Fin 328 – Retirement and estate planning – Week 4 tutorial

docx

School

University of Wollongong *

*We aren’t endorsed by this school

Course

328

Subject

Finance

Date

Jan 9, 2024

Type

docx

Pages

Uploaded by mitchelledwards17

Fin 328 – Retirement and estate planning – Week 4 tutorial Question 1: Investment is always dependent upon the level of risk a person is willing to take. Whether it be a direct investment or indirect investment, an individual should only invest in what they are comfortable with and to meet their circumstances. For example, my dad about 20 years ago wanted to invest my parent’s savings pool into BHP shares. They decided against the idea as they had 2 young children and decided it was too much risk. While that stock is now worth a lot more now than at that time, it didn’t suit the needs and risk tolerance for them. In my experience, I had purchased a small amount of TPG telecom shares via Commsec, in order to familiarize myself with the share market and thought they would be a safe investment. While I only kept those shares for short time, I learnt that timing is a key element is short term investments. If you purchase at the wrong time in which the stock is overpriced or the company is meeting expectations, the price will fall in the short term, however should recover in the long term if the company is sustainable. There is always a tradeoff between risk and return and the balance is at the individual’s discretion. At this point in time when the real estate market is so strong, I would like to save my earnings and invest them in the stock market over the medium term, in order to gain a strong house deposit. Investment is made because a person has a goal or need and would like to grow their financial health in order to accomplish those goals. While I have some knowledge regarding a range of financial investments such as shares, bonds, property, derivatives, fixed interest and cash, I would like to expand my knowledge in order to properly use these instruments in order to create a healthy portfolio and limit systematic risk exposures. Question 2: a) “The risk that the purchasing power of your money may be eroded by inflation” (The trade off, Fin 328 subject outline, autumn 2017, p4). This quote illustrates the consequences of inflation as inflation is an index in which the costs associated with living are increased each year, and as such, cause cash to ‘lose’ value, in other words, inflation is an increase in the price we pay for goods and services. For example, if a cup of coffee at Starbucks costs $3.50 today, and inflation is set at 3%, at the same time next year one could assume the cost for the same coffee would be approximately $3.61. b) 1. Stick with your long-term investment goal 2. Protect yourself by diversifying 3. Match your objectives with realistic time frames. (The trade off, Fin 328 subject outline, autumn 2017, p17). c) Mismatch risk means “the investment opportunity may not suit your needs and circumstances” (The trade off, Fin 328 subject outline, autumn 2017, p4). For example, a client is 60 years old and wants to retire at 65. We calculate that the client needs $10,000 more than the $550,000 they currently have, in order to retire. Mismatch risk would mean the client would be put into a high-growth investment when they only require a small-risk investment such as a treasury bond or term- deposit.

Question 3: Stuart seems to have a small risk tolerance and could be categorized as a cautious investor (40% growth investment portfolio). From the limited information in order for Stuart to achieve his goal in the desired time frame there could be a mismatch risk element. In order to achieve an 8% pa return, Stuart would have to invest more in high- growth investments. The planner should recommend a few options: 1. Stuart should re-evaluate whether he needs the car in 5 years’ times or whether he needs a $5,000 car. 2. If Stuart doesn’t not re-evaluate the timing of the purchase or the cost, he needs to re-evaluate his ability to cope with volatility. ( Ling, H 2016, ‘Investments’, in Australian Master Financial Planning Guide, Wolters Kluwer CCH, Sydney, pp.692). Question 4: a) Non-deductible debt is money used to purchase an item for personal use. For example, borrowing for a home loan that you intend to live in. ( Ling, H 2016, ‘Financial planning for the family’, in Australian Master Financial Planning Guide, Sydney, pp.871). b) The repayment of non-deductable debt is a low risk strategy as the money use to repay the debt does not carry market risk (volatility). Therefore, it provides savings upon payment. For example, the increase in home loan payments from $1,500 p/m to $1,800 p/m can pay the loan off faster and with less interest paid (savings). c) The after-tax cost of debt is an interesting concept in which the cost of one’s debt is lowered by an offset in taxable income. For example, a client wants to borrow $500,000 for a $750,000 rental property and use personal funds to fund the rest. This would be an example of a negatively geared investment in which interest exceeds income. However, there are two main benefits to a negatively geared investment. The interest payments are tax deductable, which means taxable income is lowered, and the loss on net loss on the investment is tax deductable. This strategy can be profitable if the client was paying a fair amount of tax as their taxable income would be reduced, and the rental property would be profitable after the loan is reduced. In context, fully funding the rental property and working full-time may not be as profitable. If the client is paying a fair amount in tax due to salary income, the client would pay additional tax on the profits of the property. (‘Gearing’, in Australian Master Financial Planning Guide, Sydney, pp.876). Question 5: a) Aust. Shares Inter. Shares Global prop. Aust. fixed Inter. Fixed Cash 31/12/06 24.50% 11.50% 32.50% 3.10% 5.40% 6.00% 31/12/07 16.20% -2.60% -16.50% 3.50% 6.60% 6.80% 31/12/08 -38.90% -24.90% -34.20% 14.90% 9.20% 7.60% 31/12/09 37.60% -0.30% 7.20% 1.70% 8.00% 3.50% 31/12/10 1.90% -2.00% 5.60% 6.10% 9.30% 4.70% 31/12/11 -11.00% -5.30% -5.80% 11.40% 10.50% 5.00% 31/12/12 19.70% 14.10% 27.00% 7.70% 9.60% 4.00%

31/12/13 19.70% 48.00% 21.10% 2.00% 2.30% 2.90% 31/12/14 5.30% 15.00% 26.70% 9.80% 10.40% 2.70% 31/12/15 2.80% 11.80% 12.50% 2.60% 3.30% 2.30% Conservative Balanced Growth 31/12/06 9.58% 16.01% 17.38% 31/12/07 4.93% 4.90% 5.07% 31/12/08 -2.00% -19.73% -24.12% 31/12/09 8.24% 15.04% 16.42% 31/12/10 4.61% 2.81% 2.03% 31/12/11 3.82% -2.75% -4.66% 31/12/12 10.37% 15.44% 16.26% 31/12/13 10.47% 21.68% 24.85% 31/12/14 8.78% 10.92% 10.93% 31/12/15 4.04% 6.02% 6.45% Average 6.28% 7.03% 7.06% Source: CCH AMFPG text on page 693. b) At 31/12/06 I would have invested in the growth portfolio, while it had the most risk (70% growth, 30% defense) it had the greatest opportunity for return. However, now that we can see the average return of all 3 portfolios, balanced would be much more attractive than growth, as the return difference is 0.03% per year while the risk difference in assets is less (60% growth, 40% defense). Conservative is also attractive as its average return was only 0.78% per year less than the growth portfolio and only had 25% in growth assets. At this point I would invest in the conservative due the low risk and high return (relative to the other portfolios). c) If CPI was 3%, the returns on the portfolios would be: Conservative = 6.28% - 3% = 3.28%  above performance objective (CPI + 2%) Balanced = 7.03% - 3% = 4.03%  above performance objective (CPI + 3%) Growth = 7.06% - 3% = 4.06%  above performance objective (CPI + 3.5%) The conservative portfolio shows the best outcome above the performance objective with a 1.28% pa in addition to what is expected. All portfolios performed better than the performance objectives.

Your preview ends here

Eager to read complete document? Join bartleby learn and gain access to the full version