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Personal financial planning (Types of financial instruments (bonds (less…
Personal financial planning
Basic steps of financial planning
set financial goals
develop financial plans
understand our current financial situation
implications of a strong financial position
able to save more to realize our financial goals
able to bear more investment risks to grow our wealth
indicators of our financial health
our wealth
our current and future earning ability
tools for assessing our financial health
personal balance sheet - summarizes the amounts of our assets, liabilities and net worth (i.e. excess of assets over liabilities; able to show how wealthy we are) at the end of a year
personal income statement - record of our income and expenses during a year
implement financial plans
review financial progress + adjust our goals / plans if necessary
Types of financial planning
cash budgeting
aim:
to allow us to plan our expenses based on projected income over the next 12 months so that we can end the year with a targeted level of savings
steps
forecast our spending
forecast expected savings
forecast our income
finalize budget (which is able to show the desired level of savings for the year)
deciding where to invest our spare cash
with risk and return balanching
invest in a major asset (e.g. a flat)
invest in stocks, bonds and other financial instruments
cash management
aim:
to decide how much in liquid assets to hold for paying bills, loan interest, and medical or other emergencies
insurance planning
two main types of insurance
life insurance
Investment-linked Assurance Scheme (ILAS)
very flexible - able to switch among funds in the pool to suit the policy holders' changing investment objectives
death benefit = the policy's cash value (the investment returns) + the sum assured (an agreed amount given by the insurer)
emphasizes high investment returns gained from investing in mutual funds making use of the accumulated savings of the policy holders in an ILAS
endowment life plan
if policy holders survive the term, the sum assured will be paid
useful to one who does not need life protection but has a financial goal he / she wants to achieve
whole life insurance
provides lifetime insurance protection
part of the premium would pay for life insurance protection while the rest goes to a savings account that constitutes the cash value of the policy --> can be obtained when the policy is terminated
premiums of whole life insurance are higher than those of term life insurance (because of the savings element)
term life insurance
provides the highest death benefit per dollar of premium
(because the entire premium goes to purchase insurance protection)
only provides protection until the age of 65
covers policy holders for a specified term, ranging from 1 to 30 years
if policy holders survive the term, no premiums will be returned
the premium increases with time because of the increasing risk of premature death --> some people may no longer be able to afford term life insurance when they get older
other supplementary life insurance
hospitalization plans - pay policy holders who lose the ability to work, but need to pay hospital bills, medical expenses and follow-up care instant cash benefits
critical illness plans - pay policy holders who lose the ability to work, but need money to treat their illnesses a percentage of the sum assured in advance
disability income protection - pays policy holders who lose the ability to work and earn an income a monthly income + the premiums of their policy
property and liability insurance:
property insurance: protects the property of policy holders from damage caused by events covered by the insurer
liability insurance: protects the policy holders against damages caused when someone is injured due to their property or by their negligence
travel insurance - provides policy holders necessary financial resources to deal with some unexpected incidences during their travel outside HK
reason for buying insurance (esp. life insurance):
to protect people who are financially dependent on us
getting credit
Types of financial instruments
stocks
more risky than deposits and bonds
volatile stock market with constant price fluctuations caused by...
investors' mood swings
investors' tendency of overreaction
herd behavior in financial markets resulted from people's fear and greed
with not guaranteed dividends because...
b. companies generally keep most of their profits for future investments
a. a company may not make a profit
with high returns, especially for long-term stock investments
foreign currency (FC) deposits
with higher returns
some FC deposits offer higher interest rates than those of HKD deposits
when the FC appreciates in value against the HKD, additional returns are given as the principal and interest from the FC deposit can be converted into more HKD
more risky than HKD deposits (with exchange rate risk)
bonds
with stable returns - annual coupon interest promised
with higher returns than deposits, but lower returns than stocks
less risky than stocks as...
a. bond investors have a higher claim on a company's assets than shareholders should it become bankrupt
b. bonds promise annual interest income to investors
risks involved in bond investment
credit risk - risk that the issuer may not be able to pay the promised coupon interest and face value
interest rate risk - with fixed coupon interest rate, the increase / decrease of the market interest rate can make bond price decrease / increase
two ways of selling bonds
selling the bond at maturity to the bond issuer, receiving the face value
selling the bond before it matures in the secondary market, receiving the market price
two kinds of bonds sold in the secondary market
discount bond - as the bond's coupon interest rate is below the market interest rate, buyers would buy the bond only if given a discount
premium bond - as the bond's coupon interest rate is above the market interest rate, the bond can be sold at a premium加價
bank deposits - fixed deposits
less liquid than savings accounts - money must be deposited for a specific period of time, ranging from 1 week to 6 months
with higher interest rates than those of savings accounts, but lower interest rates than those of other more risky financial instruments
with stable returns
mutual funds
i.e. professionally managed investment schemes that pool the money of individual investors together to invest into equities, bonds and other financial assets
offered by a fund management company (FMC)
five kinds of funds
income funds - help us obtain a steady income from interest and dividends (low risk)
balanced funds - help us obtain capital appreciation and a steady income by investing in a mix of bonds and stocks (moderate risk)
growth funds - help us maximize long-term capital gain by investing mainly in stocks (high risk)
guaranteed funds - the rate of return and the initial capital investment guaranteed + able to earn high returns provided some conditions are satisfied (e.g. depending on the performance of stocks)
index funds - invest in portfolios that mimic some broad market index (e.g. Hang Seng Index) ==> passively managed --> low annual fees
factors involved in choosing a suitable fund
our risk tolerance
a fund's past performance
our investment objectives
reputation of the FMC and the fund manager
two types of costs
front-end fee - one-time subscription fee that is deducted directly from an investor's initial investment
management fee - annual fee paid for the fund manager's services
three types of benefits
diversification - an FMC has enough financial resources to invest in many assets worldwide
affordability - mutual funds are usually sold in small denominations
professional management by professional fund managers of an FMC
bank deposits - savings
with stable returns
Macro financial system
financial markets
primary market
(i.e. a wholesale market for borrowers to raise funds directly)
secondary market
(i.e. a market where financial instruments can be traded once they are issued)
financial institutions - able to provide loans of all sizes to individuals and companies
purpose of a financial system:
to help transfer money from those who have surplus cash (i.e. savers) to those who need more cash (i.e. borrowers)
Types of consumer credit
overdraft
revolving credit lines
does not have fixed repayment schedule
interest charged only on the money used
with annual service charge of around 1% of the credit limit
credit card
benefits
easy to apply and qualify for
convenience provided
costs:
annual fees
high interest rates which can easily run up to 25-35%
other fees related to the credit card services
instalment loans
has fixed repayment schedule with equal monthly repayments containing part of the loan principal and the interest
usually borrowed for a specific purchase (e.g. a car)