them. The stock owner also gains decisional power since he earns voting rights. One stock is equal to one vote. The dividends of stocks are taxed at lowed preferred tax rates. The capital gain in the value of a stock is not taxed until the person sells the stocks in the open market. Common Stocks are considered a risky investment. There are different categories of investment within the common stock market. The most popular and safer types of common stocks are blue chip stocks. Blue chip stocks are the stocks of large multinational corporations with many years of experience in their industry and a proven financial record. Two examples of blue chip stocks are Microsoft and Wal-Mart. Another different type of stock investment is initial public offerings (IPO). An initial public offering is when a company sells its stock for the first time. An IPO indicates the company has not yet reached the growth stage in its life cycle. The IPO will provide a company the capital to expand or established its business. IPO stocks have are risky investments with a lot of upside because they have the potential to go up a lot in price. The stocks with the highest level of risk are penny stocks. Penny stocks are stocks whose value in the market is below one dollar per stock. Sometimes an investor can find some good gems in this category of stocks. A penny stock has a very low value and if an investor finds a good stock the returns on the investment can be enormous. A mutual fund is an offering that is very popular among investors. In January of 2004 there were 39.2 billion Euros in mutual fund sales in the United Kingdom (Davies, 2005). A mutual fund is portfolio of investments with is sold to the public as a single unit. A professional manages the portfolio of investment to with the objective of increasing the value of the mutual fund. Mutual funds provide investors with an inexpensive way to diversify without having to buy a bunch of different stocks or investment instruments. Real Estate is a great investment option for individuals. Investing in a home substitutes the expense of paying rent for housing. Interests on mortgage payments are tax deductible. Home have always appreciated in value over long periods of time. Investing in a second home provides the buyer an asset that can generate revenues in the form of rent income. Commodities are objects that can be obtain from the earth. These objects can be categorized into five types: energy, agricultural, precious metals, industrial metals and livestocks. There two strategies that can be utilized by an investor in the commodity market. One strategy is called the active approach. This approach involves a high level of expertise since option products such as future contracts. A normal investor does not have the capability to create the quantitative models required for such a strategy. The second strategy is called the passive approach. Utilizing a passive approach involves investing in one of the indexes that exist for the different commodities. These indexes are composed of different commodity products and the market tracks on a daily basis its appreciation or depreciation in value. An index that has been very successful profitable in the last few years is the GSCI index. The composition of this index includes a 33% investment into crude oil. The GSCI index had an annual return of 23.1% between 2003 and 2005 (Plante, 2007). Bonds are debt instruments which companies and governments utilized to raise capital. Investors buy bonds which are typically sold at $1000 a unit to receive a interest return in exchange for the money. The interest which is called the coupon rate is paid in semiannual payments. Once a bond expires the person receives his original investment back. Corporate bonds pay anywhere between 7-15%. Governmental bonds pay lower coupon rates, but are have the advantage of being tax free. T-bill are very popular debt investments. These are issued by the treasury department of the United States and they have three month duration. People invest in different instruments depending on their tolerance towards risk. Individual by nature tend to be risk adverse. They want to earn a return with a relative level of assurance they will not lose their investment. The best way to minimize the risk and earning a good return is by creating a diverse portfolio. It is not wise to invest all your money in one instrument. Younger people with no family responsibilities can assume an investment strategy with higher risk. A person with family responsibilities can not afford to lose the money in the market. People investing towards retirement invest in financial instruments of lower risk that will assure them accumulation of wealth over long periods of time. Humans are in need of products to protect their families and durable assets. The insurance industry provides people the products to protect themselves. If a person owns a home they need to buy insurance since a house is typically the most valuable asset in a person’s investment portfolio. A lot of people protect their family members from unforeseeable situation such as death to insure a good financial future for their love ones. A couple in which only one of the members works is in need of life insurance. Another popular product people buy is disability insurance. Disability insurance protects a worker by providing a lump sump payment if the person becomes disable and is unable to continue to work. Financial planning analysis of Dr. Mark Taylor Dr. Mark Taylor is a married 48 year old man and proud father of a seven year old child. For the last 15 years he has worked at Nuffiels Hospital. He is making £80,000 a year at his job and receives a £20,000 yearly bonus. Mark is a family man and he and his wife decided that she should not work