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Personal Financial Management

Personal Financial Management. Semester 2 2008 – 2009 Gareth Myles g.d.myles@ex.ac.uk Paul Collier p.a.collier@ex.ac.uk. Lecture Notes. These slides are available at: www.people.ex.ac.uk/gdmyles/GDM.html Course Textbook G. Callaghan “Personal Finance” Wiley Secondary Textbook

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Personal Financial Management

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  1. Personal Financial Management Semester 2 2008 – 2009 Gareth Myles g.d.myles@ex.ac.uk Paul Collier p.a.collier@ex.ac.uk

  2. Lecture Notes These slides are available at: www.people.ex.ac.uk/gdmyles/GDM.html Course Textbook G. Callaghan “Personal Finance” Wiley Secondary Textbook T. W. McRae “Managing Your Own Finances” Thomson Learning

  3. PFM Classes • The class teachers are Zhiren Mao and Humaira Asad • There are six groups • Each group meets once every two weeks • Groups/times are displayed on notices • Exercises are found on the web page

  4. Reading • Callaghan: Chapter 1 • McRae: Chapter 1

  5. Why manage? • Increasing self-dependence • Student tuition fees and loans • “Tories plan to keep student fees” (Link) More students declare bankruptcyThree times more students wrote off student loans by declaring themselves bankrupt in 2003 than in 2002. 899 filed for bankruptcy last year, compared with 276 in 2002, 249 in 2001, 97 in 1998 and eight in 1992. A number are thought to have taken advantage of a loophole in government legislation allowing student loan debts to be cancelled out by bankruptcy. (Link)

  6. Why manage? • Increasing self-dependence • Health care • “Two-tier NHS care for pregnant women ready to pay £4,000” (Link) • Private pensions • “New bond threat to pensions” (Link) • “Pension reform: what other countries do” (Link)

  7. The State Pension

  8. Why Manage? • Financial risks Property prices continue to fall House price inflation in England and Wales dropped sharply in December, according to the Land Registry. Average prices fell by 0.4% in December. The December fall was the first decline recorded by the Land Registry since August 2005. It said the latest data was "a clear indication of a weakening market". The average house price was £184,469 in December. (Link)

  9. Why Manage? • Increasing financial complexity • Range of products • Mortgages (discount, fixed, interest only) • Insurance (car, house, life, travel) • Pensions (defined contribution, defined benefit) • Exposure to products • Student loans • Credit cards • Legislation: sellers’ packs (Link) • Choice: saving for children (Link)

  10. Why Manage? • The current financial crisis has shown • The vulnerability of the financial system • The extent of risk • The implication is uncertainty about the future • When will economic growth return? • How will the economy be organized in the future? • Financial planning must take this into account

  11. Lecture Topics • Week 1: Introduction • Week 2: Risk and Return • Week 3: Financial Assets • Week 4: Personal Taxation • Week 5: Capital Gains and Estate Duty

  12. Lecture Topics • Week 6: Insurance • Week 7: Interest and Interest Rates • Week 8: Purchasing Real Assets • Week 9: Pensions and Annuities • Week 10: Revision Lecture

  13. Style • Partly practical • E.g. What kinds of mortgages are available? • Partly analytical • E.g. How do you calculate the payments? • Intention • To allow evaluation, comparison and selection

  14. The Need for Planning Example 1: Housing • A “standard” 1930s three-bed semi-detached house in Exeter costs £200,000 • This is 8 times average earnings (£24908 in 2007: Data)

  15. The Need for Planning • The interest payments on a 100% mortgage would be £10,000 per year • Most mortgage lenders would not lend more that 4 times income • This is only half what is required • How can this be affordable?

  16. The Need for Planning Example 2: Pensions • USS, the pension scheme for university employees, pays a pension of 50% of final salary plus a lump-sum of 150% of final salary. • A professor earning £60,000 would receive a pension of £30,000 (protected against inflation) plus a tax-free lump-sum of £90,000. • How much would you need to save to obtain this with a private pension?

  17. The Need for Planning • Assume inflation/length of life cancel out • Assume a 5% interest rate. Then £30,000 per year requires savings of £600,000. With the lump-sum, total required is £690,000 • With a 4% interest rate, £840,000 is required • Even with 7%, the sum is £520,000 • Can this be accumulated?

  18. The Need for Planning Example 3: Life-Cycle Earnings • Most career paths have earnings that increase over time • The typical earnings profile is shown in Figure 1 • The typical pattern of savings is shown in Figure 2

  19. The Need for Planning Income Retire Enter work Age Figure 1: Income

  20. The Need for Planning Saving Age Enter work Retire Figure 2: Saving = Income - Expenditure

  21. Earnings Profiles University Lecturer NHS Hospital Medical Staff Police Officer

  22. The Need for Planning • The need for planning is to produce a smooth flow of consumption • This requires borrowing early in life, saving in mid-life and planned dis-saving in retirement • This process should be planned and managed

  23. The Need for Planning Example 3: Costs and Rewards • Consider the annual cost of a maintaining a typical standard of living for a family of four • Mortgage 15,000 Food 7,000 • Utilities 4,000 Holidays 5,000 • Cars 3,000 Other Items 5,000 • TOTAL 39,000 • To support this expenditure requires a pre-tax income of about £60,000

  24. The Need for Planning • For some additional items • Education 15,000 • Leisure 5,000 • The required pre-tax income is now £90,000 • And this does not include pension contributions • How does this compare with salaries?

  25. Salaries in the UK • Teacher £30,000 • General Manager £30,000 • Junior Civil Servant £35,000 • Accountant (non-partner) £40,000 • Solicitor £40,000 • Professor £50,000 + • MP £60,000 • Accountant (partner) £65,000 + • Doctor (GP) £80,000 + • Doctor (Consultant) £80,000 + • Judge/Senior Civil Servant £120,000

  26. Observe • How few achieve the required £60,000 • And very few £90,000 • Conclusion • To meet such aspirations requires planning: • career choice • expenditure • investment

  27. Financial Plan • Short-term • Example 1: To provide finance for university • Aim: to graduate with only student loan outstanding • Expenditures: fees, accommodation, books, leisure • Income: loan, work, savings • Options: summer work, reduce leisure costs

  28. Financial Plan Medium Term Example 2: To provide finance for house purchase • Aim: To purchase in fifth year of employment • Expenditures: Rent, food, car, utilities • Income: Work • Options: Reduce holidays, sell car

  29. Financial Plan • Long-Term Plan • Objectives: To enjoy at least two holidays a year, detached house, run two cars (<3), finance children through university • Requirements: Evaluation of costs, borrowing possibilities • Choices: Career options to make this achievable

  30. Financial Plan • Very Long-Term Plan • Objective: To retire at 55 • Requirements: Sufficient savings • Pension rights • Potential lifespan • Choices: Career options, investment choices

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