considering his hefty income. He owns a home which cost him £350,000, but is currently value at £500,000. The home was a great investment that has appreciated close to 43% in value since the purchase. For Dr. Taylor education is very important. He has his child enrolled in private school which costs £14000 a year. Exhibit A illustrates a personal income statement of Mark Taylor. The personal statement shows he has stocks valued at £75,000 and joint savings that amount to £65000. This professional is in need of a financial plan to secure the necessary capital to be able to retire without any financial worries. Exhibit B illustrates what his portfolio would look like 15 years into the future. Dr. Taylor projected retirement age is at 63 years of age. He currently has a pension plan that would give him a pension income of approximately £67,535 a year assuming he works another 15 years. At first glance exhibit B illustrates some good numbers, but there are many flaws in this plan. Since the Taylor family is a one income family, Mrs. Taylor needs security. Currently there is life protection insurance for her, but it exists only if Dr. Taylor continues to work for this hospital. If he changes job there is no life insurance for her. It is very important for Dr. Taylor to purchase a £500,000 to £1,000,000 life insurance policy for his wife. Mr. Taylor is currently depending on his hospital pension for retirement. If the doctor changes job his pension fund will not grow anymore. If no more money enters into the pension fund the doctor right now would be eligible for £18,750 a year in pension benefits. The doctor cares a lot about education, but he has not set aside any money for his son’s college education. His only investment in stocks is only giving him a 2.5% yearly return which is quite low. The doctor is saving a small percentage of his income. The client needs a plan to increase his monthly income upon retirement, increase his return on investment, create funds for his children education and increase his net income saving percentage. To attend his child’s future educational needs Mark needs to lower his current spending in education for his child. He is spending £14000 a year in elementary school tuition. It is necessary to lower that amount by at least 50% to reduce his monthly expenses. A good financial product for his child is an Educational IRA. An educational IRA works in similar fashion to an IRA but the timeline for withdraw of the money starts when the child becomes an adult and goes to college. In this case since Mr. Taylor’s son is seven years old, it would be 11 years from now. The plan for Mr. Taylor is to save 20% of his regular net wages and 50% his yearly bonus. “A 40 year old with a replacement retirement income of $100,000 and an 80 percent income replacement goal needs to be saving 21.4%” (Should we have a national savings rate?, 2007).The 20% savings will be utilized towards the purchase of a second home with a £125,000 value. To purchase the home the couple will utilized £25,000 of their current savings as a down payment. The £100,000 balance will be finance with a 15 year mortgage which at a 6.11% interest rate would pay £1019 including property taxes. To align their plan towards retirement at 63 years of age the 1st home will be refinanced into a 15 year mortgage. This move would also eliminate the variable mortgage clause in the current mortgage contract. The second home has the potential to generate over £1000 in rent income a month in the year 2022. Another strategy is to sell 80% of their current stocks and diversify that money into a more profitable portfolio. Exhibit C shows the composition of the portfolio. The 50% savings of the yearly bonus, which after tax is estimated to be around £7000 a year will be invested in IRA, Educational IRA and into the investment account on a yearly basis. Exhibit D illustrates the projected retirement portfolio of Dr. Mark. The new financial plan increased his wealth by £393398, created an educational fund of £43597 and gave the Mark family rental income stream of £1000 a month upon retirement. References Davies, P. (2005). MARKETPLACE: Europe’s mutual sales fund bounce back. The Financial Times. Retrieved June 4, 2007 from Accessmylibrary database. Should we have a national savings rate? (2007). Journal of Financial Planning, 20(5). 16. Retrieved June 4, 2007 from EBSCOhost database. Plante, J.F. (2007). The Passive Approach to Commodity Investing. Journal of Financial Planning, 20(5). 69. Retrieved June 4, 2007 from EBSCOhost database. Prudential.com (2007). Comprehensive Financial Planning. Retrieved June 5, 2007 from http://www.prudential.com Exhibit A: Mr. Taylor Personal Income Statement Assets Home 500000 Stocks 75000 Savings 50000 Wife savings 15000 Total Assets 640000 Debt Mortgage debt 200000 Net capital £440000 Exhibit B: 15 year plan under current scenario Year 2007 2022 Assumptions Stocks 75000 108622 stocks are growing at 2.5% a year Family Savings 65000 150308 the assumptions were £300 monthly savings at 2% interest Home 500000 1198280 10% yearly appreciation Portfolio value £1,457,210 Exhibit C: Composition of investments Year 2007 2022 Rate African stocks 15000 21724 2.50% commodity 15000 62658 10.00% Bonds 15000 47582 8.00% T-bills 15000 29029 4.50% mutual fund 15000 41386 7.00% Exhibit D: 15 year plan with financial planning Year 2007 2022 Assumptions Investments 75000 202379 Portfolio is earning 6.4% a year Yearly investment 0 49401 £2000 yearly investment at 6.4% IRA 0 44144 £2000 IRA savings earning 5% Savings 40000 53834 Earning 2% yearly 1st home 500000 1198280 6% yearly appreciation 2nd home 125000 299570 6% yearly appreciation Portfolio value £1847608 Year 2007 2018 Edu IRA 0 £43597 £3000 yearly at 5% for 11 years Read More